Full text of Monetary Control and the Membership Problem : Hearings Before the Committee on Banking, Finance and Urban Affairs, House of Representatives, Ninety-Fifth Congress, Second Session, on H.R. 13476, H.R. 13477, H.R. 12706, H.R. 14072, July 27, 31; August 4, 11; and September 22, 1978

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MONETARY CONTROL AND THE
MEMBERSHIP PROBLEMC UF. SUPREME
COURT LIBRARY

JAN 3 1979

HEARINGS

DEPOSITORY

BEFORE THE

...,Tl

COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS

HOUSE OF REPRESENTATIVES
NINETY-FIFTH CONGRESS
SECO:'.'ID SESSION
ON

H.R. 13476
A BILL TO A...'\IEXD THE FEDERAL RESERVE ACT TO PROVIDE
FOR THE MAINTENA.. ·cE OF RESERVES FOR CERTAIN L ,._
STITUTIO. "S

H.R. 13477
A BILL TO AMEND THE FEDERAL RESERVE ACT TO AUTHORIZE THE PAYMENT OF INTEREST ON RESERVE BALANCES

H.R. 12706
A BILL TO AMEND THE FEDERAL RESERVE ACT TO PROVIDE

FOR THE PRICING OF FEDERAL RESERVE SYSTEl\I SERVICES
AND THE PAYMENT OF INTEREST ON RESERVES

H.R. 14072
• BILL TO FACILITATE THE D .I PLE::\IEXTATIOX OF l\IOXETARY
POLICY A.ffi TO PROMOTE COMPETITIYE EQ ALITY AMOXG
CO:\DIERCIAL BA. "KS
JULY 27, 31; A. GUST 4, 11; AXD SEPTE)fBER 22, 1978

Printed for the use of the
Committee on Banking, Finance and Urban Aft'airs

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Federal Reserve Bank of St. Louis

MONETARY CONTROL AND THE
MEMBERSHIP PROBLEM
HEARINGS
BEFORE THE

COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
NINETY-FIFTH CONGRESS
SECOND SESSION
ON

H.R. 13476
A BILL TO AMEND THE FEDERAL RESERVE ACT TO PROVIDE
FOR THE MAINTENANCE OF RESERVES FOR CERTAIN INSTITUTIONS

H.R. 13477
A BILL TO AMEND THE FEDERAL RESERVE ACT TO AUTHORIZE THE PAYMENT OF INTEREST ON RESERVE BALANCES

H.R. 12706
A BILL TO AMEND THE FEDERAL RESERVE ACT TO PROVIDE
FOR THE PRICING OF FEDERAL RESERVE SYSTEM SERVICES
AND THE PAYMENT OF INTEREST ON RESERVES

H.R. 14072
A BILL TO FACILITATE THE IMPLEMENTATION OF MONETARY
POLICY AND TO PROMOTE COMPETITIVE EQUALITY AMONG
COMMERCIAL BANKS
JULY 27, 31; AUGUST 4, 11; AND SEPTE:\IBER 22, 1978

Printed for the use of the
Committee on Banking, Finance and Urban Affairs

U.S. GOVERNMENT PRINTING OFFICE
32-1172

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WASHINGTON : 1978

HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
HENRY S. REUSS, Wisconsin, Ohairman
THOMAS L. ASHLEY, Ohio
J. WILLIAM STANTON, Ohio
WILLIAM S. MOORHEAD, Pennsylvania
GARRY BROWN, Michigan
FERNAND J. ST GERMAIN, Rhode Island
CHALMERS P. WYLIE, Ohio
HENRY B. GONZALEZ, Texas
JOHN H. ROUSSELOT, California
JOSEPH G. MINISH, New Jersey
STEWART B. McKINNEY, Connecticut
FRANK ANNUNZIO, Illinois
GEORGE HANSEN, Idaho
HENRY J. HYDE, Illinois
JAMES M. HANLEY, New York
P ARREN J. MITCHELL, Maryland
RICHARD KELLY, Florida
CHARLES E. GRASSLEY, Iowa
WALTER E. FAUNTROY,
MILLICENT FENWICK, New Jersey
District of Columbia
JIM LEACH, Iowa
STEPHEN L. NEAL, North Carolina
NEWTON I. STEERS, JR., Maryland
JERRY M. PATTERSON, California
JAMES J. BLANCHARD, Michigan
THOMAS B. EVANS, JR., Delaware
CARROLL HUBBARD, JR., Kentucky
BRUCE F. CAPUTO, New York
HAROLD C. HOLLENBECK, New Jersey
JOHN J. LA.FALCE, New York
S. WILLIAM GREEN, New York
GLADYS NOON SPELLMAN, Maryland
LES AUCOIN, Oregon
PAULE. TSONGAS, Massachusetts
BUTLER DERRICK, South Carolina
MARK W. HANNAFORD, California
DAYID W. EVANS, Indiana
NORMAN E. D'AMOURS, New Hampshire
STANLEY N. LUNDINE, New York
EDWARD W. PATTISON, New York
JOHN J..CAVANAUGH, Nebraska
MARY ROSE OAKAR, Ohio
JIM MATTOX, Texas
BRUCE F. VENTO, Minnesota
DOUG BARNARD. Georgia
WES WATKINS, Oklahoma
ROBERT GARCIA, New York
PAUL NELSON, Clerk and Staff Direator
MICHAEL P. FLAHERTY, Oounsel
GRASTY CREWS II, Oounsel
MERCER L. JACKSON, Minority Staff Direator
GRAHAM T. NORTHUP, Deputy Minority Staff Direator

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(II)

CONTENTS
Hearings held onJuly 27, 1978_________________________________________________
July 31, 1978_________________________________________________
August 4, 1978________________________________________________
August 11, 1978_______________________________________________
September 22, 1978____________________________________________
Text of-H.R. 13476___________________________________________________

!Paire

H.R. 13477___________________________________________________

H.R. 12706___________________________________________________
H.R. 14072___________________________________________________

13
509

1
167
269
421
507
2

STATMENTS

Barnes, Theodore W., president, Old Stone Bank, Providence, R.L______
Blackshear, A. Harrel, president, Western Bank, Houston, Tex_________
Boatwright, H. Lee, president, Suburban Trust Co., Hyattsville, Md____
Boemi, A. Andrew, chairman and president, Madison Bank & Trust Co.,
Chicago, Ill_____________________________________________________
Campbell, Raymond D., president, Oberlin Savings Bank, Oberlin, Ohio,
first vice president, Independent Bankers Association of America, representing the association, accompanied by Richard Peterson, chief
legislative counseL _ _ _ _ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __
Coldwell, Hon. Philip E., member, Board of Governors, Federal Reserve
System_________________________________________________________
Craig, Ben T., chairman, Northwestern Financial Corp., North Wilkesboro, N.C_ _ _ _ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __
Crozier, William M., Jr., chairman and president, BayBanks, Inc.,
Boston, Mass___________________________________________________
Daly, Owen, chairman of the board, Equitable Trust Bank, Baltimore,
Md____________________________________________________________
Davis, Jack, executive vice president, United Bank of Arizona__________
DeLay, J. J., president, Huron Valley National Bank, Ann Arbor, Mich_
Foster, Robert M., senior vice president, Arlington Trust Co., Lawrence,
Mass___________________________________________________________
Geddes, William W., president and chief executive officer, Wilmington
Trust Co., Wilmington, DeL____ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __ __
Harper, Michael G., vice president, Southgate Bank & Trust Co., Prairie
Village, Kans___________________________________________________
Haywood, Dr. Charles F., vice chairman of the board of directors, Bank of
Lexington, Lexington, Ky________________________________________
Hemann, Charles W., vice president, First National Bank of Arizona,
Phoenix, Ariz___________________________________________________
Hill, Richard D., president, Association of Reserve City Bankers, chairman, The First National Bank of Boston___________________________
Holding, Lewis R., president, First-Citizens Bank & Trust Co., Raleigh,

N.C ______ _ --------------------------------------------------

Johnson, Walter, president, Allied Bank of Texas, Houston, Tex_________
Johnson, W. W. chief executive officer, Bankers Trust of South Carolina,
Columbia, S.C ________________________________________________ I
Lattanzio, Elizabeth J., president and chief executive officer, First National Bank, Wilmington, Del_____________________________________
Jordan, Jerry L., senior vice president and economist, Pittsburgh National Bank, Pittsburgh, Pa_______________________________________
LeMaistre, Hon. George A., Chairman, Federal Deposit Insurance Corporation__________________________________________________________

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Federal Reserve Bank of St. Louis

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585
678

175
218
707
459
578
654
657
591
675
626

745
652
192
691
603
609
677
427
270

STATEMENTS--Continued
Leonard, Harry E., bank commissioner, State of Oklahoma, president-elect,
Conference of State Bank Supervisors, on bellalf of the conference; accompanied by Dr. Lawrence E. Kreider, executive vice president-economist of the conference ___________________________________________ _
Long, C. Michael, senior vice president, Ranchmart Bank & Trust, Overland Park, Kans ________________________________________________ _
McConnell, J. H. Tyler, president and chief executive officer, Delaware
Trust Co., Wilmington, DeL _____________________________________ _
McCracken, Prof. Paul W., Edmund Ezra Day University, professor of
business administration, University of Michigan ____________________ _
Mc9rady, Howard C., senior vice president, Valley National Bank, Phoenix, Anz _______________________________________________________ _
McNair, John, III, vice chairman, Wachovia Bank & Trust Co., N.A.,
Winston-Salem, N.C ____________________________________________ _
Matthews, Robert L., president, Continental Bank, Phoenix, Ariz _____ _
Mayer, Thomas, professor of economics, University of California at Davis_
Miller,
Hon.
G. William, Chairman, Board of Governors, Federal Reserve_
System
________________________________________________________
¥orris, Frank E., president, Federal Reserve Bank of Boston __________ _
Nye, Harry H., executive vice president, Franklin State Bank, Somerset,

N.J ___________________________________________________________ _

O'Leary, Dr. James J., vice chairman, U.S. Trust Co., New York, N.Y __
Orr, L. Glenn, Jr., president, Forsyth Bank & Trust Co., Winston-Salem,

N.C ___________________________________________________________ _

Perkins, John H., president, Continental Illinois National Bank & Trust
Co., Chicago, Ill., president-elect, American Bankers Association, on
oehalf of the association; accompanied by Leif Olsen, chief economic
policy committee, Citibank, New York, N. Y., and chairman, economic
advisory committee, American Bankers Association _________________ _
Riefler, Donald B., chairman, sources and uses of funds committee, Morgan
Guaranty Trust Co:,,T.New York, N.Y _____________________________ _
Romberg, Bernhard w ., president, Payment and Administrative Communications Corp., New York, N.Y ______________________________ _
Rosenberg, Allen, vice chairman, Great Western Bank & Trust Co.,
Phoenix, Ariz _________________________________________________ -Say}es, Thomas D., Jr., president, Summit & Elizabeth Trust Co., Summit,

N.J ___________________________________________________________ _

Schechter, Henry, director, Department of Urban Affairs, AFL-CIO ____ _
Shea, Jeremiah P., president and chief executive officer, Bank of Delaware,
Wilmington DeL __________________________ -- -- -- -- -- -- -- -- -- -- -Snyder, Clair A., executive vice president, American Bank & Trust Co.,
Reading, Pa ________________________________________________ -- __
Sprinkel, Beryl W., executive vice president and economist, Harris Trust &
Savings Bank, Chicago, llL ______________________________________ _
Staley, Rex E., president, City Bank, Sun City, Ariz __________________ _
Stone, Robert F,:.i president, Continental Bank, Phoenix, Ariz __________ _
Tisdall, Joseph v., executive vice president, Farmers Bank of Delaware __
Weil, Leonard, president, Manufacturers Bank, Los Angeles, Calif ______ _
Wicks, Parke W., president and chief executive officer, First Trust &
Deposit Co., Syracuse, N. Y _________________________ -- -- -- -- -- ----

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ADDITIONAL INFORMATION SUBMITTED FOR THE RECORD
American Bankers Association (ABA), prepared statement on behalf by
John H. Perkins, president-elect___________________________________
American Federation of Labor-Congress of Industrial Organizations
(AFL-CIO) statement presented on behalf by Henry Schechter, director, Department of Urban Affairs________________________________
Association of Reserve City Bankers, prepared statement on behalf by
Richard D. Hill, president________________________________________
Austin, Aubrey E., Jr., chairman of the board and chief executive officer,
Santa Monica Bank, Santa Monica, Calif., mailgram dated September

19, 1978________________________________________________________

Barnes, Theodore W., prepared statement____________________________
BayBanks, Inc., Boston, Mass., prepared statement on behalf by William
M. Crozier, Jr., chairman and president____________________________

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422
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ADDITIONAL STATEMENTS SUBMITTED FOR THE RECORD--Continued
Bellinger, John D., president, First Hawaiian Bank, Honolulu, Hawaii,
telegram dated September 22, 1978 __________________ -- ___________ _
Blackshear, A. Harrel, prepared statement ___________________________ _
Blythe, Samuel L., president, Western Carolina Bank & Trust Co., Asheville, N.C., letter dated September 21, 1978 ________________________ _
Board of Governors of the Federal Reserve System, prepared statement
presented on behalf by Chairman G. William Miller ________________ _
Boatwright, H. Lee, prepared statement _____________________________ _
Bowden, Ralph H., president, Gateway Bank, Greensboro, N.C., letter
dated Se})tember 22, 1978 _______________________________________ _
Campbell, Raymond D., prepared statement ________________________ _
Coldwell, Gov. Philip E., prepared statement ________________________ _
Conference of State Bank Supervisors (CSBS) statement presented on
behalf by Harry E. Leonard, president-elect _______________________ _
Courson, Merle D., executive vice president, Western Bank, Coos Bay,
Oreg., telegram dated September 21, 1978 _________________________ _
Craig, Ben T., prepared statement _________________________________ _
Crozier, William M., Jr., prepared statement ________________________ _
Culberson, James M. Jr., president, First National Bank of Randolph
County, Asheboro, N.C., letter dated September 21, 1978 ___________ _
Daly, Owen, exhibits submitted:
Exhibit A: outline of general comments _________________________ _
Exhibit B: outline of remarks __________________________________ _
Evans, Hon. Thomas B., Jr., statement submitted of Hon Pierre S. DuPont,
Governor, State of Delaware _________ ---------------------- _____ _
Federal Deposit Insurance Corporation (FDIC), prepared statement on
behalf b_y Hon. George A. LeMaistre, Chairman ____________________ _
John20,A.,1978
Jr.,_____________________________________________
Bank of Granite, Granite Falls, N.C., letter dated_
Forlines,
September
Foster, Robert M., letter submitted from Daniel J. Murphy, president,
Arlington Trust Co., Lawrence, Mass. dated September 21, 1978 _____ _
Franz, Robert W., president, First State Bank of Oregon, Milwaukee, Wis.,
mailgram dated September 20, 1978 ______________________________ _
Frenzel, Otto N., III, chairman, Merchants National Bank & Trust Co.,
Indianapolis, Ind., letter with D. W. Tanselle, president, dated September 13, 1978 ____ -- __ -- -- ____ -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- ---- -Friedman, Milton, professor of economics, University of Chicago, senior
research fellow, Hoover Institution, Stanford University ____________ _
Fugate, Ivan D., president, Independent Bankers Association of America,
telegram dated September 14, 1978 _______________________________ _
Gaskins, E. D., chairman of the board, chief executive officer, American
Bank & Trust Co., Monroe, N.C., letter dated September 21, 1978 ____ _
Grady, Stafford R., chairman of the board, Lloyds Bank of California,
Los Angeles, Calif., telegram dated September 21, 1978 _____________ _
Green, Hon. S. William, article entitled "Fed Use of Incorrect Money
Supply Data May Spur Economic Woes, Analysts Say," from the Wall
Street Journal of July 10, 1978 ___________________________________ _
Haywood, Dr. Charles F., prepared statement _______________________ _
Hikam, Howard, president Citizens Valley Bank, Albany, Oreg., mailgram
dated September 20, 1978 _______________________________________ _
Hill, Richard D., prepared statement _______________________________ _
Holding, Lewis R., prepared statement ______________________________ _
Independent Bankers Association of America, prepared statement on behalf by Raymond D. Campbell, first vice president _________________ _
Johnson, Leland H., president, First National Bank of Oregon, Portland,
Oreg., telegram dated September 20, 1978 _________________________ _
Jordan, Jerry L., prepared statement _______________________________ _
Kane, Edward J., Everett Reese, professor of banking and monetary economics, Ohio State University, statement __________________________ _
LeMaistre, Hon. George A., prepared statement ______________________ _
Lucas, Tom, president, The Heritage Bank, Lucama, N.C., letter dated
September 21, 1978 _____________________________________________ _
McCracken, Paul W., prepared statement ___________________________ _
McNair, John, III, prepared statement and letters from bankers of North
Carolina _______________________________________________________ _
Mayer, Thomas, prepared statement ________________________________ _

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758
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ADDITIONAL STATEMENTS SUBMITTED FOR THE RECOR~ontinued
Miller, Hon. G. William:
Letters dated August 14, 1978 re section 1411 of the Financial Insti-

Page
tui~i:.
~:r:!:~
7.
ttt~~~~I!_~~~~--~~~=~~:~~ _______________ _ 154
Hon. Chalmers P. Wylie __________________________________ _
0

"Preliminary Proposal," document to promote competitive equality
among member banks and other financial institutions and to encourage membership in the Federal Reserve System ____________ _
Prepared statement with attached charts ________________________ _
Response to questions of:
Chairman Henry S. Reuss _________________________________ _
Hon. Garry Brown _______________________________________ _
Hon. Parren J. Mitchell ___________________________________ _
Mitchell, Hon. Parren J., opening statement _________________________ _
Morris, Frank E., prepared statement_ ______________________________ _
Nye, Harry H., prepared statement _________________________________ _
Okinaka, Richard T., president and chief operating officer, City Bank,
Honolulu, Hawaii, telegram dated September 21, 1978 ______________ _
O'Leary, Dr. James J., prepared statement with attached charts _________ _
Payment and Administrative Communications Corp., New York. N.Y.,
prepared statement presented on behalf by Bernhard W. Romberg,
president ____________ -----------------------------------------Perkins, John H., pI'epared statement ________________________________ _
Reuss, Chairman Henry S.:
Opening statement ___________________________________________ _
Questions submitted to Hon. G. William Miller, Chairman of the
Federal Reserve Board, with attached responses _________________ _
Riefler, Donald B., prepared statement _____________________________ _
Robinson, Craig, president, Citizens' Bank of Oregon, Eugene, Oreg.,
telegram dated September 21, 1978 _______________________________ _
Romberg, Bernhard W., prepared statement __________________________ _
Ronta, F. D., president, Independent Bankers Association of Northern
California, Santa Rosa, Calif., telegram dated September 20, 1978 ______ _
Sayles, Thomas D., Jr., prepared statement_ __________________________ _
Shore John W., Jr., _president, Commercial & Savings Bank, Boonville,
N.C., letter dated September 21, 1978 _____________________________ _
Solso, V. E., president, The Oregon Bank, Portland, Oreg., mailgram dated
September 20, 1978 _____________________________________________ _
Staley, Rex E., letter dated September 18, 1978, enclosing copy of resolution unanimously adopted by the Arizona Bankers Association _________ _
Stanley, W. H., chairman and president, Peoples Bank & Trust Co.,
. Rocky Mount, N.C., letter dated September 21, 1978 _________________ _
Stanton, Hon. J. William, study submitted entitled "The Decline of
Federal Reserve Membership: Its Implications and Proposed Solutions,"
dated February 1978, by Charlotte Goldsten, minority professional staff
member, House Committee on Banking,Finance and Urban Affairs_____ _
Stevens, Robert G., chairman, president, chief executive officer, BancOhio,
statement with John G. McCoy, president and chief executive officer,
First Banc Group of Ohio, Inc., and Arthur D. Herrmann, president and
chief executive officer, Huntington Bancshares, Inc ___________________ _
Taba, Clarence T., executive vice president, Hawaii Bankers Association,
Honolulu, Hawaii, mailgram dated September 22, 1978 _______________ _
Tanselle, D. W., president, Merchants National Bank & Trust Co., Indianapolis, Ind., letters with Otto N. Frenzel III, chairman, dated
September 13, 1978 _____________________________________________ _
Tressler, David L., president and chief executive officer, Northeastern
Bank__________________________________________________________
of Pennsylvania, Scranton, Pa., mailgram dated September 21,_
1978
Vento, Hon. Bruce F., telegram dated September 21, 1978, from Richard H.
Vaughan, president, Northwest Bancorporation, Minneapolis, Minn ____ _
Weil, Leonard, prepared statement _________________________________ _
Whiteside, William E., secretary of banking, Pennsylvania Department
of Banking, Harrisburg, Pa., letter dated September 21, 1978 ________ _

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vn:
APPENDIX
CORRESPONDENCE RELATING TO LEGISLATIVE PROPOSALS CONCERNING THE FEDERAL
RESERVE'S MONETARY CONTROL AND THE MEMBERSHIP PROBLEM

Congressional correspondence:
Chairman Henry S. Reuss:
April 27, 1978_____________________________________________
May 17, 1978_____________________________________________
June 5, 1978______________________________________________
June 28, 1978_____________________________________________
Hon. G. William Miller:
May 5, 1978_ --------------------------------------------May 31, 1978_____________________________________________
June 12, 1978_____________________________________________
Hon. Parren J. Mitchell:
April 27, 1978_____________________________________________
May 17, 1978_____________________________________________
Hon. Fernand J. St Germain:
April 27, 1978_____________________________________________
May 17, 1978_____________________________________________
Senator William Proxmire, June 5, 1978__________________________
Correspondence from economists:
Martin J. Bailey, University of Maryland, July 29, 1978_ _ _ __ __ __ __
Phillip Cagan, Columbia University, July 26, 1978________________
Samuel B. Chase, Jr., Golembe Associates, Inc., Washington, D.C.,
August 1, 1978______________________________________________
William G. Dewald, Ohio State l.Jniversity, July 28, 1978_ _ _ _ _ _ __ __
Albert Gailord Hart, Columbia University, July 27, 1978___________
George G. Kaufman, University of Oregon, July 28, 1978__________
Benjamin J. Klebaner, City College of the City University of New
York, August 2, 1978________________________________________
Allan H. Meltzer, Carnegie-Mellon University, August 10, 1978_ ____
Almarin Phillips, University of Pennsylvania, July 29, 1978________
James L. Pierce, University of California, Berkeley, July 31, 1978___
William Poole, Brown University, July 20, 1978___________________
Robert M. Solow, Massachusetts Institute of Technology, July 24,
1978______________________________________________________ _
James Tobin, Yale University, August 8, 1978____________________
Correspondence from financial institutions:
Credit Union National Association, Inc. (CUNA), David S. Wright,
chairman of the board, August 3, 1978_________________________
National Association of Mutual Savings Banks, Saul B. Klaman,
president, August 7, 1978_____________________________________
National Credit Union Administration, Lawrence Connell, Administrator, August 10, 1978_______________________________________
National Savings and Loan League, William L. Reynolds, executive
director, August 1, 1978______________________________________
Other correspondence:
Federal Home Loan Bank Board, Robert H. McKinney, Chairman,
August 3, 1978______________________________________________

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Federal Reserve Bank of St. Louis

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MONETARY CONTROL AND THE MEMBERSHIP
PROBLEM
THUBSDAY, JULY 27, 1978

HouSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,

W a1Jhi;n,gton, D.O.
The committee met at 9 a.m., in room 2128, of the Rayburn House
Office Building, Hon. Parren J. Mitchell, Hon. Fernand J. St Germain presiding.
Present: Representatives Reuss, Ashley, St Germain, Gonzalez,
Minish, Hanley, Mitchell, Patt.erson, Blanchard, LaFalce, AuCoin,
Derrick, Lundine, Pattison, Cavanaugh, Oakar, Mattox, Vento, Barnard, Stanton, Brown, Wylie, Hansen, Kelly, Grassley, Fenwick,
Leach, Steers, Evans of Delaware, Caputo, Hollenbeck, and Green.
Mr. MirouELL. Good morning, ladies and gentlemen.
This morning the Committee on Banking, Finance and Urban Affairs begins hearings on legislation dealing with Federal Reserve member bank reserves: the payment of interest thereon1 and corollary
questions.
The legislation before us includes H.R. 12706, which was introduced
by Mr. Stanton with cosponsors, in May; a proposed amendment to
that bill; and two Federal Reserve proposals which the chairman of
this committee, Mr. Reuss, introduced on request on July 14: H.R.
13476 and H.R. 13477.
[The t.exts of the referred to bills, H.R. 13476, H.R. 13477, and H.R.
12706, follow:]

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(1)

95TH2DCONGRESS
SESSION

H• R• 13476

IN THE HOUSE OF REPRESENTATIVES
JULY 14, 1978
l\fr. REuss (by request) introduced the following bill; which was referred to
the Committee on Banking, Finance and Urban Affairs

ABILL
To amend the Federal Reserve Act to provide for the maintenance of reserves for certain institutions.
l

Be it enacted by the Senate and House of Representa-

tives of the United States of America in Congress assembled,

3 That this Act may be cited as the "Federal Resene Require4

ments Act of 1978".

TITLE I-RESERVE REQUIREl\fENTS OF MEMBER

BANKS AND OTHER DEPOSITORY INSTITUTIONS

Siw. 101. The first section of the Federal Reserve Act,

as amended (12 U.-S.C. 221), is amended by adding at the

end thereof the following new paragraphs:

"The term 'depository institution' meansI

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" ( 1 ) any inRnrcd hank aR defined iu sPctiou !1 of the

l
•>

Federal l)ppo~it Insnmncc A ct.;

3
4

" ( 2) any mutual sayings hnnk as dcfiiwd in section 3 of the Federal Deposit Insurance Act;

5
li

"(3) any savings hank as defined in section 3 of
the FcdPral Deposit I1rnnrance Act;

" ( 4) any insured credit union as defined in section 101 of the Federal Credit Union Act;

9
10

" (5) any member as defined in section 2 of the
Federal Home Loan Bank Act.

11
12

" ( 6) any insured institution as defined in section
401 of the National Housing Act; and

" ( 7) for the purpose of section 13 and the four-

teenth paragraph of section 16, any association or entity

which is wholly owned by or which -consists only of

institutions referred to in clauses ( 1) through (6).

"The term 'transaction account' means a deposit or

18 account on which the depositor or account holder 1s
19 allowed to make withdrawals by negotiable or transferable
20

instrument or other similar item for the purpose of making

21 payments to third persons or others. Such term includes
22 demand deposit, negotiable order of withdrawal, and share
23 draft ac-counts.".
24

SEC. 102. Section 19 (a) of the Federal Reserve Act, as

amended (12 U.S.C. 461), is amended by adding at the end

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4
3

thereof the following: "In order to prevent ernsions of the

reserve requirements imposed by this Act, after consultation

3 with the Board of Directors of the }'edernl Deposit Insur4 ance Corporation, the }'ederal Home Loan Bunk Board, and
5

the Administrator of the Natimial Cwclit Union Administrn-

6 tio11, the ]foar<l of Uo\'l'rnor~ of tlw Ft•d(•rnl Hl'H('!'Yc f-\y~tl'lll
7 i~ further ,rnthorize<l to dcicn11i11c, hy regulation or onler,
8 that an accou11t or deposit i~ a transaction al'conut where such
9

account or deposit may Le used to provide fonds directly or

10 indirectly for the purpose of making payments or transfers to
11

12
13

third persons or others.".
SEO.

103. The lust sentence of subsection (b) of section

19 of the Federal Reserve Act, as amended (12 U.S.C.

14 461), is designated as paragraph (7) and that part of sub15

section ( b) that precedes that sentence is amended to read

as follows:

" (b) ( 1) Except as provided in paragraph (4) , every

18 depository institution as defined in section 1 of the Federal
19 Reserve Act, as amended (12 U.S.C. 221), shall maintain
~O reserves against its demand deposits ·at such average ratio of
21 not less than 7 per centum nor more than 22 per centum, as
22

shall be determined by the Board.

" ( 2) Except rns provided in paragraph (4), every

depository institution as defined in section 1 of the Federal

Reserve Act, as amended (12 U.S.C. 221), shall maintain

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Federal Reserve Bank of St. Louis

5
4

reserves which shall be at the same leYel for all depository

2 institutions against all other transaotion accounts a:t such
3 average ratio of not less than 3 per centum nor more than
4 12 per centum, as shall be determined by the Board.
5

" (::I)

Ji]vcry mrmhcr hank f;hall maint,ain reserves

6 against its tiuw dt•posits nud ~a ,·iug1' dqlOsits ( other thnn
7 ll('gotiahle ordt>r of withdrawal ne<•o1mti-;) as Ruch average

ratio of not less thai1 one-half of 1 per ceutnm nor more than

9 10 per ccutnm, as Hhall he determined by the Board.
10

"(4) A total of $.3,000,000 of transaction accounts

11 of a depository institution shall not be subject to the reserve
12 requirements of this section, subject to such rules and regu13 lations as may be adopted by the Hoard. However, the
14 Board may impose reserve requirements on such tr.ansaction
15 accounts at such avera.ge ratio of up to 7 per centum if

16 determined to he appropriate in ,light of general liquidity,
17 considerations of monetary policy, or other relevant condi18 tions prevailing in the •banking system.

" ( 5) Every depository institution as defined in section

20 1 of the Federal Reserve Act ( 12 U.S.O. 221) shall make
21 reports concerning its deposit liabilities and required reserves

22 at snch times ancl in such manner and form as the Board may
23 require.
24

"(6) (a) For purposes of determining the reserve re-

25 quirements of a depository institution established .alter June

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Federal Reserve Bank of St. Louis

6
5

1 30, 1978 which is an affiliate of a depository institution sub-

2 ject to the reserve requirements of this section, the trans3

action accounts of such newly established depository insti-

4 tutions shall be added to the total transaction accounts of
5 such affiliated depository institution.
6

" (b) In addition to its authority under section 19 (a) ,

7 the Board ii- authoriz<'d to determine, hy regulation or order,

the affiliated depository institution to whose transaction ac-

9 counts the transaction accounts of a depository institution
10 established after June 30, 1978, shall he added for purposes
11 of this provision.".
12

SEC. 104. With respect to any depository institution

13 that is not a member of the Federal Reserve System on
14 June 30, HJ78, the required reserves imposed pursuant
15

to subsection ( n) against its .transaction accounts on the ef-

16 fective date of this ,\d shall be reduced by 75 per ccntum
17 during the first year that begins after the effertive date, 50
18 per centum during the second year, and 25 per centum dur19 ing the third year.
20

SEc. 105. (a) Section 19 (c) of the Federal Reserve

21 Act, as amended ( 12 U.S.C. 461), is amended to read as
22 follows: "Reserves held by any depository institution to
23 meet the requirements imposed pursuant to subsection (b)
I

24 of this section r,;hall he in the form of-

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Federal Reserve Bank of St. Louis

" ( I ) hulances maintained for su<'h purpose!:! by

7
6

such depository institution in the :Federal Reserve bank

of which it is a member or at which it maintains an ac-

count. However, the Bourd may, hy regulation or order,

permit depository institutions to maintain all or a portion

of their re4uired reseryes against the transaction accounts

in the form of vault cash: Provided, Thnt such J>ropor-

tion shall uc ideuticnl for all depository institutions; and

"(2) balances maintained by a nonmember de-

pository institution in a memuer bank or in a Federal

home loan bank maintains such funds in the form of

balances in a Federal Reserve bank of which it is a

member or at whieh it maintains an account. Balances

received by u. mcmucr uank from another depository

institution that arc used to satisfy the reserve requirc-

mcnts imposed on such depository institution by this

section shall not be subject to the reserve requirements

of this section imposed on such member bank and shall

not be subject to assessment imposed on such member

bank pursuant to section 7 of the Federal Deposit In-

surancc Act, as amended ( 12 U.S.C. 1817) .".

TI'.l.'LE II-CONFOR:UING AMENDMENTS AND

EFFECTIVE DATE

SEC. 201. Se<:tion 5A of the Federal Home Loan Bank

24 Act, as nmm11led ( 12 U.R.O. 1425a), is amended hy rc25

designating snusection ( f) as subsection (g) .and by in-

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Federal Reserve Bank of St. Louis

8
7
1

serting before such subsection, as redesignated, the follow-

2 ing new subsection :
3

"(f) Every institution which is a member or is an

4 insured institution as defined in section 401 (a) of title IV
5

of the National Housing Act ( 12 U .S.C. 1724 (a) ) shall

maintain reserves against its transaction accounts as defined

7 in section 1 of the Federal Reserve Act ( 12 U.S.C. 221)

8 in accordance with the provisions of section 19 of the
9 Federal Reserve Act (12 U.S.C. 461) in amounts not less
10 than such percentages of its aggregate amounts of such

11 deposits or accounts as may be prescribed under section
12 19 (L) of the Federal Reserve Act (12 U.S.C. 461) by the
13 Board of Governors of the Federal Reserve System.".
14

SEC. 202. Section 116 of the Federal Credit Union

15 Act, as amended ( 12 U.S.C. 1762), is amended by adding
16 at the end thereof the following new subsection:

" ( c) Each insured credit union shall maintain re-

18 serves against its transaction accounts as defined in section
19 1 of the Federal Reserve Act (12 U.S.C. 221) in accord20 ance with the provisions of section 19 of the Federal Re21 serve Act ( 12 U.S.C. 461) in amounts not less than such
22 percentages of its aggregate amounts of such deposits or
23 accounts as may be prescribed under section 19 (b) of the
24 Federal Reserve Act (12 U.S.C. 461) by the Board of
25 Governors of the Federal Reserve System.".

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Federal Reserve Bank of St. Louis

9
8

SEC. 203. (a) The first paragraph of section 13 of the

2 Federal Reserve Act (12 U.S.C. 342) is amended as~
3 follows:
( 1) by inserting after the words "member banks"

4
5

the words "or other depository institutions";

( 2) by inserting after the words "payable upon

presentation" the first and third times they appear,

the words "or other items, including negotiable orders

of withdrawal or share drafts";

(3). by inserting after the words "payable upon

presentation within its district," the words "or other

items, including negotiable orders of withdrawal or

share drafts";

(4) by inserting after the words "nonmember

bank or trust company," wherever they appear the

words "or other depository institution";

(5) by striking the words "sufficient to offset the

items in transit held for its account by the Federal

Reserve bank" and inserting in lieu thereof the words

"in such amount as the Board determines taking into

account items in transit, services provided by the Fed-

eral Reserve bank, and other factors as the Board may

deem appropriate" ;

32•9?2 0 • TB • 2
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Federal Reserve Bank of St. Louis

( 6) by inserting after the words "nonmember

10
9

bank" after the second colon the words "or other de-

pository institution".

(b) The thirteenth paragraph of section 1G of the

4 :Federal Reserve Act (12 U.S.C. 360) is amended as
5

follows:
( 1)

by Htrikiug ont the words "member banks"

whercrnr they appear nml inserting in lien thereof

"depository institutions";

(2) by Rtriking out the words "memhcr bank"

wherever they appear and iuserting in lieu thereof

"depository institution";

( 3) by inserting ,after "checks" wherever it ap-

pears the words "and other items, including negotiable

orders of withdrawal and share drafts".

( c) The fourteenth paragraph of section 16 of the

16 ]federal Reserve Act ( 12 U.S.C. 248 (o) ) is amended by
17 striking out "its member banks" mid inserting in lieu there18 of "depository institutibns".

SEC.

204. The provisions of this Act shall become

20 effective one year after the date of enactment.

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Federal Reserve Bank of St. Louis

11
D;JTuCONGRESS
2D SESSION

H R 13477
• •

IN nm HOUHB

()11'

IrnPRBSEN'fA'l'IVES

,J FLY H, 1!)78
i\lr. H1mss (l,_y l'<'<}l!Pst) introdn(·Pd tlw following- bill; whieh was·rde1T!'d to
the Committre on Hanking, l<'innncr nnd Urban Affairs

A BILL
To amend the Federal Reserve Act to authorize the payment of
interest on reserve balances.
1

Be it enacted by the Senate and House of Representa-

tives of the United States of America in Congress assembled,

That this Act may be cited as the "Interest on Reserves Act

4 of 1978."
SEC. 2. Section 13 of the Federal Reserve Act is

6 amended by adding at the end thereof the following new
7

paragraph:

"Subject to such limitations, restrictions, and regula-

tions as the Board of Governors may prescribe, the Federal

10 Reserve banks are hereby authorized to pay interest on bal11 ances held in any Federal Reserve bank pursuant to section
I

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Federal Reserve Bank of St. Louis

1 19 (c) ( 1) of this Act. The total amount of such interest

2 paid with respect to any year shall not exceed the sum of

the following items computed with respect to the same year:
" (A)

total receipts by J?ederal

neserYe

banks

from the recipients of snd1 iutereRt for sPrYircs rendered

to sul'h rrcipirnt:-; hy snch hnukR. nnd

"(B) 7 per centum of the total net earnings of the

Federal neserve banks computed without regard to the

payment of such interest.

The rate of interest paid under this section shall not ex-

11 ceed 2 per eentum per annum with respect to required bal12 ances in excess of $25,000,000 held at Federal ncscne
13 banks.".

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Federal Reserve Bank of St. Louis

95mCONGRESS
2D SESSION

H• R• 12706
.

IN THE IIOUSE OF REPRESENTATIVES
MAY 12,1978
:Mr. STANTON (for himself, Mr. AsnLEY, l\Ir. H.\NNAFOnD, Mr. B.rnNAnD, l\Ir.
WATKINS, l\fr. ,VYLIE, Mr. RoussELOT, Mr. McKINN}:Y, Mr. HYDE, l\Ir.
KELr,Y, Mr. STEERS, Mr. EVANS of Dclawar<>, and Mr. GREEN) introduced
the following bill; which was l'l'fonl'tl to the Committee on Banking,
l•'innncc and Urban Affairs

ABILL
To amend the Federal Reserve Act to provide for the pricing
of Federal Reserve System servicrR and the payment of intcrrst on reserves.
I

Be it enacted by the Senate and House of Representa-

tives of the United States of America in Congress assembled,

3 That this Act may be cited as the "Federal Reserve Mem4 bership Act of 1978".
SEC. 2.

PRICING OF

SERVICES.-(a) The Federal Rc-

6 serve Act is amended by inserting after section 11 ( 12
7 U .S.C. 248) the following new section:
"SEC. llA. (a) Not later than July 1, 1979, the

9 Board -0£ Governors shall have prepared and shall publish
I

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Federal Reserve Bank of St. Louis

14
2

for public comment ·a set of pricing principles in accord-

2 ance with this section and a proposed schedule of fees for
3

Federal Reserve System services; and not later than July 1,

1980, the Board shall put into effect a schedule of fees for

5 such services which is based on those principles.
G

"(b) The Federal Reserve System services which shall

7 he eovcired hy the schedule of fees under subRec·tion (a) are8

" ( 1 ) currency and coin services ;

" ( 2) check collection services;

" ( 3 ) wire transfer services;

" (4) automated clearinghouse services;

" (5) net settlement services;

" ( 6) securities safekeeping services; and

" ( 7) any new payment services which ,the Federal

Reserve System provides, including but not limited to

payment services thnt effef'tuatc the eleetronic transfer

of funds.

" ( c) The pricing principles referred to in subsection

(a) and the schedule of fees prescribed pursuant to this

20 section shall he based on the following general principles:
21

" ( 1) All serviceR shall be priced explicitly.

" (2) Prices shall be established on the basis of all

direct and indirect costs actually inrnrred in providing

the services priced, including overhead, and an allocaJtion

of imputed costs that .take into account the taxes that

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Federal Reserve Bank of St. Louis

15
3

would have ·been paid and the return on capital that

would have been provided had the payment services

been furnished by a private business firm.

" (3) SerYices shall ·be made available to any

depository institution at the same fee schedule applicable

to member banks.".

SEC. 3. INTEREST ON RESERVES.-'4-Section 19 of the

8 Federal Reserve Act is amended by inserting after subsec9 tion (b) (3) (12 U.S.O. 461 (bj) the following:
10

" (4) The Board shall pay interest on those reserves re-

11 quired to be held pursuant to this subsection. The rate of in-

12 terest shall be periodically determined bf an affirmative vote
13 of not less than four members of the Board. The rate of in-

14 terest shall not exceed the awrage rate paid during the
15 preceding calmdar quarter on United States Treasury bills

16 with maturities of three mouths.
17

"(5) Not later than July 1, 1981, the ]hml shall pre-

pare u study to be transmitted to the House Committee on

Bankiug, ]fo1a11ee and Urbnn Affair:s and Senate Committee

20 on Banking, Housing, and Urban AfTairs

011

the feasibility

21 and impact of permitting member banks to im-est a percent22 age of their required reserves in United States Treasury se-

23 curitics. 'fhe study shall examine the impact of such an ar24 rangement on-

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Federal Reserve Bank of St. Louis

" ( 1) monetary and financial conditions;

16
4

" ( 2) Treasury revenues ;

" ( 3) safety and soundness of member banks;

" ( 4) impact of benefits and costs of membership

in ]!' ederal Ueserve System.

" ( 6)

In its annual report to Congress the Board shall

6 provide a full account of the changes in membership during

7 the preceding year, the pricing structure for services in

effect during the preceding year, and the interest rate struc-

ture on reserves in effect during the preceding year.".

SEc. 4. DEFINITIO:XS.-(a) The Federal Uescrve Act

11 is Hllll'mlcd by uddiug at the eud of section 1 ( 12 U .S.C.
12
13

221) the following new paragrnph:
"The t~rm 'depository institution' meuus" ( 1) any imured bank as defiued iu section 3 of the

lh•deral Deposit Insunmce Act;

16
17

" ( 2) any mutual savings bank as dcfiued in section
3 of the l!'cdernl Deposit Iusnrauce Act;
"(3) any savings bank ns defined in section 3 of

the :Federnl Deposit Insurance Act;

20
21

" ( 4) any insured credit union as defined in section
101 of the Federal Credit Union Act;

22
23

" ( 5) any member as defined in section 2 of the
l!'cdcral Home Loan Bank Act;

24
25

" ( 6) any insured institution as defined in section
401 of the National Housing Act; and

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Federal Reserve Bank of St. Louis

"{7) any association or entity which is wholly

17
5

owned by or which consists only of institutions referred

to in clauses ( 1 ) through (6) .".

( b) The first paragraph of section 13 of the Federal

Reserve .Act (12 U.S.C. 342) is amended( 1) by inserting "or other depository institutions"

5
6

after "member banks" ;

( 2) by inserting "or other depository institution"

after "nonmember bank or trust company" each place it

appears;

( 3) by inserting "and other factors as the Board

may deem appropriate" after the words "held for its

account by the :Federal Reserve bank"; and
(4) by inserting "or other deposito1y institution"

after "nonmember bank" in the second proviso.

( e) The thirteenth paragraph of section 16 of the Il'ed-

16 ernl Ueserve Act (12 U.S.C. 360) is amended as follows:
17

( 1) by striking out the words "member banks"

wherever they appear and inse1ting in lieu thereof "de-

pository institutions" ; and

( 2) by striking out the words "member bank"

wherever they appear and inserting in lieu thereof

"depository institution".

(d) 'l'he fourteenth paragraph of section 16 of the Fed-

24 eral Reserve Act ( 12 U.S.C. 248 (o) ) is amended by strik25

ing out "its member banks" and inserting in lieu thereof

26 "depository institutions".

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Federal Reserve Bank of St. Louis

18
Mr. MITCHELL. At the same time, Chairman Reuss announced that
Mr. St Germain and I-as chairmen of the two subcommittees of relevant jurisdiction-would serve as cochairmen pro tern for these
hearings. I am pleased to cochair these hearings.
Our ultimate purpose is to produce legislation that effectively improves the Federal Reserve's monetary control and promotes eqmtable
competition in our banking system, without unduly increasing the
Federal budget deficit.
I am concerned-as I am sure all of us are-about the Federal Reserve's failure to hit its announced target for M 1 growth for more than
a year now. But I am not convinced that either mandatory universal
reserve requirements or the payment of interest on member bank
reserves to retain and attract members is needed to improve the accuracy of monetary control.
I can't take seriously the argument that universal reserve requirements are needed. In regard to the need for membership, I cannot
resist quoting from a July 1977 study prepared by Golembe Associates for the American Bankers' Association:
* * * In fact, careful studies indicate that precise control of the monetary
aggregates is not harmed by "nonmembership."

The proposed amendment to R.R. 12706 provides an alternative. It
would improve the accuracy of monetary control without imposing
universal reserve requirements.
It provides for the payment of interest on reserves, albeit a lesser
amount than the Federal Reserve would like, and would take the necessary step of authorizing the Federal Reserve Board to obtain, on a
timely basis, whatever summary statistics it may require on the assets
and liabilities of any depository institution.
The proposed amendment to R.R. 12706 provides for two other ways
by which to improve monetary control. Specifically, it would tie the
discount rate by formula to the Treasury bill rate; and second, establish statutory reserve requirement ratios for demand deposits and
transactions balances. Many economists argue that discretionary
changes both in the discount rate and in reserve requirements often are
counterproductive and that open market powers are sufficient to conduct monetary policy effectively. I tend to a.~ree.
The second basic ouestion raised by the legislation before us is
how to enhance equitable competition 'in our banking system. All of
the proposals before us contemplate the Federal Reserve's charging
competitive prices for its services. This change from the current practice of providin~ these services gratis will enable other suppliers of
these services-including commercial banks offering correspondent.
services-to compete with the Federal Reserve on a more equal basis.
However, the payment of interest on reserves-which also is contemplated by all of the proposals before us-could have anticompetitive effects. In all fairness, shouldn't we also authorize all correspondent banks to pay interest on their respondents' deposits? If we
don't, won't we have given the Federal Reserve an unfair advantage
vis-a-vis commercial banks offering correspondent services?
The proposals before us also would restructure reserve requirements. The proposed amendment to R.R. 12706 would reduce them
progressively. The Federal Reserve would change them to help middle-

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Federal Reserve Bank of St. Louis

19
sized banks most of all, and l~rge banks more than small ones. On this
issue, I am on the side of the little guy, as always.
The proposed amendment to H.R. 12706 would treat savings accounts subject to 1automatic transfer and other transactions balances
identically the same as demand deposits for reserve requirements'
purposes.
The idea behind this approach is that it is neither necessary nor wise
to link the payment of interest on any bank deposits which are effectively subject to withdrawal by check to a reduction in reserve requirements. However, that is what we will do if we don't treat transfer and
transactions accounts the same as demand deposits for reserve requirements' purposes. Is this what we want to do? I think not,
Finally, I want to make clear that I am not unsympathetic to paying interest on reserves, provided that the budget deficit is not thereby unduly increased. However, I can think of many ways to spend a
few hundred million dollars every year which are more appealing
than paying interest on reserves.
~
A possible middle ground is delineated by the proposed amendment
to H.R. 12706, which would limit the payment of interest on reserves
to the amount that the Federal Reserve e.arns from discounting plus
fees it is expected to charge for services. This seems about right to
me.
In summary, the case for adopting H.R. 12706, with the proposed
amendment, appears to be a strong one on all counts. However, I come
to these hearings with an open mind.
If there is no objection, I would like to put my full statement in
the record at this point.
[The complete opening statement of Mr. Mitchell follows:]

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Federal Reserve Bank of St. Louis

20
OPENING STATEMENT
of
THE HONORABLE PARR EN J. MITCHELL
CHAIRMAN OF THE SUBCOMMITTEE ON DOMESTIC MONETARY POLICY
Hearings on
H.R. 13476, the Reserve Requirements Act of 1978
H.R. 13477, the Interest on Reserves Act of 1978
~.R. 12706, the Federal Reserve Membership Act of 1978
July 27, 1978
Good morning, ladies and gentlemen. This morning the Committee
on Banking, Finance and Urban Affairs begins hearings on legislation
dealing with Federal Reserve member bank reserves, the payment of
interest thereon, and corollary questions.

On June 26, 1978, the

Democratic Caucus of this Committee resolved that these are matters
for Congressional determination and called for "thorough legislative
hearings." On July 7, the Federal Reserve forwarded its legislative
proposals on these matters.

colleague, Mr. Reuss, the Chairman of

this Committee, introduced H.R. 13476 and H.R. 13477, the Federal Reserve
proposals, at the request of the Federal Reserve on July 14.
At the same time, he announced that the Committee would shortly
hold hearings on the subject and that Mr. St. Germain and I, as Chairmen
of the two subcommittees of relevant jurisdiction, would serve as co-chairmen
pro tern for the hearings.

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Federal Reserve Bank of St. Louis

Our Chairman also recommended that H.R. 12706

21
on Federal Reserve membership, which the ranking minority member of the
Committee, Mr. Stanton of Ohio, introduced with co-sponsors in May, serve,
together with a proposed amendment to it, as "the primary legislative
vehicle at our upcoming hearings."

I am pleased to co-chair these hearings.

Our ultimate purpose is to produce legislation that effectively improves
the Federal Reserve's monetary control and promotes equitable competition
in our banking system, without unduly increasing the Federal budget deficit.
To accomplish these purposes, H.R. 13476 would extend statutory reserve
requirements to all depository institutions and require them to make reports
concerning their deposit liabilities and required reserves.

H.R. 13477

would have Congress authorize the payment of interest on required reserves
en deposit in Federal Reserve Banks.

Additionally, the Federal Reserve

contemplates charging for Federal Reserve services and-restructuring reserve
requirements.
On Improving Monetary Control
am concerned, as I am sure all of us are, about the Federal Reserve's
failure to hit its announced targets for Ml growth for more than a year
now.

But I am not convinced that either mandatory universal reserve

requirements or the payment of interest on member bank reserves is needed
to improve the accuracy of monetary control.
The proposed amendment to H.R. 12706 provides an alternative.

would improve the accuracy of monetary control without imposing universal
reserve requirements.

It provides for the payment of interest on reserves,

albeit a lesser amount than the Federal Reserve would like. Moreover, the
amendment would take the necessary step of authorizing the Federal Reserve

Board to obtain, on a timely basis, whatever summary statistics it may

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Federal Reserve Bank of St. Louis

22
require on the assets and liabilities of any depository institution.
am certain that these hearings will shed light on whether there is a
compelling monetary policy need either to mandate universal reserve
requirements or to provide incentives for Federal Reserve membership
through the payment of interest on reserves at the expense of an increased
budget deficit.
I remain educable on this subject, but currently lean toward the view
that all the Federal Reserve needs to control the monetary aggregates,
besides the will to do so, is more complete, timely information on deposits,
other liabilities and assets of depository institutions, as provided for in
the proposed amendment to H.R. 12706.

I don't take seriously any argument

that universal reserve requirements are needed.

In regard to the need for

membership, I cannot resist quoting from a July 1977 study prepared by
Golembe Associates for the American Bankers Association:
The continuing, and perhaps accelerating, decline in
bank membership in the Federal Reserve System is a
serious problem, largely for practical and political,
rather than economic, reasons •... In fact, careful
studies indicate that precise control of the monetary
aggregates is not harmed by nonmembership.
The proposed amendment to H.R. 12706 provides for two other ways by
which to impro~e monetary control. Specifically, it would tie the discount
rate by formula to the Treasury bill rate, and second, establish statutory
reserve requirement ratios for demand deposits and transactions balances,
including savings accounts which after November 1 will provide for
automatic transfers to checking accounts.
Let me turn now to whether the Federal Reserve needs discretionary
authority to set the discount rate and to change reserve requirements in
order to conduct monetary policy effectively.

Many economists think not.

Indeed, they argue that discretionary changes both in the discount rate and

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Federal Reserve Bank of St. Louis

23
in reserve requirements often are counterproductive.

For example, in

1974, when we were experiencing our worst recession since the 1930s,
the discount rate wasn't reduced until December, although the Treasury
bill rate clearly had peaked in August. Surely, it would have been
better if at that time the discount rate had been tied by formula to the
Treasurj' bill rate.
In February 1975, testifying before the Senate Banking Committee,
former Chairman of the Federal Reserve Board Arthur Burns pointed to
reductions in reserve requirements, which released $2½ billion in reserves,
as evidence that the Federal Reserve had been purs~ing an expansionary
policy since the preceding September.

He said, "Reductions in member

bank reserve requirements were also ordered -- in September, November,
and January, releasing a total of nearly $2½ billion in reserves to the
banking system."

However, these changes were misleading indicators of

the thrust of monetary policy.

For during that period the Federal Reserve

was using open market operations to drain an equivalent amount of reserves
from member banks. The net result was that while the Federal Reserve
was congratulating itself on being expansionary, the growth of the money
supply was dropping precipitously and recessionary forces were thereby
exacerbated. The point I am making is that the Federal Reserve fooled
itself into thinking that its policies were expansionary because it had
lowered reserve requirements when, in fact, they were contractionary.
Another kind of counterproductive change in reserve requirements occurred
in September and October 1972 when, at a time when the forces of inflation
were being unleashed, reserve requirements were reduced substantially. In
the language of the Federal Reserve Board, the reductions were "designed
to make reserve requirements of member banks and Federal Reserve checkcollection procedures more equitable and more efficient."
these were not monetary policy actions.

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Federal Reserve Bank of St. Louis

In other words,

However, they had monetary policy

24
effects.

The reductions powered the money supply upward, when what was

needed was to slow down its growth.

It was precisely the wrong action

to take in 1972.
The Corrmittee has to decide whether discretionary changes in the
discount rate and reserve requirements are needed to conduct monetary
policy or, as there is ample reason to believe, whether monetary control
is best exercised only through open market operations.

In this regard.

it should be noted that we have no proposal before us which would limit,
constrain or modify the Federal Reserve's open market powers in any way
whatsoever.

All in all, adopting H.R. 12706, with the proposed amendment,

would appear to be the best way to provide for the improvement of monetary
control.
On Promoting Equitable Competition
In The Banking System
The second basic question raised by the legislation before us is
how to enhance equitable competition in our banking system. All of the
proposals before us contemplate the Federal Reserve's charging-competitive
prices for clearing checks·, coin and currency pick-up and deliveries,
wire transfers and safekeeping of securities. This change from the
current practice of providing these services gratis definitely would
improve competition in our banking system.

It will enable other suppliers

of these services to compete wit~ the Federal Reserve on a more equal
basis. These suppliers include commercial banks offering correspondent
services, clearing houses and nonbank businesses.
However, the payment of interest on reserves, which also is contemplated
by all of the proposals before us, could have anti-competitive effects.
This is because Federal Reserve Banks are correspondent banks. Therefore,
if the Federal Reserve is authorized to pay interest on the deposits of

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25
its respondents, then in all fairness, shouldn't we also authorize all
correspondent banks to pay interest on their respondents' deposits? If
we don't, won't we have given the Federal Reserve an unfair advantage
vis-1-vis commercial banks offering correspondent services? I have not
yet made up my mind on this particular issue.

I hope that our witnesses

will shed some light on it.
Competition also will be affected by the changes in reserve
requirements, either by the proposed amendment to H.R. 12706 or by
regulation as contemplated by the Federal Reserve.

One difference

between the two is that the proposed amendment is progressive: it releases
proportionately more reserves as the size of the bank decreases.

contrast, the restructuring of reserve requirements contemplated by the
Federal Reserve favors middle size banks over all, .and large banks over
small ones. Speaking personally, I always will be on the side of the
little guy.
A second difference between the two concerns how they would treat

automatic transfer accounts and other transactions balances for reser.ve
requirement purposes. The Federal Reserve proposes either to treat
automatic transfer accounts as time deposits or to lump them into a
special category for reserve requirement purposes along with NOW accounts
and share drafts. Either way, the reserve requirement would be lower
than on demand deposits. The proposed amendment to H.R. 12706 would treat
automatic transfer accounts as transactions balances and all transactions
balances, in turn, as identically the same as demand deposits, since all
are subject to withdrawal by check. Some might object that doing so will
hold back the growth of interest-paying automatic transfer accounts,
which are scheduled to be introduced this fall.

32-9?2 0 - ?8 - 3
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There is an element of

26
truth in this argument, but it is not persuasive.

This is because,

analytically, there really is no difference between allowing interest
to be paid on demand deposits and allowing interest-paying automatic
transfer accounts.

Therefore, the question this Committee must resolve

is whether i.t is necessary or wise to tie legislation which would allow
the payment of interest on demand deposits to legislation that reduces
reserve requirements.

That is exactly what we will do if we fail to

legislate treating demand and so-called transactions accounts as identically
the same for reserve requirements purposes.

Is this what we want to do?

I think not.
Budgetary Impact of Paying Interest on Reserves
Finally, this Committee must resolve what restrictions, if any, should
be placed on the payment of interest on member bank reserves.

I am not

unsympathetic to the proposal to pay interest on reserves, provided that
the budget deficit is not thereby unduly increased. However, I can think
of a lot of ways to spend a few hundred million dollars every year which
are more appealing than paying interest on reserves. A possible middle
ground is delineated by the proposed amendment to H.R. 12706, which would
limit the payment of interest on reserves to the amount that the Federal
Reserve earns from discounting plus the fees it is expected to charge for
its services. This seems about right to me.
In summary, the case for adopting H.R. 12706, with the proposed
amendment, appears to be a strong one on all counts.
these hearings with an open mind.

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27
Mr. MITCHELL. This morning our witness is G. William Miller, the
Chairman of the Federal Reserve Board. Welcome, Mr. Miller. As
always, we are pleased to hear your views.
Before asking you to proceed, I want to ask Chairman Reuss and
the other members if they have opening statements.
Chairman Reuss.
The CHAIRMAN. Thank you, Mr. Mitchell.
This morning the committee begins hearings on legislation to improve monetary control and the equity, efficiency, and competitiveness
of our banking system.
Some of the proposals before us would have a, significant impact on
the budget. The proposals differ: from an open-ended authorization
to pay out billions in one case, to a restriction of net direct-budget costs
to a few tens of millions in another. In a time of budgetary austerity,
these differences are important. We will view each proposal with a
sharp eye on its potential budget costs.
The Federal Reserve has requeste'd legislative action to help halt
the erosion of membership in the Federal Reserve System. Member
banks are leaving the system at a rate of 1.5 percent per year. Most of
these banks are small : The median asset size of the last 50 banks to
leave was about $25 million. It is estimated that total demand deposits
of the last 50 banks to leave the system were under $1 billion. This
suggests that the net effect, if any, of the erosion of membership on the
Federal Reserve's degree of monetary control or the quality of Federal
Reserve monetary data is small-and increasing only very slowly. In
these hearings, we must ask not only, "How much does it cost to keep
member banks in the Federal Reserve System?" but ,also, "Is membership worth it?". My answer to that latter question is, for three of the
four proposals before us: "No."
Making Federal Reserve membership more attractive to commercial
banks should not be an end in itself. We must hold down costs. We must
insure that the proposal we pass promotes competitiveness and equity
in our banking system. We must examine the contribution of each
proposal to the effectiveness of monetary policy. We must evaluate the
e:fl'ect of each proposal on the safety of our financial institutions taken
individually and as a whole. If Federal Reserve membership is not
necessary to promote these goals, then it jg not necessary at all.
We begin consideration today of three bills and a proposed amendment.
One, the first bill, H.R. 13476, introduced at the request of the
Federal Reserve, would extend reserve requirements to demand deposits and transactions accounts, vaguely defined, in all depository
institutions. It would also permit the Federal Reserve to collect information relevant to monetary control directly from these institutions.
H.R. 13476 closely resembles the bill first submitted to the Congress
by then Chairman Arthur Burns of the Federal Reserve on Januarv
25, 1974, a draft entitled "The Reserve Requirements Act of 1974;"
which would have extended requirements to all institutions receiving
demand deposits on NOW accounts. This bill was never acted upon. In
the Fine discussion principles, committee print of February 1976,
the following principle was put forward:

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All federally insured depository institutions would be required to meet reserve requirements on their deposit liabilities, and on their liabilities to other
depository institut1011s.

However, in the bill introduced by Mr. St Germain and myself on
April 7, 1976, H.R. 13077, which embodied the essential elements of
the Fine study, the provision for mandatory reserve requirements
on the deposit liabilities of all federally insured dep<>sitory institutions was not included, largely because of the committee's view that
nonbank depository institutions were subject to such limitations on
the sources and uses of assets as to make reserve homogenization inequitable. It should be noted that the Federal Reserve noted the removal of this provision with regret. In a letter from Chairman
Burns to the House Banking Committee, dated April 26, 1976, he said:
We also note with regret that H.R. 13077 fail@ to implement the Fine Discussion Principles calling for reserve requirements on the deposit liabilitiei& of
all Federally insured depository institutions, with such reserves to be held at
the Federal 'Reserve. The Board continues to believe that such a system of
univel'sal l'equirements would contribute to the effectiveness of monetary policy.

Two, the second bill, H.R. 13477, also introduced at the request of
the Federal Reserve, would authorize payment of interest on required
reserves, limiting the total of such payments to 7 percent of the Federal Reserve banks' net earnings plus receii;>ts from the sale of services
to member banks. This limit would authorize net direct Treasury cost
of more than $500 million per year.
Three, the third bill, H.R. 12706, has been introduced by Mr. Stanton
and cosponsored by Messrs. Ashley, Hannaford, Barnard, Watkins,
Wylie, Rousselot, McKinney, Hyde, Kelly, Steers, Evans, and Green.
This bill provides for the following:
It would require the Federal Reserve to place individual prices on
each of the services it offers. Currently, services are offered free to member banks, but at a cost of $410 million annually to the taxpayers according to Federal Reserve estimates. This measure would promote
efficient production and use of these services. The Stanton bill, in calling for market-competitive prices on these services, assures that private
competitiors of the Federal Reserve will not be undercut by unfair
subsidized competition.
It authorizes the payment of interest on member bank reserves, at a
rate determined by the Board but not exceeding the average yield of
3-month TreaS11ry bills during the preceding quarter. The Stanton bill
thus places a flexible limit on the rate of interest that can be paid, but
not a dollar cap. It has the undesirable feature, in my view, of being
somewhat open-ended: At current rates banks could receive over $2.2
billion per year in net benefits under the proposed formula.
It asks for a study of the impact of permitting member banks to
invest some of their reserves in U.S. Treasury securities. This bill also
calls for an annual report to the Congress by the Board on changes
in membership, the pricing structure of services, and the interest rate
structure on reserves in effect during the preceding year.
The fourth proposal before us 1s the proposed amendment to the
Stanton bill, largely the work product of some of our highly respected
less-senior members. This is designed to accomplish the basic goals of
the Stanton and Federal Reserve bills-improved efficiency, competi-

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tive equity, and monetary control-while holding costs to the Treasury
to a minimum. Frankly, Chairman Miller, in view of your own
frequent admonitions about the Federal deficit, I think the substantially lower cost of the amendment to H.R. 12706 is a decided argument
in its favor.
The amendment to H.R. 12706 has five distinct provisions:
First, the Federal Reserve would be authorized to pay interest on
reserves up to a limit of the receipts from services and earnings from
discounts and advances. This provision sets a tight limit on the cost of
the overall pro~am to the taxpayer.
Second, specific statutory reserve requirements would be established
to replace the current reserve requirement ranges. Banks with under
$10 million in demand deposits-over 60 percent of all banks-would
be exempt from reserve requirements on transactions accounts altogether. For banks with more than $10 million a simplified progressive scale would be introduced. Under this provision, the burden of
Federal Reserve System membership, which for most banks consists
of the requirement that they hold sterile reserve balances, would be
eliminated for the class of small banks who are now leaving the System
Third, the discount rate would be tied to the average yield on 3month Treasury bills issued in the past 2 weeks. This proVIsion would
lessen arbitrage possibilities and the danger of disruptive, unintended
signals that is inherent in the current procedure for adjusting the
discount rate.
Fourth, the Federal Reserve, under the amendment would be authorized to obtain the information it needs on nonmember savings and
loans', and credit unions' assets and liabilities. It would put the arm
on the specific regulatory agencies to get this information and pass it
on posthaste and forthwith to the Fed.
Finally, the Fed would be required to transfer $575 million of its
surplus to the Treasury. This is the same figure as the Fed came up
with as an adjunct to its need, and it can be looked at as the surplus the
Feds have-they pay $575 million and we pay $575 million, who could
quarrel with that i
In terms of the cost, the cost under the proposed amendment is far,
far less than either of the other two bills-although, of course, the universal reserve requirements of the Fed really costs nothing and is
therefore less costly.
The net direct costs to the Treasury from the payment of interest on
reserves would be limited to the diversion of earnings on discounts and
advances from the Treasury to reserve-holding banks.
We estimate the savings over the Fed's proposal at around a third of
a billion a year-ignoring the ripple effect on tax liabilities. These savings of a third of a. billion reduce the budget deficit by a correspondingly amount, contributing to a goal which is in the minds of a great
many of us.
Under the bill introduced by Mr. Stanton, H.R. 12706, interest
could be paid on reserves held by member banks, up to the average 90~ay Treasury bill rate. As I ha~e said, it would have to go up $2.2 billion a year.
There are three questions which I would ask here:
First, are these levels of interest payment necessary i

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Second, would they induce a bank verging on defection from the
Fed to remain in? And third, if so, what will be the effect on monetary
policy?
There are three answers to this, and I am going to just cover them.
One, in my belief, the levels of interest proposed by the Fed and in
the Stanton 'bill are not necessary. They are too high. The overwhelmjng volume of interest payments would be made to very large banks
which have no intention of leaving the Federal Reserve System.
For example, a $1 billion depository bank would get a payment in
interest of $3 million a year from the taxpayers, and this seems to be
quite a high price to pay.
In fact, the banks that have left the Fed have been almost exclusively small. The median asset size of the last 50 banks to leave the
System was $25.7 million. Yet for every $1 in interest paid to banks
susceptible to defection from the System, $3 would go to banks that
are not.
Second, there is no evidence that banks on the margin of membership would be induced to return. We simply don't have any evidence
on this. Such banks would certainly need to consider: first, the advantage of lower reserve requirements and higher interest payments
on them available under State regulation; and second, the offsetting
cost of having to pay for services provided by the Fed. These vary from
case to case. And I would say, at this point, that it is surely significant
that the small bankers are highly unenthusiastic about the interest on
reserves proposal.
Third, the effect on monetary control would be indeed minimal.
Even if H.R. 13477 is enacted in toto, and even if it completely halts
the attrition of members, and even if this were highly important for
monetary control-and it isn't-it would still be true that the incremental fraction of the money supply to come under the Fed's jurisdiction would be negligible to the point of invisibility.
At present, the Fed is losing demand deposits via defection at an
annual rate of about $1 billion per year. This is less than the money
supply growth often in a single week. The net direct and indirect cost
to the U.S. Treasury would be over 70 cents for every dollar of demand
deposits retained by the System.
So I have to ask: Why is it desirable to limit interest payments on
member bank reserves to Federal Reserve earnings on discounts and
advances, plus the gross receipts from the pricing of services?
This administration, right or wrong, has identified the federal budget deficit as a major source of inflationary pressure on the economy,
it has committed itself to deficit reduction. Chairman Miller, you have
pledged that you fully support this view in thought, word, and deed.
Already, the President's proposed tax reduction package has been
pared twice, and major social and defense spending programs have
been cut back or delayed.
The present proposal, directly or indirectly, would cost the Treasury
about $700 million a year.
Under the other proposal, the reduction in the reserves requirements-has a far greater relevance for the smaller banks who are inclined to leave the Federal Reserve System than under the Federal
Reserve's own proposal.

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Conclusion: Given the tightness of the budget, the Federal Reserve, in my judgment, has not made a sufficiently strong case to
justify expenditure of the sums it proposes to spend on interest on
reserves. The alternative proposal-the amendment to H.R. 12706-is
far less costly and therefore, I believe, preferable.
From the standpoint of competitive equity and efficiency: The amendment to H.R. 12706 provides the best deal for the small banks. In
this era of electronic fund transfer, NOW accounts, and international
high-rolling, it is the small banks of this country who are feeling the
competitive squeeze. It is small banks which are leaving the Federal
Reserve System. The amendment to H.R. 12706 takes the pressure off
these banks. It would enable them to earn market rates of interest on
their reserves without quitting the Federal Reserve System. Nor
would it require a massive subsidy from the U.S. taxpayers to the
large banks. The amendment would also preserve an essential feature
of competitive equity under present law: the flexibility that banks have
to seek out their best regulatory bargain. Universal reserve requirements would effectively make this flexibility a dead letter.
Finally, on monetary control, the amendment as proposed to H.R.
12706 provides the greatest gain in the effectiveness of monetary policy
per dollar of Treasury cost. It would solve the information problem,
without imposing an overlapping regulatory jurisdiction on nonmember depository institutions. It would eliminate discrepancies between
the discount and market interest rates, thereby cutting down on steadily increasing higher interests. It would eliminate the uncertainties
now associated with abmpt, sporadic shifts in the discount rate.
The amendment eliminates the present flexible ranges of reserve requ~rements in favor of statutorily fixed ones, but this would not impair the effectiveness of monetary control. The Federal Reserve does
not now use reserve requirements for monetary policy. To do so would
be clumsy and imprecise. The reserves of the "banking system and the
cash held by the public can be controlled down to the last penny
by open market operations. Why swing a meat ax, when you have a
scalpel?
Are universal reserve requirements necessary for monetary control i
No, they are not. Monetary policy is conducted almost exclusively
with open l?:Lrket operations: the buying and selling of U.S. Government securities by the New York Federal Reserve Bank. This occurs
through a network of traders, independently of whether the transacting institutions are or are not members of the Federal Reserve
System, of whether they are or are not subject to Federal Reserveimposed reserve requirements, or of anything else. Reserve requirements are not altered £or monetary policy purposes. Universal reserve
requirements would have no impact on this aspect of monetary policy.
Reserves held do determine the multiplier relationship between
the creation of reserves by open-market operations-the purchase of
Government securities-and the creation of new money in circulation. This is an important relationship. It is, however, estimated
statistically in practice and for this purpose any schedule of reserve
requirements, universal or otherwise, is as good as any other. Since
banks hold cash inventories whether they are subject to reserve requirements or not, there is no danger that exempting some classes

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of depository institutions from reserve requirements would destabilize
the relationship between open-market operations and money creation.
Are flexible reserve requirements necessary for monetary control i
No; they are not. Since 1935, the Federal Reserve System has
been empowered to adjust reserve requirements applicable to member
banks within legislated bands. The proposed amendment would set
reserve requirements for demand deposits and other transactions
accounts of member banks at fixed levels. Six reasons for this change
are:
One, the Federal Reserve does not need variable reserve requirements to conduct monetary policy; open-market operations are
sufficient.
Two, the Federal Reserve, in practice, does not use changes in reserve requirements as a basic tool for the day-to-day implementation
of monetaray policy. Changes in reserve requirements have been
made at an average of once a year since 1935.
Three, the large, discrete changes in reserve requirements are a
clumsy, imprecise way to change the money supply. M<:metary policy
would benefit from the elimination of this tool and by concentration
on open-market operations as a means of controlling the money supply. Through open-market operations the monetary base can be controlled very precisely, releasing or contracting the reserves to the
nearest penny.
Four, the two previous Chairmen of the Board of Governors have
acknowledged that factors other than monetary developments have
influenced Federal Reserve decisions concerning the use of reserve
requirement changes. Both Chairmen cited the adverse impact of
reserve requirement increases on the profitability of member banks
relative to nonmember banks.
Five, the general trend in reserve requirement levels strongly suggests that the Federal Reserve has been sensitive to member bank
profitabi:lity-'-resistin~ increases and yielding to member bank preferences for decreases. Smee 1951, changes in reserve requirements, with
few exceptions, have been in a downward direction. In 1951, the
highest applicable reserve requirement was 24 percent and the lowest
was ·14 percent. Today, the highest marginal rate is 16¼ percent
and the lowest is ·7 percent, the lowest permissible under existing
le¢slated bands.
Six, setting reserve requirements at fixed levels would eliminate a
potential source of interference with Federal Reserve independence
m the conduct of monetary policy, pressure from member hanks to
use reserve requirement changes selectively; namely, only when a
change would be made in a downward direction whether in the best
interest of proper monetary policy or not.
Safety : It is true that, while the amendment to H.R. 12706 meets
the legitimate underlying policy concerns which have been identified
with the question of Federal Reserve System membership, it does
not resolve the question o:bnembership itself. The Federal Reserve
has maintained that the "viability" and "safety" of our banking
system may be adversely affected if System membership continues to
decline. So far, however, neither the Federal Reserve nor any outside

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expert has come forward with one scintilla of evidence to support
this view.
I would be happy to have such evidence, if anY exists. Are nonmember FDIC-insured banks less safe than member banks for depositors? If we add up the deposits of failed banks, which is the
greater-that for nonmember or member banks? Are correspondent
banking relationships less safe than the Federal Reserve's provision
of services such as check-clearing? Do nonmember banks hold dangerously small cash inventories~ Engage in less sound banking practices~ Get on their regulatory agencies' danger lists more often~ And
if not, why does the Federal Reserve maintain that the safety of
American banking is at stake.
Chairman Miller, may I personally welcome you before this committee. On July 18, I sent you a list of 16 questions, your answers to
which will be of great assistance to us.
I ask unanimous consent that the 16 questions propounded by me
to Chairman Miller on July 18, and to which he has furnished a reply,
that both of them may be made a part of the record at this point.
Mr. MITCHELL. Without objection, they will be entered into the record following your complete opening statement.
[The complete opening statement of Chairman Reuss along with
the referred to 16 questions submitted to Chairman Miller and his
responses follow :]

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OPENING STATEMENT OF
CHAIRMAN HENRY S. REUSS.
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
U. S. HOUSE OF REPRESENTATIVES
AT HEARINGS ON THE f,1ONETARY CON'rROL AND THE
MEMBERSHIP PROBLEM
JULY 27, 1978
Room 2128 Rayburn HOB

This morning the Committee begins hearings on legislation to
improve monetary controi and the equity, efficiency and competitiveness of our banking system.
Some of the proposals before us would have a significant impact on the budget.

The proposals differ,

from an open-ended

authorization to pay out billions in one case to a restriction of
net direct budget costs to a few tens of millions in another.
a time of budgetary austerity these differences are important..

In
We

will view each proposal with a sharp eye on its potential budget
costs.
The Federal Reserve has requested legislative action to help
halt the erosion of membership in the Federal Reserve System.

Mem-

ber banks are leaving the System at a i:ate of l. 5 percent per year.
Most of these banks are small:

the median asset size of the last

50 banks to leave was about $25 million.

It is estimated that

total demand deposits of the last 50 banks to leave the System ware

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under$~ billion.

This suggests that the net effect, if any, of

the erosion of membership on the Federal Reserve's degree of monetary control or the quality of Federal Reserve monetary data is
small.

(And increasing only very slowly.)

In these hearings, we

must ask not only, "How much does it cost to keep member· banks in
the Federal Reserve System?" but also, ''Is membership worth it?".
My answer to that latter question is, for three of the four proposals before us:

"No".

Making Federal Reserve membership more attractive to commercial banks should not be an end in itself.

We must hold down costs.

We must ensure that the proposal we pass promotes competitiveness
and equity in our banking system.

We must examine the contribution

of each proposal to the effectiveness of monetary policy.

We must

evaluate the effect of each propos21l on the safety of our financial
institutions taken individually and as a whole.

If Federal Reserve

membership is not necessary to promote these goals, then it is not
necessary at all.
We begin consideration today of three bills and a proposed
amendment.

The first bill, H.R. 13476, introduced at the request of

the Federal Reserve, would extend reserve requirements to demand
deposits and transactions accounts, vaguely defined, in all depository institutions.

It would also pE:rmit the Federal Reserve to

collect information relevant to wonetc1ry control directly from
these institutions.

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H.R. 13476 closely resembles the bill first submitted to the
Congress by then-Chairman Arthur Burns of the Federal Reserve on
January 25, 1974, a draft entitled "The Reserve Requirements Act
of 1974", which would have extended reserve requirements to all
institutions receiving demand deposits or NOW accounts.
was never acted upon.
Print of

~ 1976,

This bill

In the FINE discussion principles, Committee

the following principle was put forward:

"All federally insured depository institutions would
be required to meet reserve requirements on their deposit liabilities, and on ·their liabilities to other
depository institutions.•
However, in the bill introduced by Mr. St Germain and myself
on ·April 7, 1976, H.R. 13077, which embodied the essential elements
of the FINE study, the provision for mandatory reserve requirements
on the deposit liabilities ·of all federally insured depository inst:1.tutions was not included, largely because of the Committee's
view that non-bank depository institutions were subject to such
limitations on the sources and uses of assets as to make reserve
homogenization inequitable.

It should be noted that the Federal Re-

serve noted the removal of this· provision "with regret".

In a let-

ter from Chairman Burns. to the House Banking Committee, dated
April 26, 1976, he said:
We also note witl:i. regret that H. R. 13077 fairs to
implement the FI~E Discussion Principle calling for
reserve requirements on the deposit liabilities of all
Federally insured depository institutions, with such
reserves to be held at the Federal Reserve. The Board
continues to believe that such a system of universal
reserve requirements would contribute to the effectiveness of monetary policy.

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2.

The second bill, H.R. 13477, also introduced at the request

of the Federal Reserve,would authorize payment of interest on required reserves, limiting the total of such payments to 7 percent
of the Federal Reserve Banks' net earnings plbs receipts from the
sale of services to member banks.

This limit would authorize a

net direct Treasury cost of ·more than $500 million per year.
3.

The third bill, H.R. 12706, has been introduced by Mr. Stanton

and co-sponsored by Messrs. Ashley, Hannaford, Barnard, Watkins,
Wylie, Rousselot, McKinney, Hyde, Kelly, Steers, Evans, and Green.
This bill provides for the following:
A.

It would require the Federal Reserve to place indi-

vidual prices on each of the. services it offers. Cur.rently services
are offered free to member banks but at a cost of $410 million
annually to the taxpayers, according to Federal Reserve estimates.
This measure would promote efficient production and use of these
services.

The Stanton bill, in calling for market-competitive

prices on these services, assures that private competitors of the
Federal Reserve will not be undercut by unfair subsidized competition.
B.

It authorizes the payment of interest on member bank

reserves, at a rate determined by the Board but not exceeding the
average yield of 3-month Treasury bills during the preceding quarter.
The Stanton bill thus places a flexible limit on the rate of interest that can be paid, but not a dollar cap.

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Federal Reserve Bank of St. Louis

It has the undesi.r-

38
able fec1ture, in my vie"-.•1, of being some\·1h.;1.t:. open-ended:

at current

rates banks could receive over $2.2 billion per year in net benefits
under the proposed formula.
C. It as%s for a study of the impact of permitting member
banks to invest some, of their reserves in U.S. Treasury securities.
This bill also calls for an annual report to the Congress by the
Board on changes in membership, the pricing structure of services,
and the interest rate structure on reserves in effect during the
preceding year.
4.

The fourth proposal before us is the proposcct amendm,-nt to

the Stanton bill7 laraely the work product of some of our highly
resp.r,cted less senior mewbers.

This is designed to accomplish the

basic goals of the Stanton and Fecteral Reserve bills

improved

efficiency, competitive equity, and monetary contro1

while hold-

ing costs to the Treo.sun" to a minimmn.

Frankly, Chairman Miller,

in view of your own frequent admonitions about the Federal deficit,
I think the substantially lower cost of the amendment to H.R. 12706,
is a decided argument in its favor.
The amendment c:o ll. R. 127 06 has five dis vLnct provisio:-1s:
a.

The Fe¢12ral Reserve ,-muld be authorized to pay interest

on res.erves, up to a limit of the receipts from services and earnings from discounts c:.nd advances.

This provision sets a tight limit

on the cost of the overall- program to the taxpayer.

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b.

Specific statutory reserve requirements would be estab-

lished to replace the current reserve requirement ranges.

Banks

with under $10 million in demand deposits -- over 60 percent of all
banks -- would be exempt from reserve requirements on transactions
accounts altogether.

For banks with more than $10 million a simpl,i-

ficd progressive scale ~rould be introduced.

Under this provis.ion,

the burden of Federal RcE:crve System membership -- which for most
banks consists of the requirement that they hold sterile reserve
balances -- would be eliminated for the class of small banks who
are now leaving the System.
c.

The discount rnte would be tied to the average yield on

3-month Treasury bills issu,;d in the past tHo weeks.

'l.'his provi-

sion would lessen arbitrage possibilities and the danger of di~ruptive, unintended signals that is inherent in the current procedure
for adjusting the discount rate.
d.

The Federal

Reser✓2

would be authorized to obtain the

information it needs on non-member depository institutions' assets
and liabilities.

This would solve the problem of monetary control.

Rather than impose a vast. new regulatory and reporting burden on
non-member institutions, however, the amendm:!nt specifies that the
need eel information is to be col lee tec1 through the good offices of
existing regulatory agencies.

The Federal RE>serve would be required to transfe1.· $575

million o:f: its surplus to the Treasury within two years rather than
three.

This is a bool:Lcc,pi "'J tr ans~c U.on, designed to relieve the

Federal Reserve of the eDbc;• ras:;r,,·2nt of holding ex.cess cash.

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Federal Reserve Bank of St. Louis

40
In my opinion, the proposed amendment to H.R. 12706 provides
the best deal -- for the taxpayer, for the competitive equity of
our banking system, and for improved monetary control.

The ques-

tion of the safety of our banking system is, I think, an important
one -- but I have seen no evidence that any of the proposals would
affect bank safety one iota for better or for worse.
~:

The amendment to H.R. 12706 is far less costly than

either H.R. 13477 or H.R. 12706, um,.mended, though H.R. 13476,
universal reserve requirements is, to be sure, less costly.
Under the amendment, net direct costs to the Treasury from
the payment of interest on reserves would be limited to the diver-sion of earnings on discounts and advances from the Treasury to
reserve-holding banks.

These earnings totaled $40 million last

year, and would be even lower under the procedures prescribed
in the amendment.

This compares with an estimated direct Treasury

cost of $355 million annually under H.R. 13477, and, as noted,
the open-ended possibility of expenditures running into billions
under the Stanton bill.

Indirect costs from reducing reserve

requirements are the same under either H,R. 13477 or H.R. 12706,
amended.
Under the Federal Reser\'C proposal (H.R. 13477), as explained
in the memorandum accompanying Chairman Miller's letter of July 6,
1978, interest would be paid on required balances held at Federal
Reserve banks as follows:

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Federal Reserve Bank of St. Louis

41
First $25 million:

1/2 percentage point below the average

return on the FRS portfolio, valued at book.

If the 1977 return

on the Fed portfolio is used as a benchmark, the rate of interest
would be 6 percent. (Of course it would be higher in the present
environment.)
Above $25 million:

2 percent interest per anpum.

Under

H.R. 13477, interest payable would be limited to the sum of:
receipts from fees on services
7 percent of the net earnings of the F. R. banks.
The Federal Reserve estimates interest payouts would total
$765 million per year on the basis of current member bank deposits
and 1977 System earnings.
from service charges.

Of this, $410 million would be recouped

Net direct Treasury cost:

$355 million.

The Federal Reserve estimates that an additional $80 million in
Treasury savings should be deducted from this figure, on the assumptions that

(1) without the legislation, current rates of attri-

tion would continue and

(2) the program would result in a halt in

the attrition of Federal Reserve membership.
Under the Stanton bill (H.R. 12706), interest could be paid
on reserves held by member banks, up to the average 90-day Treasury
bill rate of the preceding calendar qua- ~er.

The estimated net

cost of going to this limit, after deducting service receipts is
$2. 2 billion.
Are these levels of interest payment necessary?

Would they

induce a bank verging on aefection from the Federal Reserve System
to remain in?

a2-en o - ,a - ,
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Federal Reserve Bank of St. Louis

If so, what will the effect on monetary policy be?

42
These three questions have the following answers.
1.

The levels of interest proposed bv the Fed and in the

Stanton bill are not necessary.
Under the Federal Reserve's proposal and~ fortiori under
the Stanton bill, the overwhelming volume of interest payments·
would bA made to large banks which have no intention of leaving
thee Federal Reserve System.
Rome ·sample Payments Under H.R. 13477:
Payment:

Banks with demand deposits of:
$ 10 million

42,000

$100 million

420,000

$400 million

$1,680,000

1 billion

$3,380,000

Total Payments to Banks in Particular Size cate';!ories
All Banks with Total
Demand Deposits:

Payment:

Avge/bank:

under $10 million
(3,220 banks)

$ 5~ M.

18,000

$10
$100 million
(2,074 banks)

$186 M.

89,000

over $100 million
332 banks)

$521 M.

$1,569,000

The banks that have left the Federal Reserve System have
been almost exclusively small.

The median

~r:·:.

size of the last

50 banks to leave the Systcr.1 1·1as $25.7 million; 45 of the 50 had

ossets under $100 million -- that•is, demand deposits well under

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Federal Reserve Bank of St. Louis

43
$50 million.

Yet f:or every dollar in interest paid to banks sus-

ceptible to dE,fection from the System, $3 would go to banks that
are not.
2.

There is no evidence that banks on the margin of membe.i::_-

~hip would b~ induced to return.
The Fedcr~l Reserve has simply not presented evidence to
Congress on this point.
a)

S_uch banks would need to consider:

The ad,:a:,tage of lower reserve requirements and higher

intereGt payments on them available under state regulation.
b)

The o-::fs<=tting cost of having to pay for services pro-

vided by the Federal :'.eserve System.
These vary :"rom case to case.
In this context, it is surely significant that the small bankers
(Independent Bankers Assn.) are not enthusiastic about the interest

on resc:c,1es proposal.
3.

The __effect on monetary coTitrol would be minimal.
Finally, asscming that (a) H,R. 13477 is enacted,

(bl

it completc>ly halts the c>.ttrit.i.on of membe.rs fror,1 the Federal Reserve System, anr1 (cl that this were important for monetnry con·i::col, Nlilcll it is not, it would still be t.:rue; that the incr,~r;i•)ntal
fr;,c:tion of !l:li:: 1:·0!1e:.· S:.\~ply to co•.K' under Yt~a~~ral Reserve juris-

cU<.;Lion would h2 n:os.L.,r.Ll.,le to t:w point. of invinibility.

At pres-

ent:, the Fedcrc.~l Reser\'e is losing dE~mund deposits via defection

of members at an annual rate of only about $1 billion per year.
'l'his is less th,m the money supply often g.rows in a single week.
'l'hc net direct and ir.di.rect cost to the U.S. •rreasury would be
over 70 cents for e·,ery dollar of demand dq1osits retained by the
System.

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Federal Reserve Bank of St. Louis

44
Why is it desirable to limit interest payments on member
bank reserves to Federal Resen,e earnings on discounts and
advances, plus the 9ross receipts from the pricing of services?
'.l'his l,drninistration, right or wrong, has identified the Federal Budget deficit as a major source of inflationary pressure on
the economy, and has committed itself to deficit reduction.

Chair-

man Miller of the Federal Reserve Board supports this view.

Al-

ready, the President's proposed tax reduction package has been
pared twice, and major social and defense expenditure programs
have been cut back or delayed.
In this atmosphere competition for the.Federal dollar is severe, and priorities must be established and followed.

The key

question is, therefore, how important is it to spend scarce Federal resources on a plan to stimulate membership in the Federal Reserve System?

Chairman Miller of the Federal Reserve has given

four reasons in favor of such a plan:
1.

It would decrease the fr.action of the nation's payments

handled "outside the safe channels of the Federal Reserve".

But:

The E'ederal Reserve has presented no evidence to substantiate the
implied claim that the correspondent banking relationships employed
by most banks outside the -Federal Reserve are any les-s safe than
the services provided by the Federal Reserve.
2.

It would increase the number. of banks with access to

Federal Reserve Bank credit facilities.

Whenever the discount· rate

is below market, access to the discount window is certainly a

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Federal Reserve Bank of St. Louis

45
blessing for member Federal neserve banks .•. at taxpayer's expense.
It is also true that i.n times of cr.i.sis, the discount window may
be used to forestall the collapse of a bank, such as Franklin
National, until major holders of uninsured CD's have ca::,hed in aml
bailed out.

But:

Whether this is wise policy or within the spirit

of Federal deposit insurunce laws is an open question.

Improved

)access to the discount window would have trivial affects on monetary control.
3.

It would r.cinforce a "national presence in bank super-

visory and regulatory fnnctions".

But:

At the present time, non··

mentber state banks arc J.r.~gulated by the Federal Deposit Insurance
Corporation.

Inducing such banks to become Syst:em membc,rs m:s,rely

transfers the "national presence" from the FDIC to the Federal Reserve.

This strengthens the nationctl presence only if the Federal

Reserve regulates better than the FDIC, a presumption for which no
evidence has been offered.
4.

It would make implementation of monetary policy easier.

Here, the Federal Reserve has offered support for its position.
The argument is that the present n:,,tworlt of reporting m0mber banks
'provides too incomplc,te a c1ata bmm on which to base monetary policy decisions.

This is true.

But:

Th.c problem could be cured,

with minimal expense, by requiring all national depository .institution regulators to collect the nccessury data 11.nd forward it to
the Federal Reserve on a timely baGiG.
would do this.

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Federal Reserve Bank of St. Louis

The amendment to H.R. 12706

46
The Federal Reserve's proposal would cost the U.S. Treasury,
directly and i1,directly, about $700 million per year.

Under the

proposed amendment to H.R. 12706, the payment of interest on reserves would be limited to the $410 million income from services,
plus about $40 million (the 1977 figure) in earnings from discounts
and advances.
ury funds.

Only the latter represents a direct drain on Treas-

Indirect costs, stellli,ling from the reduction of reserve

requirements, are the same under H.R. 13477 and R.R. 12706 (amended)
-- about $350 million.

However, under the latter proposal the re-

·duc.tion of reserve requirements is far greater, relatively, for
the smaller bankio who are inclined to leave the Federal Reserve
System than under the Federal Reserve •·s own proposal.
Conclusion,

Given the tightness of the budget, the Federal Reserve

has not made a s,ufficiently strong case to justify expenditure of
the sums it proposes to spend on interest on reserves.

The alter-

native proposal -- the amendment to R.R. 12706 -- is far less costly
.:end thercfo·c,e preferable.
Cornp~•t.i.Li_vc Gqu_ity and Efficie!!£.Y:'

The aniendmcnt -Lo 1-I.R. 12706

provides the best deal £or the small banks.

In this era of EFT,

NOW accounts, and internationa). high-rolling, it is the small
banks of this country who are feeling the competitive squeeze.
is small banks which are leaving_the Federal Reserve System.
amendment to 1-1.R. 12706 takes the pressure off these banks.

It
The

would enable them to earn market rates of interest on their re-

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Federal Reserve Bank of St. Louis

47
sc,rvcs wi.thout quitting the Federal Reserve SysLcrn.
require

Nor would it

massive subsidy from U. S, -taxpayers. to the large banks.

'I'he amendment would also preserve an essential feature of competitive equity under present law:

the flexibility th<1t banks

h'lve to seek out their best regulatory bargain.

Universal re-

serve requirem2nts would effectively make this flexihility a dead
letter..
In addition, payment of interest on reserves, coupled with
chc.1:rge1; for services, W<JUld enable the Federal R•~LJex-F ..; to improve

the eff:Lcie-.1cy of the p.ro-vls.ion of services at only a vc,:y rnod~st
net cost to ei thcr the taxp::iy(,r or• the banking system.
Wou]d univarsal rcscLve require111ents enhance "competitive
equity\' b:::~t'..120.r1 11,2mber nnd non-rn~1,1b(:~r i~1stitutions?

'£he .E'E.!d,.)x~-11 Rnse1:ve asserts thut impos.i tion of uni fouu, uni·-

versal reserv.-:: reguircmeuts on a] 1 depositary ins ti bl tions would
place such institutions on a "more equal" competitive b.:tsis.

There

arc two rn,•. ·Ln ren>1ons why this clai1~ does not stand up.
1.

Depository institutions do not operate on an equal com-

petitive footing in many rE,spects aside from unequal. reserve reqnircmont:::..

Su.vings and Lo:tn institntion~•, for example, m-ny not

be, required to hold sl:crile balances at a reserve bank, hut they
are subject to limilations on tl1eir portfolio of: ,rnscts that do not
apply to cor,1mcrcial banks.

Imposing compulnory st0.rilc reserve re-

quirem2nts on the-!£.~•·· institutions merely makf?S them worse off; it
does not make th0 system morr. equul unl csr; S .& L I s

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Federal Reserve Bank of St. Louis

HGre

sigrd. .Li-

48
cantly better off than commercial banks beforehand.

If this is the

case, it has assuredly not been demonstrated by the Federal Reserve.
2.

The Federal Reserve provides services to member banks

free of charge; these services compensate those institutions for
the burden of holding sterile reserve balances.
Federal Reserve System is voluntary:

Membership in the

if a bank's costs of member-

ship exceed the benefits, it can switch to a state charter and
leave.

Many banks do not leave.

Conclusion:

for those banks, the

value of services provided by the Federal Re,;;erve exceeds the cost
of reserve requirements.

There is therefore no "burden" of member-

ship for these banks.
But what about non-member banks, and non-bank depository· in-.
sti-tutions?

Non-member banks are those for whom Federal Reserve

membership is too costly.

Universal reserve requirements merely

force these banks to accept a bad bar.gain into which th§!Y would not
voluntarily enter.

And for non-bank depository institutions, the

situation is worse:

such institutions have no more standing to join

the Federal Reserve System or gain access to its services than the
corner drugztore even if they would be made better off by doing so.
Universal reserve requirements would make their operations more
costly, with no offsetting ben·efits.
Conclusion:

Universal reserve requirements do not reduce the

"burden" on member banks, who are member, voluntarily; they merely
make life harder for all non-member inst.,itutions.

Only non-bank

depository institutions, which do not have the option of membership

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Federal Reserve Bank of St. Louis

49
even i.f they wanted it, can be .said to be inequitably treated under
present law.

Universal reserve ;--equircmcnts would make them worse

off, and would therefore detract from, not enhance, competitive
equity.
Monetar)'._~(?~:

'l'hf, amendment. to H. R.. 12706 provides the

greatest gain in the effectiveness of monetary policy per dollar
of Treasury cost.

It would solve the information problem, without

imposing an overlapping regulatory jurisdiction on non-member depository institutions.

It would eliminate discrepancies.between

the discnunt and market interest rates, thereby insuring that banks
could not turn a profit by borrowing below-market at the discount
window to obtain reserves on which they would then earn a nearmarket return from the Federal Reserve.

It would eliminate the un-

certainties now associated with abrupt, sporadic shifts in the discount rate.
Whlle, for reasons of competitive equity, the amendment to
I-1. R.

12706 eliminates th(, present flexible ranges of reserve re-

quirements in f:avor of stat1.1torily fixed ones, this would i.n no
way impair the effectiveness of monetary control.

'fhe Pednrc.,l Re-

serve does not now use reserve requirements for monetary policy.
To do so would be clumsy and imprecise.

The reserves of the banking

system and the cash held by the public can be controlled down to
the last penny by open market operations.
when you have a scalpel?

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Federal Reserve Bank of St. Louis

Why swing a meat ax,

50
Are 1mivf,r:sal reserve reuuirements necessary for monetary
control?
No, they an, not.

Monetary policy is conducted almost exclus-

ively with open market operations:

the buying and selling of U.S.

government securitios 'by the New York Federal Reserve Bank.

This

occurs through a network of traders, independently of whether the
transacting institutions are or are not members of the Federal Reserve System, of whether they are or are not subject to Federal Reserve-imposed reserve requirements, or of any:·.hing else.
requirements are not altered for monetary policy purposes.

Reserve
Univer-

sal reserve requirem,,·,nts would have no impact on this aspect of
monetary policy.
Reserves held do def:ermine the multiplier relationship between
the creation of resr,rves by open-market operations (the purchase
of government securities) and the creation of new money in circulation.

This is an important relationship.

It is, howe:ver, estimated

statistically in practice, and· for this purpose any 'schedule of reserve requirements, universal or otherwise, is as good as any other.
Since banks hold cash inventories whether they are subject to reserve requi.nm1ents or not, there is no danger that exempting some
classes of depository institutions from reserve requirementG would
destabilize the relationship between open market operations and
money creation.

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Federal Reserve Bank of St. Louis

51
Are flexible reserve requirement" necessary for monetary
control?
No, they are not.

Since 1935, the Federal Reserve Syst.em

has been ernpowercc;.1 to ucJjust rese:rve requirements applicable:= to
member b.::,.nks witld.11 le<JisJ.a,ted ba,1ds.

The proposed amendment ,-1ould

set reserve rcqnj_remont.s foJ· deri\and de:>osits and other transactions

accounts of member banks at fixed levels.

Six reasons for this

change follow:_

The Federal Rcscrvc docs not need variable reserve requirc-

mentR to conduct mom,tary policy; open ma_rket operations. are
sufficient.
2.

'£he Fe.derul Rf\sc-rvc, in practice, does not use chn.nges in

re£Jerv,, requirement,; as a basic tool fc;,r the d;,y-to-day implcmentuti 011 of r.,on0.tary policy.

Chancres in rcRervc• requirements

ha\re b2en mc1dc at an average of one,;; a yE~ar since·] 935.

The large, discrete chan:.res in resG:t'VC:! requ.ireni,:=!nts arc a

clumsy, imprcci.f,L' way to change the money supply.

Monetary

policy would benefit from the climL1atio;1 of this tool and by
co11c81d:.1c:it.ion on open mnrket operations as
t.rolling the money supply.

.:i.

means of con-

Thro . .1gh ope11 murk£'t opE-!ration::.1

the mone-tar:y bas.~~ can he ccntr.olJ.cd very precisely, releasi.ng or coi1trertinq reservt~s to the nearest penny.

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Federal Reserve Bank of St. Louis

52
-4 •

The two previous Chairmen of the Board of Governors have

acknowledged that factors other than monetary developments
have influenced Federal Reserve decisions concerning the use

of·reserve requirement changes.

Both Chairmen cited the ad-

verse impact of reserve requirement increases on the profitability of member banks relative to non-member banks.
5.

The general trend in reserve requirenient levels strong].~•

suggests that the Federul Reserve has been sensitive to menber
bank profitability•- resisting increases and yielding to ~ember bank preferences for decreases.

Since 1951, ~hangcs in

reserve requirements, with few exceptions, have been in a
downward direction.

In 1_951, the highest applicable reserve

requirement was 24 percent and the lowest was 14 percent.

To-

day, the highest marginal rate is 16¼ percent and the lowest
is 7 percent, the lowest permissible under existing legislated
bands.
6.

Setting reserve requirements at fixed levels would eli~i-

nate a potential source of interference with Federal Reserve
independence in the conduct of monetary policy, pressure from
member banks to use res~rve requirement changes selectively,
·namely, only when a change would be made in a downward direction whether in the best interest of proper monetary policy
or not.

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Federal Reserve Bank of St. Louis

53
~}'._:

It is t:n,e that, while the amendment to H.R. 12706

meats the legitimate underlying policy conerns which have been
identified with the question of Federal Reserve System membership,
it does not resolve the question of membership itself.

The Fed-

eral Reserve has maintained that the "viability" and "safety" of our
bankinq system may be adversely affected if System membership
continues to decline.

So far, however, neither the Federal Reserve

nor any outside expert haa come forward with one scintilla of
evidence to support this view.
I would be happy to have such evidence, if any exists.

Are

non-member FDIC-insured banks less safe than member banks for
df,positors?

If we add up the deposits of failed banks, which is

the greater -- that for nonmember or member bariks?

Are corres-

pondent ban.king relationships les-s safe than the Federal Reserve' s
p1:ovision of services such as check-clearing?
banks hold dangerously small cash inventories?
sound bnnking practices?
list!: !ll<'.'i:e often?

Do non-me,-nber
Engage in less

Get on their regulatory agencies danger

And .i.:I: not, why does the F.'erleral Reim:cve main-

t;;in that the isa:f:µty of l,rnerican banking is at stake?
Chail:Jllan Hiller, may I_ personally welcome you before this
Committee.

On July 18, I sent you a list of sixteen questions,

your answers to which wi.11 be of crreat assistance to us.

If in

vour statement this morning vou have not fully ans,-:ered all o-f
them, I would appreciate your cloi_ng so 0

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Federal Reserve Bank of St. Louis

54
QUESTLONS SUBMITTED BY CHAIRMAN HENRY S. REUSS TO CHAIRMAN G. WILLIAM
MILLER, ALONG WITH CHAIRMAN MILLER'S RESPONSES

Could you give us a complete breakdown of the costs of the various
services the Fed now provides to commercial banks?
The cost breakdown below provides a detailed listing of the

direct and indirect costs of those services provided to member banks and
to the public.

These data are for 1977 and are taken from the Federal

Reserves' Planning and Control System Expense Report (PACs).

The total

expense of check and automated clearinghouse operations (ACHs) is the
total of service lines 4, 5, 6, and 7 in the table below.
Service Line:

PACs Cost
($ millions)

Services to Members:
1.

Currency (with shipping, w/o note issue)

Coin (with shipping)

30.5

Transfer of Reserve Account Balances

19.6

ACH Operations

Check Processing (w/o shipping)

Intradistrict Transportation

21.9

Interdistrict Transportation

8.4

Se<..urities

Securities - Safekeeping

Purcha3a and Sale

90.5

6.7
194.8

17.7

10.

Securities - Clearing

11.

Reserve Accounts - Settlement

12.

Noncash Collection

Subtotal

416.8

3.3
15.7

Other Services:

265.1

System Total (including shipping}:

681.9

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Federal Reserve Bank of St. Louis

55
2)

Could you further breakdown the classification in Question 1 into
member and nonmember banks? Would you describe fully the services
rendered to nonmembers, such as those provided through automatic
clearinghouses.
The Planning and Control System (PACS) of the Federal

Reserve Banks does not collect data on the amount of services provided
to each individual bank using the services.

PACS also does not

allocate costs by individual user of services.

Thus, a further break-

down of services provided to member and nonmember banks is unavailable.
ACH Services
Nonmember banks that are members of local clearinghouse
associations for which the Federal Reserve provides clearing and
settlement services may originate and receive payments through the
ACH.

When acting as an originating bank the nonmember may send to

the ACH charges or credits, recorded on magnetic tape, for delivery
to other financial institutions which participate in the ACH.

The

Federal Reserve clearing and settlement operation receives magnetic
tapes from originating banks, sorts the payment instructions by receiving financial institution, makes the appropriate charges or credits to
designated member bank reserve accounts, and delivers the payment ·instructions to the receiving financial institution.
A nonmember bank acting as a receiving financial institution,
may receive the payments instructions in either magnetic tape or
computer printed listing format delivered to its premises or any other
location mutually acceptable to that bank and the Federal Reserve.

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Federal Reserve Bank of St. Louis

56
Check Collection Services
All-non-member banks which pay checks at par receive deliveries
or pres~ntments of cancelled checks from the Federal Reserve in· the
normal process of check clearing.

As in ACH deliveries the delivery

or presentation ·site may be bank premises or any other location acceptable to both the bank and the Federal Reserve.
Non-member banks desiring to clear checks they receive from
customers which are drawn on other banks may deposit at Federal Reserve
·offices only checks drawn on other banks located in the same regional
check processing center (RCPC) geographical area.

These RCPC checks

must be deposited by 12:01 a.m. and funds are made available through
credits to the reserve account of a member bank on the processing day
-which commenced at the deposit deadline,
Federal Reserve.offices process checks drawn on bank located
in a variety of specifically designated geographical areas which include
Regional Check Processing Center, City, Country and Inter-office
designations.

Not all Federal Reserve offices service all these types

of designated geographic areas.
There are 48 Federal Reserve offices which process checks.
Of these offices 44 have designated RCPC areas, 15 have designated
country areas and 43 have designated city areas.
check processing operations are similar.

All Federal Reserve

Checks are received from

eligible banks, sorted by paying bank,and delivered or presented to
the paying bank.
Currency and Coin Services
Non-member banks receive and send shipments of currency and
coin from and to Federal Reserve Banks and Branches.

A shipment pre-·

parat:1,on fee is assessed to each non-member that utilizes this service.
Charges and credits for currency and coin shipments and fees are made
to the reserve accounts of designated member banks.

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Federal Reserve Bank of St. Louis

57
3)

Would you provide estimates of the effects on Federal Reserve membership of:
a)
b)
c)

the reduction in reserve requirements that has occurred since
1970
the two phase reductions in reserve requirements submitted to
us in. the Federal Reserve proposal of July 6
the reduction in reserve requirements from the proposed amendment to R.R. 12706.
None of the three reserve requirement reductions fully offsets

the burden of membership for all member banks or for all banks within
a given size class.

It is very difficult to determine the efiect on

Federal Reserve membership of any action that does not fully offset
·the burden for a given class of banks, and therefore, the impact on
membership of these three reserve requirement reductions cannot be
determined.

The possible effect would be to reduce the rate of attri-

tion from what it otherwise would be.
The impact on membership is espe~ially uncertain for the
reserve requirement reductions since 1970';

The average required reserve

ratio for member bank deposits has been reduced somewhat since 1970.
Jn the ether hand, state reserve requiremer:~ ratios have also declined,
·partially offsetting the effects of the Federal Reserve actions.

important, interest rates in the seventies have been consistently higher
than in periods prior to 1970 and have raised the opportunity cost
of holding sterile reserves.

Hence, cost of membership probably has

increased for most banks over the past decade despite the reduction
of •reserve requirements.
Both the reductions in reserve requirements in the Federal
proposal and that in the proposed amendment to R.R. 12706 would partially
offset ~he burden of membership for some banks and therefore might
reduce attrition somewhat.
attrition.

32-972 0 • 78
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Federal Reserve Bank of St. Louis

• 5

However, neither can be expected to stop

58
4)

What will be the effect on membership of paying interest on reserves?
a)" under H.• R. 134 77
b) under H.R. 12706
c) under the proposed amendment to H.R. 12706
Payment of a market interest rate on member bank reserves--

as proposed in (b)--would fully eliminate the burden of Federal Reserve
membership and should, therefore, halt membership attrition.

Indeed,

depending on the scope of access by depository institutions to Federal
Reserve Bank services, payment of a full market rate could induce most
nonmember institutions to join the System.

Payment of less than a

market rate, as contemplated in (a) and (c), would not halt attrition
unless combined with other features whi~h compensate member banks
sufficiently to offset the burden of membership.

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Federal Reserve Bank of St. Louis

59
5)

What will be the joint effect on membership of the reserve requirement reductions and the interest payments of the preceding two
_questions?
The combined impact of reserve requirement reductions and

payment of interest on reserves, in conjunction with changes for System
services under H.R. 13477 would be to offset the burden of Federal
Reserve membership, on average, for all, member banks.

It is probable

that this plan will not fully offset the burden for every individual
member bank, so that some may still choose to leave the System.

the other hand, after "the plan goes into effect, some nonmembers may
find Federal Reserve membership attractive and choose to join the
System.

On balance, membership attrition should halt under the Federal

Reserve proposal.
H.R. 12706 would tend to make me~pership attractive to
virtually all depository institutions eligible
for membership.
.,.

There-

fore, the fact that the Stanton bill also requires Federal Reserve
Banks to provide payments and other operational services to all depository
inst.itutions would not adversely affect membership--although the pricing
provisions of the Stanton bill are unduly restrictive and could lead to
a ·reduction in payments services provided to the banking system.
The reduction in reserve requirements and the interest payments proposed under the amendment to H.R. 12706, when combined with
the effects of pricing of services and opening access to all depository
institutions, would not be sufficient to offset the membership burden.
Membership attrition would continue and may even accelerate, since a
member could withdraw and still enjoy all of the benefits of membership
(except access to the discount window), while also earning a market
rate of return on the reserves released by withdrawal.

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Federal Reserve Bank of St. Louis

00
6)

Explain exactly how you believe the erosion in membership up to now
has interfered with the Federal Reserve's ability to conduct
monetary policy. Explain how the further erosion of membership
would interfere with the· Federal Reserve's ability to copduct
monetary policy?
Membership erosion has weakened the Federal Reserve's ability

to conduct monetary policy for the following reasons:

(1)

A stable

relationship between reserves and the money stock facilitates implementation of monetary policy.

However, nonmember reserve requirements are

beyond the oversight of the Federal Reserve.

The resulting differential

reserve requirements have weakened the reserve-to-money stock relationship.

(2)

An effective monetary policy requires use of the discount

window to lessen the uneven impact of policy changes on individual
banks.

Since nonmember banks do not have direct access to the discount

window, the Federal Reserve may be precluded from adopting appropriate
monetary policies if increasing numbers of banks cannot cushion their
adjustments to, for exampie, tightening credit conditions through
regular, and reliable, day-to-day access to the discount wind01,.

(3)

An effective monetary policy depends on up-to-date information about
the size of the money stock.

However, accurate information about the

current money stock only becomes available with an average two-quarter
·lag.

The difference between the initial estimate and the final bench-

mark estimate·of M-1 has varied by as much as two billion dollars with
an average error without regard to sign of 700 million dollars over
the last ten years.

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Federal Reserve Bank of St. Louis

61
7)

The Federal Reserve's money supply is now growing, and has been
growing since early 1977, outside the target bands given to the
Congress pursuant to H. Con. Res. 133 prior to November 1977 and
pursuant to the Federal Reserve Reform Act of 1977 after that.
Would the Fe\! have been able and willing to slow down its money
growth if it had more member banks, or is the relationship between
faster monetary growth and the number of member banks irrelevant?
Please analyze fully.
The faster growth in M-1 since early 1977 could have been

more easily identified and contained from a technical point of view
if considerably more deposits were held within the Federal Reserve
System.

It is probable that actual money growth would have been

reduced somewhat under the circumstances.

For example, now that all

benchmark adjustments have been completed for the first three quarters
.of 1977,.M-l in that period has been revised upward by between $1.4
and $2.0·biliion as a result of initial mis-estimates of nonmember
I.•·,

bank deposits.

The Federal Reserve ~ould have been· able to respond
:-4,

to this "higher level° sooner had the full extent of growth been observed
promptly.

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Federal Reserve Bank of St. Louis

62
8)

Explain why you believe the erosion of membership up to now has
jeopardized the safety of individual commercial banks or the bank~ng·system as a whole. Explain how the erosion of member banks
in the future could jeopardize the safety of individual member
banks or the banking system as a whole.

Declining membership means increasing liquidity risk for
the banking system as a whole, since fewer banks have ready, direct
access to the discount window to meet unexpected withdrawals or demands
for credit or to cushion themselves against temporary liquidity pressure
during periods of general stringency.

Furthermore, membership attri-

tion may result in some increases in the riskiness of the banking
system as the proportion of the banking system's assets held as risk
free reserves at Reserve Banks is reduced.
Current law and Board procedures specifically allow for
emergency credit to nonmember institutions, including even non-depository institutions; however, no nonmember institution has borrowed from
the Federal Reserve since 1966.

The infrequency of discount window

borrowing by nonmembers may be attributed primarily to two factors.
First, the_ Federal Reserve can lend· to nonmembers on collateral other
than U.S. Government securities only under emergency

circumstances--

when the nonmember is unable to obtain credit from other sources and
when·failure to lend to the nonmember would adversely affect the
economy.

Second, in view of these emergency conditions, most nonmembers

have no doubt been reluctant to se~k Federal Reserve credit since to do
so would label them as being in serious financial difficulty.
lending became public knowledge, it could generate a run on the

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Federal Reserve Bank of St. Louis

If such

63
uninsured deposits of the bank, further worsening the bank's financial
condition,
It is important to note that the private market cannot
easily perform the discount window's function.

For example, for a

bank suffering a liquidity crisis, alternative forms of short-term
~redit, such as Federal funds, may become unavailable at precisely
the time they are needed most.

Furthermore, in·times of general

stringency, the private banking system may be incapable of mobilizing
the needed amount of funds.
9)

Do you believe that nonmember banks are less safe and more liable
to go bankrupt than member banks? What has the record been? List
the banks, and their total assets, that have failed since 1945,
cl_assified by member and nonmember status.
(,

The record of bank failure since 1947, the earliest data

available in FDIC Annual Reports, shows that 0.72 per cent of the
average number of member banks operating during 1947 to 1977 failed
during that period.

In contrast, 1.33 per cent of the average number

of nonmember banks operating in the period failed,

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Federal Reserve Bank of St. Louis

64
Table 1
l
Insured Banks That Have Required FDIC Disbursement _/
1947-1977

Bank Name

Location
(cityl state)

First National Ba'D.k of

Evanston, WY

First National Bank of
Central City National Bank
Peoples Bank of

Lemont, IL
Central Cit;y, PA
Donalds, SC
Lyons, WI
Newark, NJ

•Lyons State Bank
Columbus Trust Company
American National Bank of

P~yor Creek
First State Bank

First National Bank of
Stockmens Bank of
Ci ,=:izens Banking Company
Farmers & Merchants State
Bank
Westphalia State Bank
Bank of Aurora

Farmers First National
Bank of
First National Bank in
Brazeau Bank
Parnassus National Bank
Thomasville Bank & Trust
Company
Camden State Bank
Bank_ of _Dierks
Mayfield State Bank
First State Bank of
Bank of Ila
Bank of White~ville
First National Bank of
Rathdrum State Bank
Bank of North Idaho
Joshua Momument National
Bank of
Frontier Trust Company
River Oaks State Bank
Home National Bank of
First State Bank of
First National Bank of
Peoples State Bank
Rushville Banking Company
Manufacturers' Bank of
Bartlett State Bank
Liberal State Bank
First State Bank
Capitol 11111 State Bank
Sheldon National Bank
Bank of Earlsboro
Bank of Ochlochnee
First National Bank of Maud
First State· Bank
First State Bank of
Chatham Bank of Chicago
First National Bank of
State Savings Bank of
First State Bank
Belleview Valley Bank
Frontier Bank
Crown Savings. Bank

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Federal Reserve Bank of St. Louis

Pryor, OK

Franklin, TX
Dyer, IN
Martins dale, MT
Weston, OH

Spencerville, IN
Westphalia, MI
Aurora, NC

Minooka, IL
Cecil, PA
Brazeau, MO

New Kensington, PA
Thomasville, AL
Camden, IL
Dierks, AR

Mayfield, PA
Elmwood Park, IL
:(la, GA

Whitesville, KY
Lewisville, TX
Rathdrum, ID
Pr:l.est R.:l.ver, ID
Twentynine Palms, CA
Fort Fairfield, ME
Fort Worth, TX
Ellensville, NY
Yorktown, TX

Halfway, OR
Richland Springs, TX
Rushville, OH
Edgewater, NJ
Bartlett, NE
Liberal, MO
Tenaha, TX
Oklahoma City, OK
Sheldon, IA
Earlsboro, OK
Ochlochnee, GA
Maud, OK
Premont, TX
Westmont, IL
Chicago, IL
Marlin, TX
Minden City, MI
Dell City, TX
Belleview, MO
Covelo, CA
Newport News, VA

Total

Date
of
failure

class

1/13/47
1/27 /47
7/14/47
12/1/47
12/8/47
7/24/48

N
N
N
NM
NM
SM

$1,803
1,666
1,693
762
874
7,893

11/22/48
12/18/48
2/21/49
5/3/49
6/13/49

N
SM
N
NM
NM

1,774
694
3,157
634
740

10/10/49
4/3/50
7/24/50

NM
NM
NM

354
744
1,291

8/14/50
10/9/50
1/22/51
8/25/51

N
N
NM
N

1,332
638
144
2,906

1/21/52
5/5/52
9/2/52
2/13/53
5/26/53
8/9/54
10/1/54
1/27 /55
4/30/55
4/30/55

NM
NM
NM
NM
NM
NM
NM
N
NM
NM

1,031
838
583
1,355
17,456
98
1,040
721
1,017

7 /25/55
10/3/55
10/15/56
12/4/56
4/10/57
3/17/58
5/5/58
5/26/58
7/17/58
5/13/59
6/9/59
12/3/59
7/29/60
1/16/61
8/11/61
9/7/61
12/19/61
12/30/61
5/24/63
8/23/63
3/10/64
3/17 /64
7/4/64
7/20/64
7 /31/64
9/4/64

N
NM

3,111
6,036
5,202
7, rl.2
1,253
1,446
618
4,476
2,365
570
1,012
1,277
7,506
4,365
962
984
1,626
1,882
7,055
19,124
3,741
1,310
1,237
1,285
2,642
7,865

Charter 21

NM
N
SM
N
NM
NM
NM
NM

NM
NM

NM
N
NM
NM
N
SM
NM
NM
N
NM
NM

NM
NM
NM

assets

(~1,000)

l,lOl

65
Table 1 (continued)

Date
Bank Name

Nebraska. State Bank of
Brighton National Bank
San Francisco National Bank
Winona State Bank
Malone State Bank
First State Bank
Five Points National Bank
Citizens Bank
Blanket State Bank
Saguache County National Bank
Bank of. Gray Summit
Public Bank
First State Bank of
Bank of Pine Apple
Southern Bank of
Sacul State Bank
Cedar Vale National Bank
Lorenzo State Bank
C~ntral National Bank of
Bank of Commerce
Rocky Mountain .Bank
Citizens State Bank
Morrice State Bank
First State .Bank
State National Bank
First National Bank of
Big Lake State Bank
First State Bank
First National Bank of
State Bank of
Peoples State. Sa.vings Bank
Farmerc; J\ank of
Eatontown National Bank
First State Bank o~
City Bank of
Berea Bank. and Trust Company
Sharpstown State Bank
Birmingham-Bloomfield Bank
Farmers State Bank of
Bank of Salem
First National Bank of
First Community State Bank of
Surety Bank & Trust Company
Delta Security Bank &
Trust Company
Skyline National Bank
Elm Creek State Bank
First State Bank
First National Bank of
United States National Bank
American Bank & Trust
Tri-City Bank
Franklin National Bank
Cromwell State Savings Bank
Swope Parkway National Bank
Northern Ohio Bank
Franklin Bank
Chicopee Bank & Trust Company

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Federal Reserve Bank of St. Louis

Location
{cit;y: 1 state)

of
failure

Charter 21
class -

Lorenzo, TX
Jacksonville, FL
Tonkawa., OK
Lakewood, CO
Al var ado, TX
Morrice, MI
Dodson, TX
Lovelady, TX
Ursa, IL
Big Lake, TX
Aransas Pass, TX
Coal ville, UT
Prairie City, IA
Auburn, MI
Peteri;burg~ KY
Eatontown, NJ
Bonne Terre, MO
Philadelphia, PA
Berea, KY
Houston, TX
Birmingham, MI
Carlock, IL
Salem, NE
Cripple Creek, co
Savannah, MO
Wakefield, MA

10/29/64
1/22/65
1/22/65
2/5/65
2/25/65
4/5/65
1/12/66
1/24/66
1/31/66
3/17/66
4/7/66
10/12/66
10/17 /66
1/31/67
2/17 /67
6/23/6 7
7/7/67
2/13/68
5/27 /68
9/25/68
2/6/69
4/12/69
5/6/69
5/12/69
5/28/69
8/20/69
8/22/69
9/5/69
10/10/69
2/22/70
4/18/70
S/25/70
8/7/70
8/24/70
9/3/70
10/8/70
1/25/71
2/16/71
2/17/71
4/5/71
11/30/71
12/30/71
5/19/72

NM
N
N
NM
NM
NM
N
NM
NM
N
NM
NM
NM
SM
NM
NM
N
NM
N
NM
NM
NM
SM
SM
N
N
NM
NM
N
NM
NM

Ferriday, LA
Denver, CO
Elm Creek, NE
Vernon, TX
Eldora, IA
San Diego, CA
Orangeburg, SC
Warren, MI
New York, NY
Croll'Mell, IA
Kans as City , MO
Cleveland, OH
Houston, TX
Chicopee, MA

1/19/73
3/26/73
5/7 /73
7/16/73
10/5/73
10/18/73
9/20/74
9/27 /74
10/8/74
10/9/74
1/3/75
2/19/75
3/24/75
5/9/75

NM
N
NM
NH
N
N
NM
SM
N
NM

Valentine, NE
Brighton, CO
San Francisco• CA
Winona, TX
Malone, TX
Covington, TX
Miami, FL
Pottsville, AR
Blanket, TX
Saguache, CO
Gray Summit, 1-io
Detroit, MI
Tuscola, TX
Pine Apple, AL
St. Petersburg, FL
Sacul, TX
Cedar Vale, KS

N
NM
NM
NM
NM
NH
NM
NM
N

NM
NM

N
NM

NM
NM

Total
assets
(~l,000)

7. 769
3,015
54,061
479
589
606
2,703
832
1,257
512
1,935
110,077
3,330
4,289
2,884
762
4,058
6,159
13,445
5,551
8,617
2,556
2,283
1,134
4,136
2,053
4,750
11,417
6,625
4,130
10,877
1,074
21,417
8,003
10,775
5,871
78,903
109,739
2,196

679
1,301
.3, 701
22,054
9,780
6,527
3,186
16,242
, 8,072
1,265,868
147,137
16,295
3,655,662
3,502
7,576
103,782
20,690
11,406

66
Table l

Algoma Bank
Bank of Picayune
Bank of Chidester
State Bank of Clearing
Astro Bank
American City Bank & Trust

Company, N.A.
Peoples Bank of the Virgin
Islands
Peoples Bank
First State Bank of
Bank of Bloomfield
Bank of Woodmoor
Hal)lilton National Bank of
South Texas Bank
First State Bank of
Northern California
Northeast Bank of
F~rst State Bank of Hudson
CountY
Mt. Zion Deposit Bank
Coronado Natiorial Bank
Citizens State Bank
New Boston Bah.k & Trust
Company
American Bank & Trust Company
Hamilton Bank & Trust Company
Centennial Bank
First State Bank & Trust Co.
International City Bank
and Trust CC?mpany
First State Bank
Monroe Bank and Trust
Company
First Augusta Bank &
Trust Company
Repub lie Nat 1 1 Bank of
Louisiana
Donahue Savings Bank
Banco Economias
Source:

(continued)

Algoma, WI
Picayune, MS
Chidester, AR

Chicago, IL
Houston, TX

5/30/75
6/18/75
7/1/75
7 /12/75
10/16/75

Milwaukee, WI
10/21/75
St. Thomas, Charlotte
10/24/75
Arnalie, VI
Willcox, AZ
12/19/75
Jennings, KS
12/27 /75
Bloomfield, NJ
1/10/76
Woodmoor, CO
1/12/76
Chattanooga, TN
2/16/76
Houston, TX
2/25/76
San Leandro, CA
5/21/76

NM
NM
SM
NM

5,176
18,049
2,449
74,354
5,471

147,563

14,879
5,657
2,898
31,652
4,03j
412,107
7,756
56,018

6/3/76

18,141

6/14/76
6/25/76
6/25/76
6/28/76

NM
NM

14,072
507
2,613
17,410

9/14/76
9/15/76
10/8/76
10/19/76
11/19/76
12/3/76

NM
NN

Foss, OK
Monroe, CT

3/10/77
3/28/77

1,850
4,054

Augusta, GA

5/20/77

23,711

New Orleans, LA

7/29/77

Donahue, IA
San German, PR

8/26/77
9/2/77

NM
NM

Houston, TX
Jersey City, NJ
Mt. Zion, KY
Denver, CO
Carrizo Springs, TX

Boston, MA
New York, NY
Atlanta, GA
Philadelphia, PA

Rio Grande City, TX
New Orleans, LA

NM
NM

NM
NM
N

SM
NM
NM

6,662
224,502
40,075
13,670
13,754
176,320

9,164
5,2&8
179,410

FDIC Annual Reports, 1947-1977.

Disbursements by the FDIC to protect depositors are made when the insured deposits of
banks in financial difficulties are paid off, or when the deposits of a failing bank are
assumed by another insured bank with the financial aid of the Corporation. In deposit payof
cases the disbursement is the amount paid by the Corporation on insured deposits. In
deposit assumption cases the principal disbursement is the amount loaned to failing banks,
or the price paid for assets purchased from them; additional disbursements are made ;l.n those
cases as advances for protection of assets in process of liquidation and for liquidation
expenses.

!/
SM

Charter class designations are: N = National bank, member of Federal Reserve System,
State member bank, NM = commercial non-member bank, MI = non-member mutual savings banl::

https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis

Table 2
Surmnari of Insured Cormnercial Bank Faflures Bi Charter Class
1947-1977

Year

Failure of
All Insured
Banks
Assets
Number

1947
1948
1949
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977

5
3
4
4
2
3
2
2
5
2
1
4
3
1
5
0
2
7
5
7
4
3
9
7
6
1
6
4
13
16
6

Total

142

6,798
10,361
4,885
4,005
3,050
2,452
18,811
1,138
11,986
12,914
1,253
8,905
2,859
7,506
9,819
0
26,179
25,849
58,750
120,646
11,993
25,155
43,571
62,147
196,519
22,054
1,309,675
3,822,596
419,950
1,039,292
223,477

All Memter Banks
Number
Assets
3
3
1
2
1
0
0
0
2
1
l
1
0
0
3
0
0
1
2
2
2
1
5
1
1
0
3
2
3
3
1
45

5,162
10,361
3,157
1,970
2,906
0
0
0
3,832
7,712
1,253
1,446
0
0
7,873
0
0
3,741
57,076
3,215
8,347
13,445
16,231
21,417
1,301
0
1,280,467
3,671,957
229,493
639,222
9,164

Failure of
Federal Reserve Member Banks
State Member Banks
National Banks
Number
Assets
Number
Assets
0
2
0
0
0
0
0
0
0
0
1
0
0
0
1
0
0
0
0
0
1
0
2
0
0
0
0
1
1
l
0
10

0
8,587
0
0
0
0
0
0
0
0
1,253
0
0
0
1,882
0
0
0
0
0
4,289
0
3,417
0
0
0
0
16,295
74,354
224,502
0

3
1
1
2
1
0
0
0
2
1
0
1
0
0
2
0
0
1
2
2
1
1
3
1
1
0
3
1
2
2
l
35

5,16<.
1,774
3,157
1,970
2,906
0
0
0
3,832
7,712
0
1,446
0
0
5,991
0
0
3,741
57,076
3,215
4,058
13,445
12,814
21,417
1,301
0
1,280,467
3,655,662
155,139
414,720
9,164

Failure of
Nonmember
Banks
Number
Assets
2
0
3
2
1
3
2
2
3
1
0
3
3
1
2
0
2
6
3
5
2
2
4
6
5
1
3
2
10
13
5
97

1,636
0
1,728
2,035
144
2,452
18,811
1,138
8,154
5,202
0
7,459
2,859
7,506
1,946
0
26,179
22,108
1,674
117,431
3,646
11,710
27,340
40,730
195,218
22,054
29,208
150,639
190,457
400,070
214,313

a:,

--1

68
10)

On November 1 of this year, Federal Reserve regulations will

allow funds deposited with member
transferred from savings accounts
you estimate the amount of demand
ferred by depositors into savings
regulation during the first year.

banks to be automatically.
to demand deposits. Would
deposits that will be transaccounts, as a result of this

The extent to which depositors will shift funds from demand
to savings accounts in the year after introduction of this new service
is quite uncertain.

It will depend on the structure of service charges

and the promotional strategies adopted by banks--few of which have been
announced to date--as well as on the speed with which the public takes
advantage of the added flexibility in cash management.
If banks choose to offer automatic transfers with minimal
service charges, then consumers might choose to react ·to the availability of such accounts in ways similar to their reaction to NOW
accounts in their introductory stage, so that.·the ?TOW account experience
in New England can be used to infer a reas·onable upper limit on the
timing and magnitude of the shift of deposits.

However, it is likely

that the service charges associated with automatic transfers will be
much higher than for NOW's, and hence the shift in the first year may
be considerably less than in the New England NOW experience.

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11)

Would you estimate the effective dollar limit on the interest that
could be paid on reserves under H.R. 13477 over the next tenye.ar period?
Many assumptions have to be made to arrive at the extended

projections requested.

System revenue projections depend on, among

other factors, currency in circulation, System service volumes, net
expenditures for providing these services, the volume· of reserves held
with System, and the average level of interest rates.

The size of these

factors could either expand or contract depending on legislation affecting the financial industry and the changing condition of the economy
as well as on membership in the System.

These uncertainties would tend

to make any specific estimate misleading, but it is probable that .the
dollar limit will rise as the System portfolio grows in an expanding
economy.

A reasonable range of estimates

fi~·· the

dollar limit a decade

from now may be on the order of $700 to $9'60 million.

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12}

In H.R. 13476, the Federal Reserve asks for a form of universal
reserve requirements. How would monetary policy have been
improved if these universal reserve requirements had been in
effect over the last ten years?
Given the quantity of reserves supplied by the Federal

Reserve, the associated variability of the monetary aggregates is
heightened by unpredictable deposit flows between member and nonmember
banks.

Such flows alter the volume of reserves available to support

deposits at nonmember banks which, in conjunction with differential
reserve requirements between member and nonmember banks, forces the
money stock away from the F0MC 1 s targeted objective under a reserves
operating target.

Ongoing research suggests that the per cent error

in M-1 for two-month growth rates due to such interbank flows would
have ranged between roughly plus or minus 3.6 per cent at an annual
rate in 1968 under a reserves operating target.
have risen to plus or minus 4.7 per cent in 1978.

This error would
If universal reserve

requirements had been imposed in 1968, the associated variability
in M-1 for short-run policy periods under a reserves operating target

probably would have fallen significantly.
The imposition of universal reserve requirements in 1968
also would have provided the Federal Reserve with more timely information
about deposits held at nonmember banks.

The average error in the initial

estimate of M-1 (see question 6) would have been reduced by sizeable
amounts--about $700 million over the period from 1968 to 1977.

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13)

Do you think the need for Federal Reserve membership to enhance
the Federal Reserve' s ability to conduct monetary policy would
vanish if universal reserve requirements were imposed?
Universal reserve requirements would be an important step

toward improving the Federal Reserve's control over the monetary
aggregates, particularly if all required reserves were held in the
form of deposits with the Federal Reserve or in currency and coin, as
is currently the case for member banks.

Nevertheless, Federal Reserve

membership would continue to be important, as full access to the
discount window is necessary to temper the impact of monetary disturbances on the monetary aggregates and the availability of bank
credit and perhaps to aid in averting a monetary crisis.

In addition,

_a Federal Reserve presence in the payments mechanism is vital for
maintaining an efficient and effective system nationwide and in reducing
the exposure of the payments system to disruptions which could adversely
affect the monetary supply and bank credit.

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14) The ten largest banks in the U.S. hold 32 per cent of the reserve
balances on deposit wi-th Federal Reserve banks. Considering these
large banks individually, from Bank of America with its 67.• 2
billion in deposits (December 31, 1977) to the tenth largest bank,
Security Pacific National Bank, Los Angeles, with its 14.9
billion in deposits, estimate the size of the individual annual
payments that each would receive under:
a)
b)
c)

R.R. 134 77
R.R. 12706
the proposed amendment to R.R. 12706

The attached table shows the payments on reserves, service
charges and net payments (payments on reserves minus service charges)
under the three plans.

Compensation payments under R.R. 13477 result

from the reduced reserve requirement structure on demand deposits,
described in the Board's "Preliminary Proposal" on the membership
plan, and interest payments of 6 per cent (1/2 percentage point below
the average return on the Federal Reserve System portfolio) on the
·,

first $25 million of required reserve bal.~nces at Federal Reserve Banks
and 2 per cent on balances in excess of' ·$45 million.

Under H. R. 12706

compensation payments would be based on the average 91-day bill rate
in the preceding quarter.

The rate used in this analysis was the

average __91-day Treasury bill rate for the first quarter of 1977, 4.55
per' cent.

Compensation payments under the proposed amendment to R.R.

12706 would be limited to service charges collected.
Service charges assessed each bank are identical under the
three plans.

The annual amount of System services used by each of the

ten banks was estimated from survey data and valued at direct and
indirect Federal Reserve costs, as shown in the PACs accounting system.
Check, ACH, wire transfer, currency, coin, reserve accounting, securities-

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handling and noncash collection are the services assumed to be priced.
However, the service charges shown here are only illustrative and do
not necessarily reflect prices that might be charged by the Reserve
Banks.
The amendment to H.R. 12706, while limiting payments on
required reserves to revenues generated from pricing, does not mention
how the revenues collected are to be distributed among banks.
assumed in the tables

that 1.5 per cent is paid on reserve balances,

a rate which exhausts collected revenues from pricing.

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74
ANNUAL PAYMENTS TO THE 10 LARGEST MEMBER BANKS
($ MILLIONS)
H.R. 13477

Bank of America
Citibank
Chase
Manufacturers Hanover
Chemical
Morgan Guaranty
Continental
Security Pacific
Bankers Trust
1st National Bk. Chicago
TOTAL

Compensation
Payments

Service
Charges

Net
Payments

26.0
15.2
26.3
10.2
4.9
7.3
15.0
14.4
10.5
16.4

$ 10.9
5.8
6.2
7.5
5.9
2.7
6.1
4.5
3.5
~

15 .1
9.4
20.1
2.7
(1.0)
4.6
8.9
9.9
7.0
11.8

$ 146. 2

$ 57.7

88.5

H.R. 12706

Bank of ·America
Citibank
Chase
Manufacturers Hanover
Chemical
Morgan Guaranty
Continental
Security Pacific
Bankers Trust
1st Nat:ional Bk. Chicago
TOTAL

Compensation
Payments

Service
Charges

Net
Payments

58.0
33.6
58.8

10.3
15.7
33.1
31. 7
22.8
_16,3

$ 10. 9
5.8
6.2
7.5
5.9
2.7
6.1
4.5
3.5
~

$ 322, 5

$ 57.7

$ 264.8

22.2

47.1
27.8
52.6
14. 7
4.4
13.0
27.0
27.2
19.3
~

PROPOSED .AMENDMENT TO H.R. 12706

Bank of America
Citibank
Chase
Manufacturers Hanover
Chemical
Morgan Guaranty
Cont inenta 1
Security Pacific
Bankers Trust
1st National Bk. Chicago
TOTAL

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Federal Reserve Bank of St. Louis

Compensation
Payments

Service
Charges

Net
Payments

19,l
10.9
19.2
7.2
3.2
5.0
10.8
10.3
7 .4

$ 10.9
5.8
6.2

8.2
5.1
13.0
(. 3)
(2. 7)
2.3
4.7
5.8
3.9
....2.,l_

47.3

7.5

-1!,_2

5.9
2.7
6.1
4.5
3,5
4.6

$ 105.0

$ 57.7

75
15)

Describe and estimate the cost of services provided to member banks
which are part of a holding company which has nonmember affiliates
that share in these services.
The Federal Reserve Planning and Control System (PACS) has

no provision for allocating costs for services to the users of those
services.

However, the Federal Reserve recently collected data on

the use of check collection services by individual member banks for
the month of May 1978.

These data are currently being analyzed, and

information on the cost of check services provided to member banks
which are part of a holding company will become available at a later
date.

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16)

In the testimony of Philip E. Coldwell before the Committee on
Banking, Housing and Urban Affairs, U.S. Senate, May 25, 1978,
h~ said "this (erosion of membership) threatens to weaken our
financial system, as n1orc and more of the nation's payments and
credit transactions are handled outside the safe channels of the
Federal Reserve •••• ". In what way, if any, are the private
businesses now providing services which compete with those
provided by the Federal Reserve unsafe?
The present payments system., including private inter-bank

clearings, is quite safe.

However, one effect of membership attrition

is that more and more of the nation's payments and credit transactions
are handle_d through correspondent banks rather than through the Federal
Reserve.

Since nonmember banks must maintain correspondent baiances

to facilitate payments settlement (and also must generally keep additional balances to compensate the correspondent for clearing and
settlement services provided to the respondent) and since the settle-.
ment function is more efficient the more respondents are served by a
single·, large correspondent, there is a tendency for "pyramids" of
banks and correspondent deposits to form.

Insolvency of an important

bank at or ne1r the apex of such a pyramid would immobilize the settlement (and compensating) balances of numerous banks lower in the pyramid,
which could lead to dangerous illiquidity for these respondent banks.
There, of course, is no such risk of insolvency when settlement balances
are held at Federal Reserve Banks.

Federal Reserve clearing channels

are in this sense inherently "safer".

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The CHAIRMAN. I thank you for giving me ~his time. .
. .
Mr. MITCHELL. The Chair will now recogmze the rankmg mmor1ty
member, Mr. Stanton, for an opening statement.
Mr. STANTON. Thank you, Mr. Chairman:
.
First I would like to commend the chairman of the full Bankmg,
Financ~ and Urban Affairs Committee, Mr. Reuss, for scheduling
these series of hearings into examining the subject of the Federal
Reserve membership.
As you know, I have been deeply concerned about this iss~e for several years. Particularly, I am concerned about the far-reachmg effects
of the vitality of the Fed and the Nation's monetary system, as more
and more banks continue to leave the Federal Reserve System.
Specifically, the possible implications which flow from this problem,
and some of the proposals for its solution, include the following:
One, the Fed's control over monetary policy may be weakened.
Presently, the Fed's staff estimates that the Fed membership controls
only about 72 percent of all of the bank deposits, which greatly contributes to continual errors in the Fed's estimate of the money supply. As membership continues to decline, this margin of error will
increase.
Two, the Nation could face risks of liquidity problems. Declining
membership means that an ever-increasing number of banks lose their
ready, direct access to the discount window. As access to the discount
window provides adjustment credit and liquidity in times of special
need, this vital mechanism for insuring the smooth operation of the
banking system during liquidity crises may become less effective.
Third, the structure of the Federal financial regulatory system
could be altered in the process of attempting to solve the membership
problem. The Federal Reserve's proposal for universal reserve requirements would bring more depository institutions under the jurisdiction of the Fed's regulatory framework. Chairman Reuss has proposed for the discount window statutorily fixed reserve requirements.
On the other hand, this would significantly change the existing role
of the Congress and the Fed in the conduct of monetary policy.
Obviously, all of these questions are highly complex. Nonetheless,
the schedule established for these hearings, and the witnesses invited,
will enable us to give each of these issues a thorough consideration, as
it deserves.
At the outset, I wish to have it clearly understood that I personally
enter these hearings with an open mind. My bill, the Federal Reserve
Membership Act of 1978, represents just one approach toward stopping the downward trend in membership.
However, I am anxious and eager to learn more about Chairman
Reuss' amendments, as well as the Fed's proposals. The two major
provisions of my bill are: the explicit pricing of Federal Reserve payments services, and the payment of interest on required reserves.
Payment of interest on reserves would enable member banks to turn
their presently vital reserves balances into investments, yielding a
more competitive rate of return.
The pricing of payments services would seek to promote increased
efficiency within the Fed, and greater competition within the banking
industry as a whole.
Other issues raised by the Reuss amendment and the Fed's proposal

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78
include, of course, adjustment of reserve requirements; limit on Treasury; revenue loss; improvement of data available to the Fed for the
conduct of monetary policy; and alterations in the discount rate.
Admittedly, some of these proposals are more appealing than others.
For example, I am pleased that we will consider lowering the existing
reserve requirements and improving the flow of monetary reports to
the Fed.
However, the Reuss amendments and the discount window, and the
statutory fixed reserve requirements, cause me, of course, great
concern.
Throughout my almost 14 years as a member of this committee, I
have consistently maintained that we should not restrict the flexibility
of the Federal Reserve. And these amendments, of course, appear to
do precisely that.
Moreover, my preliminary analysis indicates that the proposal on
the discount rates is directed at a truly nonissue. Chairman Reuss has
stated that tying the discount rate to the Treasury bill rate would reduce the possibilities for reduced profits in discount operations.
Presently, however, the charge for membership to member banks on
this transaction is negligible, as the Fed polices these operations and
only rarely grants such activities on a case-by-case basis.
Finally, I wish to compliment you, Mr. Miller, on the Fed's efforts,
and on your proposals that you presented to us. I have had a chance
to look at your statement last night. I think you have summarized the
issue quite well in your final remarks when you state that: "This
morning, we are dealing with matters of crucial importance to the
longrun viability of the Nation's central banks, to the health of the Nation's depository institutions, and indeed to the Nation's economy."
And I can only say, in conclusion, Mr. Chairman, that I would
hope that as we all enter this subject with an open mind, that we not
necessarily consider this on the subject of "loss of money to the Treasury," or "gain of money to the Treasury"; but that we would keep in
mind that, in the last 65 years of the Federal Reserve Board System,
that this Congress that we are so proud of, our predecessors 65 years
ago, set for the Federal Reserve Board certain basic responsibilities
in setting up this system.
We require many things of them :for monetary policy and the safety
of our banking system, and that is our concern, and I think we should
keep that uppermost in our mind as we give the Fed the opportunity
and the tools to provide the lessons that we need in carrying out the
goal that we have set for them.
And so, Mr. Chairman, I thank you for this opportunity and look
forward to these hearings.
Mr. MITCHELL. Thank you.
Welcome, Chairman Miller. You have been welcomed three times.
As always, we are pleased to hear your views, and the Chair will now
ask that you proceed.

STATEMENT OF HON. G. WILLIAM MILLER, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. Mn..LER. First, I think I should say not only for myself personally, but on behalf of the Board of Governors, how much we appre
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Federal Reserve Bank of St. Louis

79
ciate this opportunity. I am indebted to you, Mr. Mitchell, for being
willing to schedule these hearings at this time; and to Chairman Reuss
for allowing this matter to go forward so late in the session. I am
most appreciative of Congressman Stanton's efforts-continuing efforts-to address the matter of membership and to bring his proposal
forward; and of the efforts of other committee members who have
co-sponsored this proposal as a basis for discussion.
I realize how difficult it is, in a busy session of Congress with many
issues to consider, to take up something this important so late, and
therefore I am particularly grateful.
When I came to the Federal Reserve in March, and when I appeared
before this committee on March 9 on the first full day of my new
assignment, in answer to a question at that time I pointed out that
I thought the so-called "membership issue" was critical and deserved
attention, and that it was my hope and expectation to bring forward
for discussion some plan by the middle of the year.
And here we are, and we have made considerable progress. I believe
that all of us are approaching this matter objectively, recognizing that
it is a complex and important issue. And because there are many complexities, there are many alternative proposals.
We are approaching these hearings and this discussion as a process
for sorting out ideas to find the optimum system to accomplish all of
our objectives-a balanced, well thought through approach, taken not
for the purpose of aiding any constituency, but for the public benefit.
I might add, Mr. Chairman, that the Senate also has been responsive
to this important issue. Senator Proxmire has introduced a single bill
combining the two bills suggested by the Federal Reserve, that is :
universal reserves and the authority to pay in interest on reserves a
total amount of up to 7 percent of Federal Reserve earnings, plus the
amount collected by the Federal Reserve for its services. This bill will
be taken up in the Senate Banking Committee in a few weeks. And
so, there is parallel action being taken by the House and Senate.
The attrition of membership in the Federal Reserve is occurring
because member banks are at a serious competitive disadvantage relative to other depository institutions. This attrition, as it continues,
dilutes the effectiveness with which the Federal Reserve can fulfill its
monetary and other objectives.
Therefore, I would like to discuss first the dimensions and the effects
of this decline in membership, and then to comment on the particular
items in the legislation that has been proposed.
The problem facing us is the continuing decline in System membership in recent years. Over the past 8 years, 430 member banks have
withdrawn from the System, while only 103 nonmember banks have
joined. By looking at chart I attached to my testimony it is easy to
see graphically the large attrition in membership. In 1977, 69 banks
chose to give up membership, and 39 more banks have withdrawn
during the first half of this year. This last statistic probably understates the trend, because many member banks appear to be delaying
their plans for withdrawal until they see what actions the System
and the Congress take to resolve this membership problem.
Most of the banks withdrawing from membership have been small,
as some of you pointed out, with total deposits under $50 million.

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But a disturbing tendency has developed recently for larger banks to
leave the System. If you compare the top and bottom of chart II, you
can see that in recent years there has been a definite shift and that
larger and larger banks are withdrawing. A bank with deposits as
large as $750 million has withdrawn fairly recently. So there is this
trend toward withdrawal of large banks. Fifteen of the 69 banks
leaving the System in 1977 had deposits of more than $100 million,
a record number for that size of bank. The steady downward trend in
the numb~r of member banks has been accompanied, of course, by a
decline in the proportion of bank deposits subject to Federal Reserve
requirements, as you can see in chart III. The number of banks-the
bottom line-is declining, and deposits are going down rapidly also.
At the end of 1977, member banks held less than 73 percent of the
commercial bank deposits, down about 8 percentage points in the last
8 years. Thus, more than one-fourth of commercial bank deposits and
over three-fifths of all banks are outside the Federal Reserve System.
In New England, where the development of NOW accounts in
the past 5 years has greatly sharpened the competition among depository institutions, the decline in membership and in deposits held by
member banks has been even more dramatic, which you can see in
chart IV. The share of deposits in New England held by member banks
fell by 11 percentage points in the last 3 years alone, from 73 percent
at the end of 1974 to less than 62 percent at the end of last year. If
you look at the chart you can see how quickly that decline is taking
place. Notice also that New England some years ago had higher
ratios of both numbers of banks and deposits than nationwide; now
it is lower. That again illustrates the trend that is of concern.
The basic reason for the decline in membership is the financial burden that membership entails. Most nonmember banks and thrift institutions may hold their re'quired reserves in the form of earning assets
or in the form of deposits-such as correspondent balances-that
would be held in the normal course of business. Member banks, by
contrast, must keep their required reserves entirely in nonearning
form. The consequences, as may be seen in chart 5, is that member
banks hold a greater percentage of their total assets in nonearning
form than do nonmember banks. Chart V shows that members-at
the top line-have a much higher percentage of their assets that are
not yielding any income.
The cost burden of Federal Reserve membership thus consists of
the earnings that member banks must forego because of the extra
amount of assets they are required to hold. Of course, member banks
are provided with services from the Federal Reserve, but the value
of these services does not, by any means, close the earnings gap between members and nonmembers. As a result, the earnings rate for
member banks runs persistently below that for nonmember banks. If
you glance for just a moment at chart VI and you will notice that nonmembers are consistently earning more on their assets than members.
The Board staff estimates that the aggregate cost burden for Federal
Reserve membership may exceed $650 million annually, based on data
for the year ending September 1977; that is about 9 percent of member
bank p1.·ofits before taxes.
The burden of membership is not distributed equally across all sizes

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of member banks, according to our estimates, which are shown in chart
VII. The relative burden is greatest for small banks-as some of you
pointed out-exceeding 20 percent of profits for banks with less than
$10 million in deposits. The top of that chart shows the aggregate
burden, but in the bottom panel you will see that the burden does fall
more on the smaller institutions.
The competitive inequality caused by sterile reserve balances can
be regarded as an additional "tax" levied upon member hanks. This
tax produces Federal Reserve earnings that are paid over to the Treasury and thereby become additional revenue to the U.S. Government.
But this tax is inherently unfair because it falls only on member banks.
Nonmember banks and thrift institutions, both of which compete with
members in many of the same markets for deposits and loans, do not
pay this tax. Member banks naturally attempt to minimize the added
burden of sterile reserves, but there are practical limitations in their
nbility to do so. Those banks most successful in taking such steps are
the larger banks. Because of their size, the character of their business,
and their managerial resources, these banks have access to sources o:f
funds or to activities that involve lower reserve requirements. Moreover, such banks are usually large correspondent banks that provide
services to smaller banks, including those that are based upon access
to Federal Reserve facilities.
Requiring sterile reserves only from member banks is an inefficient
way to raise revenue for the Treasury, because it leads to withdrawal
from the System. resulting in reduction in Treasury revenues. For example, since 1970, the withdrawals of member banks have reduced
Federal Reserve earnings in 1977 by nearly $200 million from what
they would have been had the hanks not withdrawn.
In chart VIII you can see the annual loss in Federal Reserve earnings
as a result of the withdrawal of hanks since 1970. This has reduced the
net income to the Treasury by about $100 million. Remember, this goes
back only to 1970, and does not project future loss.
It is obvious from the continuing erosion in Federal Reserve membership that more and more banks are becoming acutely aware of the
cost burden of membership and of the competitive handicap arising
from that burden. The cost of membership is due in part to the high
interest rates being induced by inflation in recent years. With market
interest rates exceeding 5 percent for much of the past decade, the
earnings opportunities foregoing by holding reqmred reserves at
Reserve banks has been painfully clear to member banks.
At the same time, competitive pressure on banks have increased.
Ranks once had a virtual monopoly on transaction accounts because o:f
their ability to offer demand deposits. But this unique position is being
nroded. Financial innovations have led to widespread use of interestbearing accounts at nonbank depository institutions as well as banks
for transaction purposes.
Since 1970, these mnovations have included such activities as limited
preauthorization of bill-paying from savings accounts at banks and
savings and loan institutions, NOW accounts that are available in
New England, the credit union share drafts, telephone transfers from
savings deposits, and the use of electronic terminals to make immediate
transfers to and from savings accounts. Growth of these transactions-

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related interest deposits has been most dramatic in recent years. For
example, NOW accounts have grown from almost zero in 1974 to nearly
8 percent of household deposit balances in New England in 1977.
Chart IX shows the very rapid dramatic growth of deposits in NOW
accounts.
There is no sign that the intense competition for transaction accounts will abate. These heightened competitive forces are compelling
all depository institutions to be more cost sensitive and to seek ways to
maintain their profitability. Experience shows that withdrawal from
the Federal Reserve System is a strategy that many bank managements have chosen in these circumstances.
The declining trend in membership is of great concern, because as it
continues it will inevitably weaken our financial system in a number
of ways.
Declining membership threatens to alter the character of the Federal Reserve System as an institution from that which Congress originally intended. Congress intended the Nation's central bank to provide needed liquidity and to establish an efficient payments system,
among other purposes. All commercial banks were made eligible to
participate in the governance and the services of the regional Reserve
banks. Membership in the System was not restricted to national banks
alone because the System's designers in Congress considered broad representation from all classes of banks located in every region in the country to be essential to the System's functioning in the public interest.
They especially wished to avoid over-representation by the largest
banks. Moreover, in founding the System, Congress hoped that Statechartered banks would join in order to strengthen both the System
and the ability of State banks to serve their communities.
These purposes are as valid today as they were 65 years ago, but
continued attrition of membership could defeat these congressional
goals. If current trends continue, membership in the Federal Reserve
will consist predominantly of the very largest banks and of the
smaller national banks who might choose for one reason or another
not to convert to State charters. The monetary and other policies of
the Federal Reserve would then have their most immediate impact on
.
a relatively small part of our financial system.
As fewer and fewer banks and a smaller share of the N at10n's
deposits remain with the Federal Reserve System, the ability of the
System to influence the Nation's money and credit becomes weaker.
The discount window provides an important safety valve function
which enables the Federal Reserve to conduct monetary policy effectively. Member bank attrition means that fewer banks have immediate
access to the discount window on a day-to-day basis. As attrition continues, we could reach the point where there would be a significant
reduction in the financial system's flexibility in adapting to such things
as a tightening of credit policies. The discount window provides individual member banks with a reasonable period of time to make
orderly adjustments in their lending and investment policies. This
cushion provided by the window facilitates implementation of a restrictive monetary policy in a period of inflationary demands. We have
seen this recently when the use of the window has helped make the adjustment to tighter conditions.

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The attrition in deposits subject to reserve requirements set by the
Federal Reserve also weakens the linkage between bank reserves and
the monetary aggregates. As a larger and larger fraction of deposits
becomes subject to the diverse reserve reqmrements set by the 50
States rather than by the Federal Reserve, the relationship between
money supply and reserves provided by the Federal Reserve becomes
less and less predictable.
Our staff has attempted to assess the extent to which growth in nonmember bank deposits would weaken the relationship between reserves
and money. Their tentative results are shown in chart X. Look at that
chart for just a moment. It depicts the greater range of short term
variability in M1 and M2 , with a given level of bank reserves, that
would develop as the percent of deposits held by nonmembers rises.
If you look at the horizontal axis, you will see that as the percent
of bank deposits not subject to reserve requirements goes up, there is a
much greater percent of va•riability in predictability than there would
otherwise be. As more and more deposits are held outside the System,
the chart suggests that control of money through the reserve base becomes increasmgly uncertain.
Finally, it should be pointed out that fewer member banks within
the Federal Reserve means that fewer institutions can be influenced by
changes in reserve requirements set by the Federal Reserve. Changes
in reserve requirements have not been a very active instrument of
monetary policy in recent years, as Chairman Reuss pointed out, but
this has been in part because of a desire to avoid worsening the membership problem if reserve requirements were raised.
If the membership problem could be resolved, possibly through
universal reserve requirements, adjustment in reserve ratios might be
made more flexibly when needed to affect bank credit throughout the
country or to influence banks' efforts to attract particular types of
deposits. Moreover, while open market operations in U.S. Government
securities provide the Federal Reserve with a powerful policy instrnment, it is possible that conditions could develop in the future-such
as a less active market for U.S. Government securities in a period of
reduced Federal deficits, which I hope we will see soon-where mqre
flexible adjustments of reserve requirements might be desirable as an
adjunct to the window or to the desk in efforts to control the 'monetary
aggregates.
Not only is monetary control made more difficult by membership
attrition, but the quality of the banking system is also adversely
affected. The Federal Reserve Act authorizes Reserve banks to discount paper for nonmembers, but only under "unusual and exigent"
circumstances. By the time such an emergency loan were made, therefore, the bank would have already encountered serious difficulties, and
more problems could be expected as it became known that the bank was
in an emergency condition. As a member, on the other hand, the bank
would probably have begun to borrow from the window under regular
procedures and the development of an eJmergency might be forestalled.
The presence of the Federal Reserve in the bank supervisory and
regulatory area-a presence that becomes diluted with membership
attrition-also enhances the quality of the banking system. The activities of the System in that area cannot be readily separated from its

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job of conducting monetary policy. Regulatory and supervisory policies
can have important implications for monetary policy and credit flows.
Changes in the ceiling rate on time deposits are only the most obvious
of such policies; others concern capital adequacy, bank liquidity, international hanking, and the quality of loan portfolios.
Attrition of membership, as it continues, also threatens to lead to
a deterioration in the quality of the payments mechanism that underlies all of the Nation's economic transactions. Reserve balances held
at Federal Reserve banks are the foundation of the payment mechanism
because these balances are used for making payments and settling
accounts between banks. Nonmember deposits at correspondent banks
can serve the same purpose. But as more and more of the deposits used
for settlement purposes are held outside the Federal Reserve, the
banking system .becomes increasingly exposed to the risk that such
funds might be immobilized if a large correspondent bank experienced
substantial operating difficulties or liquidity problems.
A liquidity crisis affecting a large clearing bank would have widespread damaging effects on the banking system as a whole because
smaller banks might become unable to use their balances in the
normal course ·Of business. The Federal Reserve, of course, is not
subject to liquidity risks and, therefore, serves as Congress intended
as a completely safe foundation for the payments mechanism.
These various problems that either cause or result from member
bank attrition could be solved in a variety of ways, some of which
we have suggested and some of which you have suggested. We believe
that the approach the Federal Reserve has suggested is an effective
one and is an appropriate one under the circumstances.
First, we have suggested the Universal Reserve Requirements Act
of 1978, which Chairman Reuss introduced at our request. It was
submitted by the Board for the purpose of reducing the competitive
inequality between banks and other institutions insofar as transactions accounts are concerned and to lay the basis for more effective
monetary control. Universal reserve requirements can eliminate the
competitive inequality by imposing a similar reserve requirements
structure on similar institutions. This bill imposes reserve requirements set by the Federal Reserve on transactions balances of all
depository institutions. The first $5 million of such balances would
be exempt from reserve requirements, although a relatively small
requirement could be imposed if it proved necessary in the public
interest. This exemption would mean that about one-third of the
present member banks and about two-thirds of nonmembers would
not be subject to reserve requirements on transactions accounts. This
is a limited extension of universal reserves which would significantly
reduce the competitive inequality that now exists.
The Board favors universal requirements for reasons quite apart
from the membership problem. Universal reserves would contribute to
improving monetary management and to insuring the stability of the
payments mechanism.
Let me stress that the Board's bill does not authorize any supervisory role for the Federal Reserve with respect to nonmembers. Indeed, the bill does not even require that nonmember institutions establish an account relationship with the Reserve bank. A nonmember's

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reserves could be held at a correspondent bank-or at a Federal Home
Loan bank in the case of savings and loan associations-and merely
passed through to the Fed on a 1 to 1 basis by the correspondent.
Nonmembers would, however, have to report data on their deposits
and certain other items to the local Reserve bank for monetary management purposes.
We realize that universal reserve requirements have been proposed
before and that the proposal raises a number of difficult problems.
The Board continues to belieYe, however, that such reserves are necessary to help correct the competitive imbalances in our financial system
and to insure an effective monetary policy.
The Board's other proposal is presented separately. I mentioned that
the Senate has linked them together in one bill, but they are presented
here separately. I recommend this second proposal to you for approval, through passage o:f H.R. 13477, even if Congress does not
enact universal reserve requirements. However, we would suggest that
the last sentence of that bill be deleted-and I will mention this again
later-the sentence that restricts the payment of interest on certain
sizes of balances.
Apart from universal reserves, the Board's proposal has four other
major features: One, reduction and restructuring of demand deposit
reserve requirements; two, payment of compensation on required reserve balances; three, charges for services provided by Reserve banks;
and four, a transfer of a portion of the Federal Reserve surplus to the
Treasury during a transition period in order to preserve the Treasury's
revenue and thus to avoid any increase in the Federal deficit. The
Board's plan is described in some detail in the preliminary proposal
that is attached to my testimony, and I believe each of you has a copy.
The reduction in reserv{l requirements, together with the proposed
payment of interest on reserves, would about offset the membership
burden as presently measured, after allowing for charges for services
to members. The net cost to the Treasury of this program, in the
absence of universal reserve requirements, would be about $300 million, based on deposits and reserves in 1977. This figure, of course,
takes into account that the reduction in Federal Reserve earnings will
be partially recouped by the Treasury from banks, stockholders, and
customers who will receive the benefit of this reduced burden in taxable income.
During a 3-year phase-in period, there would be no loss in Treasury
revenues, since the System would reimburse the Treasury from its
accumulated surJ?lus. After that, the actual loss would be considerably
less than the estimated $300 million cost of the Board's plan.
Membership attrition would continue in the absence of a program to
resolve the problem. Please look at chart XI: You will see that without
this program, by the fourth year, continuing attrition would cost the
Treasury an estimated $80 to $210 million a year as a result of the
continuing decline in membership and in member bank reserves held
at the Fed. The straight lines slanting upward are the ones to follow.
The bottom line shows the cost of attrition to the Treasury if the national .trend in loss of membership should continue. The upper line
shows the cost to the Treasury if attrition were to increase to the rate
that has been experienced in New England.

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It is my personal view that conditions are such that we could experience an increase in loss of membership such as has already happened in New England. It is my view that the upper line represents
the more probable result in the absence of this program. Compare that
with the cost o:f the Board plan-which costs less in its early years and
then jumps up once the :full plan is in effect-and you will see that
there is a close approximation between what our plan would cost given
a stabilized situation and what the Treasury would lose anyway i:f we
do not stop attrition.
The Board's proposed Interest on Reserves Act would limit the
amount o:f the interest paid under the Board's plan, after deducting
the total amount o:f charges imposed for services, to no more than 7
percent o:f the net earnings o:f the Federal Reserve banks in any 1 year.
The purpose o:f that limitation, as you know, is to give Congress control over the Fed's authority to pay out net earnings.
As you know, last year the earnings o:f the Federal Reserve were
about $6 billion, so a 7 percent limit would give us about $420 million
to be used for this purpose.
Within this limitation, the Board proposes to pay close to the mar~
ket rate o:f interest on required reserve balances up to $25 million in
size. The proposed rate would be one-half percentage point below the
average return on the System's portfolio. In 1977, the return on the
portfolio was such that the resulting figure would be about 6 percent.
On larger balances, the Federal Reserve proposes to pay interest at
2 percent.
The Board's proposal was embodied in H.R. 13477. But that bill
also imposes a 2-percent limitation on reserve balances in excess o:f
$25 million. While the Board intends to do that, we do not believe that
that kind of limitation should be written into law. We think the 7percent cap assures Congress o:f a limitation in interest payments, and
we would prefer to have some flexibility in setting the point at which
interest rates change. Over the years conditions could change, and we
need to be able to adapt as experience is gained.
Now let me turn :for a moment to a discussion o:f the Stanton bill
and Chairman Reuss' proposed amendment to it. In the Board's view,
the Stanton bill is a constructive approach to dealing with the membership problem. Indeed, by permitting the payment of a market rate
o:f interest on reserve balances, the bill would likely make membership
in the System attractive for virtually all banks that are now nonmembers. In the context o:f this bill, open access to Federal Reserve services
could then be provided to all depository institutions without risking
any adverse effects o:f membership. O:f course, let me point out that we
adjusted our own proposals as to rate of payment of compensation to
reduce their cost impact, in the belief that some limitation at this
time was necessary.
The Board is concerned, however, that the specific provisions regarding changes :for Federal Reserve services in the Stanton bill might
be unduly, restrictive. For example, the bill requires that the Federal
Reserve price take account of capital and other costs tha.t would have
been paid by a private firm. However, we believe that any provision
requiring the System to charge :for services should also recognize the
realities of the competitive marketplace and the responsibility of the

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System to provide a basic level of service nationwide. I believe this
would be in the public interest.
The amendment to the Stanton bill is broad in scope. It seeks major
changes in the powers and responsibilities of the Federal Reserve, and
would adversely affect the System's ability to carry out its res:ponsibilities. The amendment, if adopted, would not provide a solution to
the membership problem; rather, it would make the problem worse.
Under the amendment, open access to all Syatem services, except the
discount window, would be available to all institutions, and the rate of
interest on reserve balances would be limited so that the amount of interest paid would be no greater than the total amount collected by the
Federal Reserve in payment for services, plus the small amount of interest earned at the discount window. In consequence, interest payable on reserves would be substanti,ally less than a market rate. Therefore, a bank willing to forego access to the discount window could
withdraw from membership and still have access to all Federal Reserve
services. Such a bank could then invest the reserve balances released
by withdrawal from the System so as to earn a full market rate of interest. If those funds were invested in Government bonds, the Treasury would be paying money to that bank. It seems more sensible to us
for the Federal Reserve to pay a lesser amount of money to that bank
to keep it in the System. If the proposed amendment were enacied, we
would expect the rate of loss of membership to accelerate.
The amendment also proposes legislating specific reserve require•
ment ratios on demand deposits and tying the discount rate to the
Treasury bill rate. Such an action would not be desirable, since it
would reduce the policy instruments available to carry out the Nation's
monetary policy and effectively limit the System to open market operations for tlhat purpose. The Board continues to believe that effective
monetary management requires at least the option of having more
than one instrument rut hand, and, recommends that the proposed
amendment therefore not be enacted.
I mentioned earlier the opportunity to use reserve requirements
ws a moneta.ry policy instrument if we solve the membership problem;
reserve requirement changes may become a more useful instrument
once this problem is resolved. In .any event, they are needed if ,action
is to be taken tha,t emphasizes credit availability at member banks
throughout the country, or if conditions require that open market
operations be supplemented in order to attain mone.ta,ry objectives.
Reserve requirement changes can al so serve at time s as a useful signal
of change in the System's policy stance. It also should be noted that
the reoorve requirement proposals on transactions 'accounts in the
amendment apply to member banks only. This would tend to increase
existing inequities because member bank savings accounts subject to
automatic transfer would bear a higher reserve requirement-equal
to that on demand deposits-than similar accounts at nonmember
institutions. That would greatly impact the a.vailability of this new
service to consumers whidh we hope to have in effect November 1.
The discount rate, too, has a useful role to play as a signal of policy.
For instance, it can be held back when market rates are rising to
suggest a certain caution about future rate developments to the market.
The stated reason for tying the discount rate to a market rate is to

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reduce the possibility of arbitrage profits when tJhe discount rate is
below market rates. However, as Congressman Stanton pointed out,
the Reserve oonks already have careful administrative controls to
keep arbitrage OJ?'.portunities to a minimum. Tying the discount rate
to the Treasury bill rate makes the cost of meµiber borrowing dependent in part on Treasury debt management, and the rate could be high
or low rela.tive to other opportunities that the bank has fur investment. Even if it were desirable to tie the discount rate to market rates,
the shifting structure of market rates makes it very difficult to find any
single rate that is satisfactory. I suppose, from a personal point of
view, I wish we could; it would make my life a little easier, and I
would not have to face those tough decisions. The Board believes its
flexibility with regard to the discount rate should not be limited, in
view of the unpredictability of changing market circumstances and
internwtional and domestic economic conditions.
The amendment also would require the Federal Reserve to transfer
$575 million of its earned surplus to the Treasury over 2 years. This
amount is what we have proposed in our plan, as Chairman Reuss
pointed· out. However, the proposed amendment does not offset the
full burden of membership, so the cost to the Treasury would be less
than $575 million. Therefore, if these amendments were adopted, it
would not be necessary to transfer $575 million to the Treasury.
Finally, the amendment provides for the collection from nonmember institutions of data needed to control the monetary aggregates.
This is very helpful. The reports are to be made through the relevant
regulatory agencies. I just want to point out that such data are needed
on a timely basis, and it would be useful for us to have the flexibility
to work out with the agencies how to handle it, rather than to have
this mandated. The intended purpose is proper, but we might need a
little more flexibility in working out how to get that data.
Mr. Chairman, ladies and gentlemen-Members of Congress who
are here today in attendance-I just want to thank you for the opportunity to present our views on this important matter. The problems
with which your committee is dealing this morning are of crucial
importance to the lon~-run viability of the Nation's Central Bank, to
the health of the Nation's depository institutions, and, indeed, to the
national economy. I know the problems are difficult, and I appreciate
vou:r willingness to tackle them. I am confident that if we do work
together and consider the issues together, we can find solutions in the
public interest.
Thank you verY. much.
[Chairman Miller's prepared statement, together with the charts
referred to throughout his oral presentation and a "Preliminary Proposal" of the Board of Governors of the Federal Reserve System,
dated July 6, 1978, follows:]

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Proposals on Financial Institution
Reserve Requirements and
Related Issues

Statement by
G. William Miller
Chairman, Board of Governors of the Federal Reserve System

32•9?2 0 • ?8
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before the
Committee on Banking, Finance and Urban Affairs
House of Representatives

July 27, 1978

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It is a pleasure to testify today on behalf of the Federal
Reserve System on the bills before your Committee that would promote
competitive equity between member banks and other depository institutions and that would strengthen the nation's financial system by
stemming the attrition of banks from the Federal Reserve.

We are

grateful to this Committee and to its distinguished Chairman for
considering the proposed legislation so late in the session.
Attrition of membership in the Federal Reserve System is
occurring because member banks are at a serious competitive
disadvantage relative to other depository institutions.

This attrition,

as it continues, dilutes the effectiveness with which the Federal
Reserve can fulfill its monetary and other objectives.

Therefore,

I should like, first, to discuss the dimensions and effects of the
decline in membership, and then to offer comments on the specific
legislation you are considering.
MEMBERSHIP IN THE SYSTEM CONTINUES TO DECLINE
The problem facing us is the continuing decline in System
membership in recent years.

Over the past 8 years 430 member banks

have withdrawn from the System, while only 103 nonmember banks have
joined, as is illustrated in Chart I.
give up their membership, and
half of 1978.

In 1977 69 banks chose to

39 more banks withdrew in the first

This last statistic probably understates the trend,

because many member banks appear to be delaying their plans for
withdrawal from membership until they see what action the System
takes to resolve the membership problem.

Most of the banks with-

drawing from membership have been small, with total deposits under

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$50 million.

But a disturbing tendency has developed recently for

larger banks also to leave the System, as shown by comparing the
top and bottom panels of Chart II.

Fifteen of the sixty-nine banks

leaving the System in 1977 had deposits of more than $100 million,
a record number for that size of bank.
The steady downward trend in the number of member banks
has been accompanied, of course, by a decline in the proportion
of bank deposits subject to Federal Reserve reserve requirements, as
may be seen from Chart III.

As of the end of 1977, member banks

held less than 73 per cent of total commercial bank deposits, down
about 8 percentage points in the last 8 years.

Thus, more than

one-fourth of commercial bank deposits--and over three-fifths of
all banks--are outside the Federal Reserve System.
In New England, where the development of NOW accounts in
the past 5 years has greatly sharpened competition among depository
institutions, the decline in membership and in deposits held by
member banks has been even more dramatic, as illustrated in Chart IV.
The share of deposits in New England held by member banks fell by 11
percentage points in the last three years alone--from 73 per cent at
the end of 1974 to less than 62 per cent at the end of 1977.
DUE TO THE EXCESSIVE COST OF MEMBERSHIP
The basic reason for the decline in membership is the
financial burden that membership entails.

Most nonmember banks and

thrift institutions may hold their required reserves in the form of
earning assets or in the form of deposits (such as correspondent
balances) that would be held in the normal course of business.

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Member banks, by contrast, must keep their required reserves entirely
in non-earning form.

In consequence, as may be seen in Chart V,

member banks hold a greater percentage of their total assets in
non-earning form than do nonmembers.
The cost burden of Federal Reserve membership thus consists
of the earnings that member banks must forego because of the extra
amount of non-earning assets that they are required to hold.

course, member ·banks are provided with services by Federal Reserve
Banks, but the value of these services does not by any means close the
earnings gap between member and nonmember banks.

And, as a result, the

earnings rate for member banks runs persistently below that for nonmembers, as illustrated in Chart VI.
The Board staff estimates that the aggregate cost burden
to member banks of Federal Reserve membership may exceed $650 million
annually, based on data for the year ending in September 1977, or
about 9 per cent of member bank profits before income tax.

The burden

of membership is not distributed equally across all sizes of member
banks.

According to our estimates, shown in the lower panel of

Chart VII, the relative burden is greatest for small banks--exceeding
20 per cent of profits for banks with less than $10 million in deposits.
INEQUITY OF COST BURDEN BORNE BY MEMBER BANKS
The competitive inequality caused by sterile reserve balances
can be regarded as an additional "tax" levied upon member banks.

This

"tax" produces ·Federal Reserve earnings that are paid over to the
Treasury and thereby become additional revenue to the U.S. Government.

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But this "tax" is inherently unfair because it falls only on member
banks.

Nonmember banks and thrift institutions, both of which compete

with members in many of the same markets for deposits and loans, do not
bear this tax.
Member banks naturally attempt to minimize the added burden
of sterile reserves that they bear, but there are practical limitations
on their ability to do so,

Those banks most successful in taking such

steps are the very largest banks,

Because of their size, character of

their business, and managerial resources, these banks have access to
sources of funds or to activities--auch as participation in international banking, making repurchase agreements with business corporations,
and borrowing Federal funds--that are either free of reserve requirements
or involve relatively small reserve requirements.

Moreover, such banks

are usually large correspondents that provide services to smaller banks,
including those based on access to Federal Reserve facilities,
Furthermore, requiring sterile reserves only from member banks
is an inefficient way to raise revenue for the Treasury, because it leads
to withdrawals from the System, resulting in reduction in Treasury revenues,

For example, withdrawals since 1970 have reduced Federal Reserve

earnings in 1977 by nearly $220 million from what they would have otherwise been, as shown in Chart VIII, and have reduced net Treasury revenues by about $100 million,
INCREASED C<MPETITION FOR DEPOSITS HEIGHTENS AWARENESS OF BURDEN
It is obvious from the continuing erosion in Federal Reserve
membership that more and more banks are becoming acutely aware of the
cost burden of membership and of the competitive handicap arising from

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that burden.

"nle cost of membership is due in part to the high interest

rates induced by inflation in recent years.

With market interest

rates exceeding 5 per cent for much of the past decade, the earning
opportunities foregone by holding required reserves at Reserve Banks
have become painfully clear to member banks.
At the same time, competitive pressures on banks have
increased.

Banks once had a virtual monopoly on transactions accounts

because of their ability to offer demand deposits.
position is being eroded.

But this unique

Financial innovations have led to wide-

spread use of interest-bearing accounts at nonbank depository
institutions as well as banks for transactions purposes.

Since 1970,

these innovations have included the following: limited pre-authorized
"bill-payer" transfers from savings accounts at banks and savings and
loan associations, NOW accounts at practically all depository institutions in New England, credit union share drafts, telephone transfers
from savings deposits, and the use of electronic terminals to make
immediate transfers to and from savings accounts.

Growth of these

transactions-related interest-bearing deposits has been most dramatic
in recent years.

For example, NOW accounts have grown from almost

zero in 1974 to nearly 8 per cent of household deposit balances in
New England in 1977, as shown in Chart IX.
"nlere is no sign that the intense competition for transactions accounts will abate.

"nlese heightened competitive forces

are compelling all depository institutions to be more cost sensitive

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and to seek ways to maintain their profitability.

Experience shows

that withdrawal from the Federal Reserve System is a strategy that
many bank managements have chosen in these circumstances.
REDUCED MEMBERSHIP IN THE FEDERAL RESERVE WEAKENS THE FINANCIAL
SYSTEM

The declining trend in membership is of great concern
because, as it continues, it will inevitably weaken our financial
system in a number of ways.
Declining membership threatens to alter the character of
the Federal Reserve System as an institution away from that which
Congress originally intended.

Congress intended the nation's

central bank to provide needed liquidity and to establish an efficient
national payments system, among other purposes.

All eemmercial

banks were made eligible to participate in the governance and the
services of the regional Reserve Banks.

Membership in the System

was not restricted to national banks alone, because the System's
designers considered broad representation from all classes of banks
located in every region of the nation to be essential to the System's
functioning in the public interest.

They especially wished to

avoid over-representation by the largest banks.

Moreover, in founding

the System, Congress hoped State-chartered banks would jo;~
in order to strengthen both the System and the ability of the State
banks to serve their conmunities.
These purposes are as valid today as they were 65 years
ago, but continued attrition of membership could defeat these
Congressional goals.

If current trends continue, membership in the

Federal Reserve will consist predominantly of the very largest banks

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and of the smaller national banks who might choose, for one reason

or another, not to convert to state charters.

The monetary and other

policies of the Federal Reserve would then have their most immediate
impact on a relatively small part of our financial system.
MONETARY MANAGEMENT WEAKENED
As fewer and fewer banks, and a smaller share of the
nation's deposits, remain with the Federal Reserve System, the
ability of the System to influence the nation's money and credit
becomes weaker.

The discount window provides an important safety•

valve function, which enables the Federal Reserve to conduct monetary
policy effectively.

Member bank attrition means that fewer banks

have inmediate access to the discount window on a day-to•day basis.
As attrition continues, we could reach the point where there would
be a significant reduction in the financial system's flexibility in
adapting to, for example, a tightening of credit policies.

The

discount window provides individual member banks with a reasonable
period of time to make orderly adjustments in their lending and
investment policies. The cushion provided by the window facilitates
implementation of a restrictive menetary policy in a period of
inflationary demands.
The attrition in deposits subject to reserve requirements
set by the Federal Reserve also weakens the linkage between bank
reserves and the monetary aggregates.

As a larger and larger

fraction of deposits becomes subject to the diverse reserve requirements
set by the

50 states rather than by the Federal Reserve, the

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relationship between money supply and reserves provided by the
Federal Reserve becomes less and less predictable.
Our staff has attempted to assess the extent to which
growth in nonmember bank deposits would weaken the relationship
between reserves and money.

lbeir tentative results are shown

in Chart X, which depicts the greater range of short-run variability
in M-1 and M-2, with a given level of bank reserves, that would
develop as the per cent of deposits held by nonmembers rises.

more and more deposits are held outside the System, this chart
suggests that control of money through the reserve base becomes
increasingly uncertain.
Finally, it should be pointed out that fewer banks within
the Federal Reserve means that fewer institutions can be influenced
by changes in reserve requirements set by the Federal Reserve.
Changes in reserve requirements have not been a very active instrument
of monetary policy in recent years, but this was in part because of
a desire to avoid worsening the membership problem if reserve requirements were to be raised.

If the membership problem could be resolved,

possibly through universal reserve requirements, adjustments in
reserve ratios might be made more flexibly when needed to affect
bank credit throughout the country, or to influence banks' efforts
to attract particular types of deposits.

Moreover, while open

market operations in U.S. Government securities provide the Federal
Reserve with a powerful policy instrument, it is possible that
conditions could develop in the future--such as a less active
market for U,S, Government securities in a period of reduced Federal

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budgetary deficits--where more flexible adjustment of reserve requirements might be a desirable adjunct in efforts to control the monetary
aggregates.

ADVERSE IMPACTS ON QUALITY OF BANKING SYSTEM
Not only is monetary control made more difficult by membership
attrition, but the quality of the banking system is also adversely
affected.

The Federal Reserve Act authorizes Reserve Banks to discount

paper for nonmembers, but only under "unusual and exigent" circumstances.
By the time such an emergency loan were made, therefore, the bank
would have encountered serious difficulties, and more problems could
be expected as it became known ~hat it was in an "emergency" condition.
As a member, on the other hand, the bank would have probably begun
to borrow under regular procedures, and the development of an
emergency might have been forestalled.
The presence of the Federal Reserve in the bank supervisory
and regulatory area--a presence that becomes diluted with membership
attrition--also enhances the quality of the banking system.

The

activities of the System in that area cannot be readily separated
from its job of conducting monetary policy.

Regulatory and super-

visory policies can have important implications for monetary policy
and credit flows.

Changes in the ceiling rate on time deposits

are only the most obvious of such policies; others concern capital
adequacy, bank liquidity, international banking, and the quality
of loan portfolios.
POTENTIAL DETERIORATION IN THE PAYMENTS SYSTEM
Attrition of membership, as it continues, also threatens
to lead to a deterioration in the quality of the payments mechanism

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that underlies all of the nation's economic transactions.

Reserve

balances held at Federal Reserve Banks are the foundation of the
payments mechanism, because these balances are used for making payments
and settling accounts between banks. Nonmember deposits at correspondent
banks can serve the same purpose, but as more and more of the deposits
used for settlement purposes are held outside the Federal Reserve, the
banking system becomes increasingly exposed to the risk that such
funds might be immobilized if a large correspondent bank experienced
substantial operating difficulties or liquidity problems.

A liquidity

crisis affecting a large clearing bank would have widespread damaging
effects on the banking system as a whole because smaller banks might
become unable to use their clearing balances in the ordinary course
of business.

The Federal Reserve, of course, is not subject to

liquidity risk and therefore serves, as Congress intended, as a
completely safe foundation for the payments mechanism.
These various problems that either cause or result from
member bank attrition could be solved in a variety of ways, and a
number of bills are before you.

We believe our approach is the

most effective one under existing circumstances.

UNIVERSAL RESERVE REQUIREMENTS
The Universal Reserve Requirements Act of 1978, introduced
as H.R. 13476, was submitted by the Board to reduce competitive
inequality between banks and other institutions insofar as transactions accounts are concerned and to lay the basis for more effective
monetary control.

Universal reserve requirements can eliminate the

competitive inequality by imposing a similar reserve requirements

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100
structure on similar institutions.

H.R. 13476 imposes reserve require-

ments set by the Federal Reserve on transactions balances at all depository institutions.

The first $5 lllillion of such balances would be

exempt from reserve requirements, although a relatively small requirement could be imposed if it proved necessary in the public interest.
This exemption would mean that about one-third of present member banks
and about two-thirds of nonmembers would not be subject to reserve
requirements on transactions accounts.

This limited extension of

universal reserves would significantly reduce competitive inequality.
The Board favors universal reserve requirements for reasons
quite apart from the membership problem.

Universal reserves would con-

tribute to improving monetary management and to ensuring the stability
of the payments mechanism.

In doing so, the Board's bill, it should

be stressed, does not authorize any supervisory role for the Federal
Reserve System with respect to nonmembers.

Indeed, the bill does not

even require nonmember institutions to establish an account relationship
with the Reserve Bank. A nonmember's reserves can be held at a correspondent bank--or at a Federal Home Loan Bank, in the case of savings and
loan associations--and merely passed through to the Fed on a one-to-one
basis by the correspondent.

Nonmembers would, however, have to report

data on their deposits and certain other items to the local Reserve Bank

for monetary management purposes.
We realize that universal reserve requirements have been proposed before, and that the proposal raises a number of difficult problems.
The Board continues to believe, however, that they are necessary to help
correct the competitive imbalances in our financial system and to assure
an effective monetary policy.

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101
OTHER PROGRAM ELEMENTS

The Board's other proposal is presented separately and is
recommended for prompt Congressional approval through passage of
R.R. 13477, even if Congress does not enact universal reserve
requirements in this session.

However--for reasons discussed later--

the Board urges deletion of the last sentence of that legislation,
which imposes a limitation of 2 per cent on required reserve balances
in excess of $25 million,
Apart from universal reserves, the Board's proposal has four
other major features: reduction and restructuring of demand deposit
reserve requirements, payment of compensation on required reserve
balances, charges for services provided by Reserve Banks (along with
slightly broadened access to those services), and transfer of a portion
of System surplus to the Treasury during the transition period in order
to preserve the Treasury's revenue position while the plan is implemented,

All of the provisions of the Board's plan are described in

some detail in the "Preliminary Proposal" that is attached to this
testimony, and which we would appreciate having made part of the
record of these hearings.
The reduction in reserve requirements, together with the
proposed payment of interest on reserves, would about offset the
membership burden as presently measured, after allowing for charges
for services to members.

The net annual cost to the Treasury of this

program, in the absence of universal reserve requirements, would be
about $300 million, based on deposits and reserves in 1977.

This

figure, of course, assumes that part of the reduction in Federal
Reserve earnings is recouped by the Treasury from banks, their

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102
stockholders, and customers ir, t.he form of taxes on increased earnings
and capital gains.
During a three-year phase-in period for the program, there
would be no loss in Treasury revenues, since the System would reimburse
the Treasury from its accumulated surplus.

After that period, the

actual loss would be considerably less than the estimated $300 million
cost of the Board's plan.

Membership attrition would continue in the

absence of a program to resolve the problem.

As shown in chart XI,

without the program, by the fourth year continued attrition probably
would be costing the Treasury between $80 and $210 million as a result
of further declines in member bank reserves held at the Federal Reserve.
Thus, the true cost of the program is considerably lower than $300
million.

Moreover, should the program increase membership, the cost

•.;ould 1Je reduced even further.
INTEREST ON RESERVES ACT
The Board's proposed Interest on Reserves Act of 1978 would
limit the amount of interest paid under the Board's plan, after
deducting the total amount of charges imposed for services, to no
more than 7 per cent of net earnings of the Federal Reserve Banks in
any one year. (During 1977, net earnings were about $6 billion.)
Within this limitation, the Board proposes to pay close to a market
rate of interest on required reserve balances up to $25 million in
size.

The proposed rate would be\ percentage point below the average

return on the System's portfo1io; in 1977, the return on portfolio
would have permitted a 6 per cent rate on such reserve balances.
Larger balances would earn interest at a 2 per cent rate.

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The Board's proposal was embodied in H,R, 134 77, but that bill
also imposes a 2 per cent limitation on reserve balances in excess of
$25 million,

The Board does not believe that the 2 per cent limitation

should be written into law,

H,R, 13477 in any event contains an over-

all percentage limitation on the amount of interest payments the Federal
Reserve can make, and it is essential to retain adminis::rative flexibility in setting interest rates within the over-all limitation, so that
adjustments can be made as circumstances change and experience is g~{r.ed.
LEGISIATIVE PROPOSALS ADVANCED BY OTHERS
The remainder of my testimony will discuss the Stanton Bil:1
and Chairman Reuss' proposed amendment to it.
In the Board's view, H,R. 12706, the Stanton Bill, is a constructive approach to dealing with the membership problem.

Indeed, by

permitting payment of a market rate of interest on reserve balances,
the bill would likely make membership in the System attractive to virtually all banks that are now nonmembers.

In the context of this bill,

open access to Federal Reserve services could then be provided to all
depository institutions without risking adverse effects on membership,
The Board is concerned, however, that the specific provisions
regarding charges for Federal Reserve services in H,R, 12706 may be
unduly restrictive.

For example, the bill requires that the Federal

Reserve price to take account of capital and other costs that would
have been paid by a private firm,

However, we believe that any provi-

sion requiring the System to charge for services should also recognize
the realities

of the competitive marketplace and the responsibility of

the System to provide a basic level of service nationwide.

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104
The proposed amendment to the.Stanton bill is broad in scope,
seeks major changes in the powers and responsibilities of the Federal
Reserve, and would adversely affect the System's ability to carry out
its responsibilities.

Moreover, the amendment, if adopted, would not

provide a solution to the membership problem; rather, it would make
the problem much worse.

Under the amendment, open access to all

System services (except the discount window) would be available to
all institutions, and the rate of interest on reserve balances would
be limited so that the amount of interest paid could be no greater than
the total amount collected by the Federal Reserve in payment for services
plus the small amount of interest earned at the discount window.

consequence, interest payable on reservmwould be substantially less
than a m~rket rate.

Therefore, a bank willing to forego access to the

discount window could withdraw from membership and still have access to
all Federal Reserve operating services, while also investing the
reserve balances released by withdrawal from the System so as to earn
a full market rate of interest.

If the proposed amendment were enacted,

we would expect the rate of loss of membership to accelerate.
The amendment also proposes legislating·specific reserve
requirement ratios on demand deposits and tying the discount rate
to the Treasury bill rate.

Such an action would not be desirable since

it would reduce the policy instruments available to carry out the
nation's monetary policy and effectively limit the System to open
market operations for that purpose.

The Board continues to believe

that effective monetary management requires the option of having more
than one instrument at hand, and thus reco11111ends that the proposed
amendment not be enacted.

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105
As noted earlier, reserve requirement changes may become a
more useful instrument once the membership problem is resolved.

In any

event, they are needed if action is to be taken that emphasizes credit
availability at member banks throughout the country or if conditions
require that open market operations be supplemented in order to attain
monetary policy objectives.
also serve, at times, as a
policy stance.

Moreover, reserve requirements changes can
useful signal of change in the System's

It also should be noted that the reserve requirement

proposals on transactions accounts in the amendment apply to member
banks only.

This would tend to increase existing inequities because

member bank savings accounts subject to automatic transfer would bear
a higher reserve requirement--equal to that on demand deposits--than
similar accounts at nonmember institutions.
The discount rate, too, has a useful role to play as a signal
of policy.

For instance, it can be held back when market rates are

rising to suggest a certain caution about future rate developments to
the market.

The stated reason for tying the discount rate to a market

rate is to reduce the possibility of arbitrage profits when the discount
rate is below market rates.

However, the Reserve Banks already have

careful administrative controls that keep arbitrage opportunities to
a minimum.

Moreover, tying the discount rate to the Treasury bill rate

makes the cost of member borrowing depend in part on Treasury debt management, and the rate could be high or low relative to other opportunities
the bank has for investment.

Even if it were desirable to.tie the dis-

count rate to a market rate, the shifting structure of market rates makes
it very difficult to find any single rate that is satisfactory.

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In any

106
event, the Board believes its flexibility with regard to the discount
rate should not be limited in view of the unpredictability of changing market circumstances and international and domestic econanic
conditions.
The amendment also would require the Federal Reserve to
transfer $575 million of its earned surplus to the Treasury over
two years.

This amount appears in the Board's plan.

But the

program in the Reuss amendment, since it does not offset the membership burden, would be less coatly than the Board's plan.

Therefore,

the amount needed to maintain Treasury revenues in a transition
period would be less than the $575 million required by the proposed
In any event, the Board does not believe a specific

amendment.

transfer of Federal Reserve surplus should be legislated, but should
be left to the Board and the Treasury, since the effect on Treasury
revenues will depend on the particular plan chosen and the period of
time over which it is practical to implement it fully.
Finally, the amendment provides for the collection from
nonmember institutions of data needed to control the monetary
aggregates.

The reports are to be made through the relevant

regulatory agencies.

It is important to note, however, that such

data are needed on a timely basis if they are to be useful for monetary
policy operations.

The amendment should, therefore, allow flexibility

in handling the flow of data, as might be worked out by the agencies.
Mr. Chairman, thank you for the opportunity to present
the Federal Reserve's views this morning.

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The problems with which

107
your Committee is dealing this morning are of crucial importance to the
long-run viability of the nation's central bank and to the health of
the nation's depository institutions and indeed to the national economy.
The problems are exceedingly difficult, but I am confident we can
together find solutions that will serve the public interest well.

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Ch■rt:C

Voluntary Changes In Federal Reserve Membership

Number of banks

JOINING

.....

- -

.+
0

...

WITHDRAWING

I
1971

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1973

I
1975

I
1977

109
Chart][

Percentage of Banks Withdrawing from the Federal Reserve System
By Size ot Bank

Per cent

1970·72
,--

---

Ill I I nl 111111

1973-75

1976-77

0-10

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10-50

50-100

Size class (total deposits, millions of dollars)

Over 100

110
Chartm

Percentage of U.S. Commercial Banks and
Deposits In the Federal Reserve System
Percent

60.

1961

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1965

1969

1973

1977

111
Chartm

Percentage of New England Commercial Banks and
Deposits in the Federal Reserve System
Per cent

0
1961

1963

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1965

1967

1969

1971

1973

1975

1977

112
ChartY.

Relative Cash Asset Positions of Member and Nonmember Banks
Average Ratio of Cash Assets to Total Assets

Ratio

.14

.13

.12

.11

' '-----

'- '- _ _ _ _ ,

NONMEMBERS

.10

' ' ...
'

.....

___ _

.__ ____....__ __._ _ __.__ _ __.__ _ _..,__ _ _.,__ _ _.___ ___, .09
1971

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1975

1977

113
ChartlZI

Profitablllty of Member and Nonmember Banks
Pre• Tax Profits H • Per Cent of Total A11el8

Per cent
1.4

1.3

NONMEMBERS
1.2

1.1

"'----

1.0

1971

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1975

1977

114
Chart:W

Estimated Burden of Federal Reserve Membership

AGGREGATE BURDEN

Millions of dollars

-300

, _ 200

1 - 100

,_
mmm I

AGGREGATE BURDEN AS PERCENT OF
ESTIMATED 1977 DOMESTIC PRE-TAX EARNINGS

Per cent
30

1--

'--

1--

'--

I
0-10

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10-50

I
50-100

100-500

I
500-1000

Bank size class(total deposits, millions of dollars)

0
Over 1000

115
Chartl!Dl

Annual Loss of Federal Reserve Revenues
Due to Attrition Occurring Since 1970
Mi!l:Ons

=·~ j:,Ha~
240

200·

180

120

1971

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1975

1977

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Chart.llt

NOW Accounts as Percentage of
Household Deposit Balances In New England

1975

1978

1977

117
Cha,tl[

Effect of Member lank Attrition On Short-Run Predlctablllty of Monetary Aggregatas
flan .. of Unpredlctable Varlablllty
Percentage points

0
Par cent of 8ank Depoelta Not Subject to Reeerve Requirements

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ChartX[

Estimated Loss of Treasury Revenues, Net of Taxes

Millions of dollars

400

350

COST OF BOA.RD PLAIII

COST OF ATTRITION

250

200

150

COST OF ATTRITION

100

+
0

1979

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1983

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1 /6/78
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
PRELIMINARY PROPOSAL
To Promote Competitive Equality Among
Member Banlts and Other Financial Institutions
and to Encourage Membership in the Federal Reserve System
The continuing decline of bank membership in the Federal
Reserve System and the increasing competition bet.ween banks and other
depository institutions in providing payments services require prompt,
responsive measures.
This preliminary proposal is intended as a means of submitting
a program for consideration and appropriate action by Congress.

Background of the Problem
Section 19 of the Federal Reserve Act provides that member
banlts of the Federal Reserve System are required to maintain reserves
against their demand and time deposits in such ratios as shall be determined by _the Board within specified legal ranges.

In order to satisfy

these reserve·requirements, member banks are required to maintain
reserves in the form of vault cash and balances held in Federal Reserve
Banlts.

Such balances maintained by member banlts do not earn any interest

at present.

By contrast, most banks that are not members of the Federal

Reserve System are permitted by State law to hold a substantial part of
their required reserves in the form of earning assets, such as United
States Treasury obligations, or in the form of balances that would be
held in the ordinary course of business in any event.

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120
member banks incur a burden in the form of foregone earnings on their
required reserve balances.
As a result of the inflation of recent years and the increased
competition between banks and other depository institutions in providing
payments services, more and more banks have become aware of the burden
of membership and have determined that the benefits associated with
remaining a member bank do not outweigh the costs.

Over the past ten
Although

years, a total of 551 banks have withdrawn from membership.

111any of the banks that have left the System are small, there is a growing trend among larger member banks to become nonmembers.

Of the 69

banks that left the Federal Reserve in 1977, 15 banks possessed deposits
in excess of $100 million.

Because of the decline in membership, the

proportion of total commercial bank deposits held by member banks has
by now been reduced to about 72 per cent.
If corrective action is riot taken, a continued, probably an
accelerated, erosion of membership and of deposits subject to regula•
tion by the Federal Reserve can be expected.

This threatens to weaken

the nation's financial system, as more.and more of the nation's pay•
ments and credit transactions are handled outside the safe channels of
the Federal Reserve, as fewer and fewer banks have immediate access to
Federal Reserve Bank credit facilities, as a national presence in bank
supervisory and regulatory functions becomes increasingly diluted, and
as implementation of monetary policy becomes more difficult.

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Proposed Legislation for Universal Reserve Requirements
In order to promote fair competition among member banks and
other depository institutions and to stem the decline in deposits subject to reserve requirements of the Federal Reserve, the Board will
transmit to Congress proposed legislation that would require all depository institutions to maintain reserves against transactions accounts
in accordance with requirements set by the Federal Reserve.

If uniform,

universal reserve requirements on transactions balances become effective,
competition among banks and other depository institutions would be on a

more nearly equal basis.
The Board's proposed legislation would make transactions
accounts--such as demand deposits and NIM (negotiable order of withdrawal) accounts--at all Federally insured depository institutions
subject to reserve requirements set by the Federal Reserve.

However, a

total of $5 million of transactions accounts at these institutions,
whether members or nonmembers of the Federal Reserve, would not be subject
to the basic reserve requirements,

The proposed legislation also

adjusts the existing 3 to 10 per cent statutory range for reserve ratios
on time and savings deposits at member banks.

A reduction in the range to 1/2

of 1 to 10 per cent is proposed for time and savings deposits other
than transactions accounts to provide needed flexibility that would

enable member banks to compete in this area on a more nearly equal basis
with other depository institutions.

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The Board sinrultaneously is considering a program, described
below, whereby the Federal Reserve would charge for certain of its
services and woul<l pay some compensation for required reserve balances,
However, if Congress enacts a requirement for universal reserves, the
Board would need to reconsider whether, and to what extent, its
proposed program of service charges and reserve compensation might
need to be adjusted in light of the effects of such legislation on
Federal Reserve membership, operation of the payments system, and
monetary control,
Proposed Federal Reserve Program
In view of the increasingly acute problems associated with
the decline in membership in the Federal Reserve System that is
attributable to the burden imposed on member banks by competitive
inequality, the Board is also considering a program with the following
principal elements:

(1) restructuring and reduction of demand deposit

reserve requirements, (2) charging for services provided by the Federal
Reserve, (3) compensating for required reserve balances held

Federal Reserve Banks, and (4) transferring part of Federal Reserve
surplus to Treasury during a transition period to offset any Treasury
revenue loss.
The program would provide time for Congress to consider
the issue of payment of interest on required reserve balances,

the Federal Reserve is not able to pay interest on reserves, or
otherwise remove the burden of membership, it would not be feasible

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to charge for services offered by Federal Reserve Banks.

A portion

of reserve balances held by member banks with Federal Reserve Banks
in effect represents payment for these services under current circum•
stances.

Charging for the services, without compensating banks for

the reserves held, would simply increase the burden of membership
and exacerbate competitive inequality.
Reserve Requirement Actions.

Under the proposed program, the

Board would amend Regulation D (Reserves of Member Banks) to simplify
the structure of reserve requirements.

The proposal would also redefine

a reserve city and impose reserve city reserve requirements on member
banks with net demand deposits in excess of $600 million (compared
to $400 million at present).

The structure of reserve requirements

would be revised in two phases as follows:
Proposed

Present
First phase
Size Class
(~ millionl

Reserve
Requirement

0-2
2-10
10-100
100-400
over 400

7%
9~%
1H;%
12¼%
16\%

Second phase

Size Class
(~ millionl

Reserve
Requirement

0-10
10-200
200-600
over 600

91,%
121,%
16½;%

Size Class
(~ millionl

Reserve
Requirement

0-200
200-600
over 600

10%
16\%

It is anticipated that these actions would have the effect of releasing
approximately $5 billion in reserves on an annual basis, with about
$2¼ billion released by the initial adjustment.

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Charges for Federal Reserve Services.

The second element

in the program relates to charging for services rendered by the
Federal Reserve.

The Federal Reserve does not now generally charge

member banks for services it renders in view of the substantial
burden of membership presently incurred by banks.

Member banks "pay"

for Federal Reserve services through the maintenance of reserve
balances with Reserve Banks.

Nonmember banks are now permitted to

use a limited number of Federal Reserve services at no charge.
Competitive equity between member banks and nonmember
institutions requires that all users of Federal Reserve services be
subject to charges established on the same basis.

Moreover, such

charges might encourage more efficient use of check clearing
facilities and provide incentives for innovations that reduce costs.
With explicit pricing, therefore, the opportunities of the private
sector to compete with and improve upon Federal Reserve services
would be enhanced.
In order to assure continued efficient functioning of the
payments mechanism and to avoid major disruption during the transition to a more competitive environment, the Board would follow a
conservative and flexible approach in establishing charges for Federal
Reserve services.

To this end, the System has concluded that its

charges should be competitive with those for comparable services
(when available) in the private sector.

However, the Board would

retain flexibility to alter charges or service policies in order to

meet its responsibilities to maintain a satisfactory, basic level of
1ervice for the nation as a whole and to encourage innovations.

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The Board would use the following general principles as
guidelines for establishing a price structure:
1.

Each Federal Reserve service category for which charges
sre to be assessed would usually have separate prices
by geographic area, activity, and class of work processed.
The price schedule would employ explicit per item charges
and be as simple as possible.

Prices would be adjusted

as the System gained experience with service charges and
observed their effects Jn the markets in which the System
operates.
2.

The System does not contemplate significant alterations
in services provided at the time charges initially are
•imposed.

However, after charges are in place, some offices

might find it nece1sary to revise their operating policies
and prices to maintain competitiveness and to enable the
System to maintain a basic level of service nationwide.
3.

All users in the same pricing zone (typically a Federal
Reserve Bank, Branch or office area) would pay the same
price for a given service.

However, identical services

might not be provided in all areas.
More specifically, guidelines established by the Board for
the pricing of Federal Reserve check and automated clearing house
(ACH) services would include the following:
a.

Charges for check services would be imposed on depositing
institutions.

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Federal Reserve Bank of St. Louis

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b.

Prices for interoffice items deposited locally might
include both a local processing charge and a uniform
national charge.

Charges for automated clearing house (ACH) items could
either be imposed on ACH associations or directly on
financial institutions using the service,

Prices for automated clearing house services would be
set to encourage the use of such services and to
reflect mature volume levels.
It is anticipated that schedules of charges for System

services would be announced for public conments, and implemented
in two phases:
First phase:

Charges for Federal Reserve payments services,
including check processing, check transportation,
and automated clearing house services.

Second phase:

Charges for certain other services, including
shipping of coin and currency to member banks,
transfer and settlement of reserve balances,
and purchase, sale, safekeeping and clearing of
securities,

Based on the present volume of Federal Reserve Bank activity,
and on the direct and indirect costs incurred by the System, it is
estimated that charges imposed for System services would result in
revenue to the Federal Reserve of approximately $225 million annually
in the first phase and about $410-million annually thereafter, The

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Federal Reserve Bank of St. Louis

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Federal Reserve does not anticipate imposing charges for governmentaltype functions it performs, such as conducting bank examinations
and monetary policy and certain activities associated with issuance
and destruction of Federal Reserve notes.
Access to Federal Reserve Facilities.

At present, Federal

Reserve Banks maintain virtually no accounts for nonmember depository
institutions.

However, nonmember institutions may have access to

Federal Reserve operated automated clearinghouse facilities (ACH's).
Nonmember conmercial banks may a~so deposit intra-regional checks
and drafts at Federal Reserve regional check processing centers
(RCPC's).

When charges are imposed for payments services under the

proposed program, the Federal Reserve would permit all nonmember
depository institutions with third party payment powers to deposit
intra-regional checks and drafts at RCPC's.

Nonmembers would pay the

same charges as member banks for services rendered by the Federal
Reserve, and would continue to be required to settle through reserve
accounts of member banks.
Once the proposed program has been fully implemented, and
the Federal Reserve has evaluated the impact of the program on membership and on the functioning of the payments mechanism, the System
expects to provide direct and full access for nonmember depository
institutions to payments and other operational services provided by
Federal Reserve Banks.

Access would be provided on the basis of

equality of treatment with respect to balances held by members and
nonmembers; balances held by nonmembers would be equivalent to the

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Federal Reserve Bank of St. Louis

128
reserve balances of members and such funds would receive similar
compensation.
Compensation for Maintenance of Required Reserves.

The

third element in the Federal Reserve's proposed program relates to
compensating member banks for the maintenance of required reserve
balances with the Federal Reserve.

Member banks are at a clear

competitive disadvantage because nonmember banks generally may
satisfy reserve requirements by holding interest bearing assets
or balances that would be held in the 0rdinary course of business
in any event, and this disadvantage contributes substantially to the
erosion of membership.

In crder to reduce this inequality and to

prevent further erosion in membership, the Federal Reserve believes
it would be appropriate to compensate member banks by paying interest
on required reserve balances.

However, in no case would the amount

of compensation paid to member banks after deducting service charges
collected exceed 7 per cent of the net earnings of Reserve Banks
(before payment of compensation).

The Board will submit to Congress

proposed legislation to formalize this limitation on the bank payment
of interest on required reserve balances.
The Board proposes to phase in the payment of interest
on required reserve balances of member banks concurrent with the
imposition of charges for System services in accordance with the
following schedule:

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rirat phase:

Payment of interest on all required reaerve balance•
maintained at Federal Reserve Banks at a rate of 2
per cent per annum.

Second phase:

Rate of interest payable would be increased to\
percentage point below the average return on the
Federal Reserve System portfolio, valued at book,
for the first $25 million of required reaerw
balances at Federal Reserve Banks,

Based on the

1977 return on the Federal Reserve portfolio, the
rate of compensation on those balances would be 6
per cent per annum,

The rate of interest payable

on required balances held at Federal Reserve Banks
in excess of $25 milliqn would be 2 per cent per
annum.
The Board estimates that interest payments to member banks
-uld amount to about $430 million in the first phase and about
$765 million annually thereafter, based on the current level of
member bank deposits.

Effect on Treasury Revenues.

Since 1947, the Federal Reserve

has paid almost all of its net earnings to the United States Treasury.
A portion of these earnings are attributable to the non-interest
earning required reserve balances that member banks bold at Federal
Reaerve Banks.

Nonmember institutions do not hold such balances and

t1lua their reserve holdings are not a source of Treasury revenue.

,rosr• being proposed by the Board would substantially reduce this

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The

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unequal "tax" borne by member banks.

At the same time the Boan

recognizes the budgetary need to maintain Treasury revenues.
The Board estimates that adoption of the proposed program,
in the absence of universal reserve requirements, would in itself
result in a cumulative net reduction in United States Treasury
revenues on the order of $575-million over a transition period of,
for example, about three years,until the program would be fully in
place.

To eliminate this anticipated loss of revenue during the

transition period, the Federal Reserve would transfer an equivalent
amount of its surplus to the Treasury.

The Federal Reserve's

program, therefore, would not result in any net reduction in the
level of revenues received by the Treasury during the f.aiplementation
period.
With the program fully in place, the net cost to the Treasury
would be expected to be minimal, if there were any cost at all.
Although Treasury revenues would be reduced by about $300 million
per year

as a

consequence of the actions in this program, there would

have been, in any case, a substantial decline of Treasury revenues ln
the absence of the program.

At a minimum, if attrition ln deposits

subject to Federal Reserve reserve requirements continued over the
next four years at the average rate of the recent past, Treasury
revenues would be reduced by about $80 million in the fourth year
and would increase further thereafter,

If the rate of attrition

were at the more rapid pace experienced in New England in recent
years, the loss ln Treasury revenues would be about $200 million by
the fourth year.

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The program could be expected to reduce, if not

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eliminate, such attrition in deposits.

There might even be a gain

in Treasury revenues if the program succeeds in increasing membership.

The gain in revenues would be more pronounced if Congress

enacted the Board's proposed universal reserve requirement legislation,
Result of the Proposal
The Board believes that implementation of the program
presented in this statement is essential to the continued maintenance
of a sound financial system.

Implementation of its various elements

should result in an environment in which financial institutions can
compete on a more equitable basis, should arrest the decline of bank
membership in the Federal Reserve System, and should facilitate the
implementation of monetary policy.

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Mr. MITCHELL. Thank you very much, Chairman Miller, for a very
detailed and meticulous statement.
Chairman Reuss and I are going to defer our questions, to allow
Mr. Stanton to raise a question or two. There is a piece of legislation
on the floor in which he has keen interest.
Mr. Stanton, you are recognized for 5 minutes.
Mr. STANTON. Thank you very much, Mr. Mitchell. Although I
would just clarify. I would hope we would all have keen interest in
the Export-Import Bank. It has come out of our committee, and the
legislation is due on the floor in a couple of minutes. And I would
sincerely hope-I think this is the first time we have ever met when
we have had legislation pending on the House floor before our committee. And I would be strongly objecting if it was not for the fact
that on this legislation before us, half of the battle is, it is an education process for all Members, and so that those who don't have a particular interest in Eximbank or aren't on that subcommittee, would,
hopefully, have a chance to hear Mr. Miller. And I would simply
ask the full chairman of our committee if it would not be possible to
have Mr. Miller_return-I see we are scheduled through about August 11-for at least 1 full day of a wrapup so that we can ask him
questions before we get into a markup.
The CHAIRMAN. I would certainly consider. The gentleman from
Ohio well knows that we are trying to accommodate the Fed's problem.
But there are other issues, and I would hope that this morning we could
move back and forth between the floor. and thus both get education
and legislation.
Mr. MITCHELL. The Chair desires to intervene for just a moment.
e have obtained permission to sit during the time that the House is
under the 5-minute rule on quorum calls and votes. I would hope that
we could go into a kind of platooning system, so that some of us can
go and vote and then return, and then the others will go. It is an
awkward way to do it, but I realize your time is very precious, and
there are certainly very heavy demands on the members of the
committee.
Mr. STANTON. ,v-ell, Mr. Chairman, with the understanding that we
will see you again before this committee before the legislation gets to
markup stage, if it ever gets to markup stage, I will defer any questions
at this particular time. And I appreciate the courtesy that was extended
tome.
Mr. MITCHELL. Thank you.
There is a vote on now. I assume that is to go into a Committee of
the Whole or approve the .iournal or something like that. Therefore,
the Chair would like to continue the proceedings, letting some members
go over and vote, then others can go.
The Chair will recognize Mr. St Germain, the cochairman of this
hearing, for 5 minutes.
Mr. ST GERMAIN. Thank you, Mr. Chairman.
Many of us share Chairman Reuss' concern about the Federal Reserve's approaches to its membership problems. And I feel the chairman has provided real leadership in bringing this issue before the
committee in a force:fnl and expeditious manner.
I know that you, Chairman Miller, are very anxious to see that these
questions are resolved and resolved quickly. We definitely do under-

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stand your perspective. You are doing an excellent job at the Fed, and
I am anxious that we do get this behind us, so that both this committee
and the Federal Reserve can move forward on other issues.
To be quite frank, I have trouble with the entire membership ques•
tion. I find membership by private institutions in a Government agency
to be somewhat of an anomaly, though I realize it is essential for the
Federal Reserve to monitor the banking system and to have access to
data to carry out its monetary functions. But I am not sure that this
is enhanced by membership. I have trouble with an agency charged
with massive regulatory functions anxiously soliciting the people it is
regulating to become members.
I think we would be appalled if the Federal Power Commission came
to the Hill asking to establish a membership club with voting rights for
Gulf Oil and Mobil, so that they could better maintain a check on oil
reserves. And I would not want the FCC setting up membership for the
major broadcasting networks. With two-thirds of the boards in the district Federal Reserve banks selected by commercial bankers, the membership of the Federal Reserve creates a real conflict of interest
situation in the minds of some of us.
We cannot deal with these now. But this debate over membership
does indeed throw a spotlight on the gerry-built structure of the Federal Reserve System and built-in conflicts between its regulatory functions and its bank membership, all structures, incidentally, which were
in place before you arrived on the scene, Mr. Miller.
In this era of proposi,tion 13, I think that we can all agree that the
Congress is going to probably move with great caution on any proposal
to pay out hundreds of millions of dollars to banks so that they will
keep their membership in the Federal Reserve. I feel we must have
sound, hard justification, evidence that this membership has benefits
for the public and not just the Federal Reserve. And I feel that any
payment of interest to large banks on their reserves must be accompanied by some kind of assurance that individual depositors at these
banks will receive some benefits.
Now, if we are going to pay inteJ.1est on reserve deposits of the banks,
then perhaps the banks should oegin to pay their customers interest on
their deposits, their demand deposiits. I am encouraged to see support
for the idea that banks should pay for services they receive from the
Federal Reserve, particularly if they are going to receive interest payments on the reserves.
Here again, the committee needs to take a look at some basic questions: Whether the Federal Reserve really should be providing all of
these ranges of services to banks. Here again, we have an agency client,
a~ency membership, agencv customer relationship, revolving around
these services, many of which we feel can be provided by private
enterprise with no necessity involving the Federal Reserve.
While we probably have to deal with these questions on a short term
basis, I think this committee has an obligation to look at the longrange issues and try to move the Federal Reserve to a point where it is
dealing at arm's length with the bankers.
I unfortunately have to get over to cast my vote, and I shall return
very expeditiously.
Mr. MILLER. Thank you very much.

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Mr. St Germain, may I just point out that I certainly concur with
you: I think the Board would be delighted to solve the monetary problem on a broader base by imposing universal requirements. That would
set up an equal competitive basis without the membership "solicitation"
aspect you mentioned.
I certainly hope that we can also understand that this is not a case
of proposing to pay out hundreds of millions of dollars to banks in the
abstract; we are proposing an equitable "tax." We should tax everybody the same way in order to reduce the competitive imbalances and
so that at least all financial institutions have the same chance to seek
to serve their customers. I think we all understand this. We have to find
a way to address the problem, and we appreciate every input we can
get in finding our way through these difficult issues.
Mr. ST GERMAIN. Thank you.
Mr. Chairman, I am going to excuse myself.
Mr. MITCHELL. Chairman Miller, on pagl\ 6 in your testimony, you
indicated that the Congress really tried to set up requirements that
would prevent large banks from dominating the Federal Reserve
System, and that was quite an accurate statement.
But, I guess my area of concern is that though the large banks are
beginning to leave the Federal Reserve System, it is the smaller banks
that are leaving the System in greater numbers. I think you would
agree with that. Is that correct i
Mr. MILLER. That has been the pattern, Mr. Chairman, but now
we are experiencing increasing loss of membership among large banks.
But you are absolutely correct; smaller banks have been leaving in
greater numbers in the past.
Mr. MITCHELL. It seems to me that your restructuring of the reserve
requirements would clearly give a ~reater break to the larger banks,
and I just don't understand why, i£ there is -a larger withdrawal of
the smaller banks, why the smaller banks shouldn't be given a greater
break under your restructuring of reserve requirements.
Mr. MILLER. Mr. Chairman, we have submitted to your staff a schedule which is our best estimate of the effect of the program on various
sizes of banks. The net effect on profits before taxes would be the
greatest for the small banks; you must combine both the reserve
requirements reductions with the payment of interest on reserve balances and the value of services that will now be charged for.
Our estimate is that banks in a class below $10 million would show,
on average, -about a 16 percent improvement in their pretax earnings,
while banks in a class of $1 billion and over would show only 6 percent
improvement. So our plan is geared toward helping the smaller and
medium size banks the most. As you will note, our limitation on the
payment of interest to 2 percent on required reserve balances of over
$25 million means that a bank gets a great deal less benefit the larger
it is. Our reason for doing that is that we believe that some of the
larger banks do get more benefits-although maybe not measurable-from being members of the Federal Reserve than some of the smaller
ones. So we thought that the plan should favor the smaller
institutions.
Mr. MITCHELL. My problem with your statement is that you indicate
that the 2-percent limitation would be helpful to the smaller banks,

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but earlier you indicated that you had wanted us to drop the 2-percent
limitation.
Mr. MILLER. Mr. Chairman, we propose to pay only 2-percent interest on required reserve balances over $25 million. We would have only
so much money to spend, and this is how we would propose to spend
it. But our suggestion was not to legislate this Hmitation. If it were
legislated, of course, we couldn't make a different percentage break
5 years from now. We would always be stuck with the break at 2 percent on deposits of over $25 million.
I want to point out one other thing. You asked about the change
in reserve requirements and maybe this wasn't clear in my answer.
You see, most of the small banks now maintain the minimum reserves
required by law; we can't reduce them further. That is why we have
to use other techniques to help the small banks.
Mr. MITCHELL. Or you have the alternative of changing the law.
Mr. MILLER. Yes; if Congress wanted to lower the minimum, that
would give us more room to do something; there is no question of
that. But we were operating within the present statutory boundaries
in proposing this particular plan.
The CHAIRMAN [presidingJ. Mr. Steers, do you have any questions?
·
Mr. STEERS. No,Mr. Chairman.
The CHAIRMAN. Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman.
Mr. Miller, I appreciate the remarks you have made this morning
and your concerns and our concerns about the erosion of membership in the Fed. In your statement you addressed the question of
the Federal discount window and the arbitrage profits and apparently from what I read in the statement it sounded as though you
recognized that as being a factor, but you tried to keep them at minimum. I think that was the word that was utilized.
Have you done a study on that, you know, as far as the discount
window? We have some graphs that I was looking at, and perhaps
there is one in your data on the same. I did not review the graphs
closely, but what I have seen is that the discount rate tends to generally
floor, and it sometimes is below the market, and I guess that is where
we run into the prdblems.
Sometimes it is above the market. Has the Fed done any type of
analysis of the type of profits that are made with regards to that?
You say they are kept at a minimum. What does that mean? Have
you done any type of evaluation of member banks in the use of that
window as to the amount of profit that is made or the amount, on the
other hand, of loss incurred by member institutions that use it?
Mr. MILLER. We all know the purpose of the discount window. It
is not there for the purpose of giving advantageous rates on bank
borrowings or for making profits for the Federal Reserve. It is there
as part of the mechanism for liquidity and for adjustment.
The discount window is administered very carefully by the Reserve
banks so that it will not become used for the purpose of a bank
getting a. break in rates by constant borrowing.
The discount rate is usually alined, in due course, with the market,
so that when interest rates are rising, it would normally tend to run
below the Federal funds rate, which is the rate charged by banks to

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other banks for borrowing for reserve purposes. And running below
slightly as it does, it is important for the Federal Reserve to be able
to adjust the discount rate-to let it lag behind sometimes to make
clear that general caution is needed in the upward trend of rates and
also to make funds available for the adjustment process when there
is a tightening of credit to enable banks to get their portfolios, investments, and securities in line with market rates without being under undue pressure.
As far as the amount of profit is concerned, I believe that in 1977,
Federal Reserve earnings from the discount window were about $25
million out of total earnings of $6 billion. That is a relatively insignificant amount, so the benefit in earnings to the Federal Reserve is
quite minor in relation to other Fed income.
For example, we are talking about charges for services that would
run a little over $400 million or on that order of magnitude. So,
"profit" is really a small item the way the discount window is
administered.
Mr. VENTO. Do you think it offers any inducement to members? Is
it a benefit to members or not?
Mr. MILLER. Its liquidity feature is extremely important.
Mr. VENTO. So in terms of looking at the services that are offered by
the Fed, it represents a substantial service, does it not?
Mr. MILLER. It represents a substantial service to be able to maintain
liquidity and keep your business going; yes.
Mr. VENTO. The thought was that we were going to provide some
other inducements in terms of benefits for membership, such as interest that that could be considered, but your suggestion is, it is im•
portant to monetary policy, and I note the chairman's comment that
you did not vote in the majority on the last discount change.
Was it set improperly at that time, do you believe?
Mr. MILLER. In hindsight I think it probably was the correct decision. At the time I wanted to see a little more data on what was
happening to the aggregates. We had moved rather rapidly in tightening up, and I thought it was appropriate for us to get a little more
data. In relation to market alinement, the rate should have gone up.
My thinking was, "Let's be careful about what's happening in the
whole economy and move cautiously and see the data first."
I thought we should wait a little. As it turned out, the aggregates
were quite strong, so I would have to give credit to my associates who
were able to perceive that and voted for more rapid action.
Mr. VENTO. Of course, we have a number of legislative proposals.
One provides for reserve requirements. I paid special attention to your
comments about what your intention was with the bill in terms of
providing universal reforms.
I think the point that I would key in on, and I think there is a difference between what you said and what the bill says, is the rule and
regulation power, and the very fact that you have the power to modify
that in a very substantial way in changing the reserve requirements
of nonmember institutions. I think it is very apparent in that legislation that there is a tremendous extension of responsibility mandated
at the Fed.
Apparently, you feel properly mandated-but that I have concern
about, and to some extent maybe it is based-I think we are really deal
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ing with the Fed regulatory responsibility in terms of financial institutions, not really primarily with monetary policy.
Only tangentially are we dealing with that, and the question comes
back: Is there anything less safe about-or what is wrong with the
FDIC regulation i Maybe the Federal Reserve System shouldn't have
as many banks in terms of membership. This question comes to my
mind, so what about the proposal that you have made for universal
and the rules and regulations impact upon these other financial institutions, regulatory roles.
And is there anything less safe about the way they are operating
now@ Are there more failures or less failures~ This gets back to a
question that the Chairman raised initially in his statement. I think
it deserves an answer.
Mr. MILLER. Congressman Vento, let me break that question down
into several points. First, when the Federal Reserve System was established in 1913, my guess is that a very high percent of the transactions
accounts were maintained in banks that became members, and therefore that the decision of Congress to give the Federal Reserve some
flexibility in setting the reserve requirements for the Nation's entire
transactions system was a conscious one.
Tliat has changed because of institutional changes, but I am not sure
there was ever a corresponding change in congressional intent. I think
it would be wise to reinstate a system where the National Government,
if you will, does look at the entire system, establish equitable reserves,
and have some flexibility to adjust them to economic and money
conditions.
We do not, however, suggest that the Federal Reserve also be given
authority to regulate nonmembers. We are not suggesting that that
be done at all ; we are not trying to extend, and do not desire to extend,
our regulatory base beyond the control of reserves.
The third point is that the FDIC insures deposits up to a certain
amount, but this does not insure liquidity in the banking system. If a
large clearing bank which is a nonmember and has a network of correspondent accounts of nonmembers should get into trouble-as we
have seen happen in the crunches of 1973 and 1974-then the whole
pyramid could be in trouble. The customers would never lose their
money, but the liquidity crunch would come down on those banks.
They would suddenly be unable to use their funds in the ordinary
course of business, and suddenly the process of doing business and
supporting their customers in commerce and industry could be very
much in jeopardy. That doesn't mean there is any ultimate loss or
any lack of safety for individual deposits up to the $40,000 limit of
insurance, but it does mean a loss of liquidity.
A member bank can come immedi•ately to the Federal Reserve. As
you know, a few years ago, the Federal Reserve made $1.7 billion available to assure very quickly that the liquidity of a large bank was
maintained. The Federal Reserve lost no money; it charged interest,
but it solved the bank's liquidity problem.
Mr. VENTO. My time has expired, but historically, I guess, in the
thirties there was a great modification in spite of the discount, when
in spite of the liquidity, a third of the banks went out of business.
So, I think the power that you ascribe to it, while maybe it is a factor I think it is hardly the potential dealings with major economic disruptions in terms of that historically.

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Now, maybe today there is some persuasion that could be brought to
bear that could demonstrate the argument, Mr. Miller, that you are
presenting to us.
My time has expired. I hope tha;t I can submit some questionr in
writing.
Mr. MILLER. I would be very happy to answer them. I did not answer
your question about bankruptcy. With the chairman's permission, 1
would just point out that since 1947-which is as far back I guess as
we have data-our data show that .72 percent of the average number
of member banks failed, while 1.33 percent of nonmember banks
failed-a much higher percentage of failure among nonmembers.
Mr. BROWN. On that, Mr. Miller, do you have the figures of assets
of the banks i
Mr. MILLER. Yes, we submitted a complete list to your committee.
The CHAIRMAN. That is in the 16 questions.
Mr. MILLER. It is. I could take the time to go over them.
Mr. BROWN. All I was going to say, Mr. Miller, was since you
are talking about numbers of banks, showing the disparity, .72 versus
1.3Mr. VENTO. If the Chairman would just indulge me, I think the basic
question here is why can't nonmember banks use the Federal discount
window today. If it is a small service and it is important to liquidityand we are talking about making up reserve requirements and they are
so essential-why don't we let nonmember banks then use that discount
window and aim that type of control there i
The CHAIRMAN. The time of the gentleman has expired, but he will
be re-recognized.
Chairman Miller, I believe you are a golfer, among other things, are
younoti
Mr. MILLER. I am accused of using a wood in the wrong places, but
I am a g-olfer, yes.
The CHAIRMAN. I would just guess, too, that the country club which
you belong to, due to inflation and higher salaries and everything
else, has had to raise its dues and initiation fees in recent years, reflecting g-eneral trends.
Would that be about true i
Mr. MILLER. That is the case in most clubs, yes, sir.
The CHAIRMAN. And wouldn't it also be true-I don't have the
ch~rts to back me up-but hasn't there been some erosion of membership among country club members because of increased dues and
charges and inflation and this and that i
Mr. MILLER. That it is an interesting point. I don't know, but I suspect there has been an overall increase in membership. But one thing
for sure, there has been no increase in the right of nonmembers to
play without paying. [Laughter.]
The CHAIRMAN. If you and I could have access to some $500 million
a year of the taxpayers' money, increase the Federal deficit though it
did, and could subsidize the present members of golf and country clubs,
not to resign their membership, it probably would have a salutary
effect on membership maintenance, would it not i
Mr. MILLER. That is not the purpose of our plan.
Our preference is to try not to look on this problem as one of mem-

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bership. Membership illustrates the limitations of our present system,
but perhaps it is just as well-perhaps preferable-to solve our problem by imposing universal reserve requirements so that those who do
have the privilege of providing banking services to the public are all
on an equal basis, so that all pay the same dues and have the same
privileges.
The CHAIRMAN. Call them what we will, it is in this world of power
in which the Congress and the Federal Reserve and the Supreme Court
and the administration all live, it is true that there is a question of
political power and clout involved here, is there not?
For example, the Fed becomes stronger and more powerful as it retains and aggrandizes its membership list. It is also true that as the
Fed retains or prevents the defection of members, it is able to assume
regulatory authority or control over them which perhaps would go to
some other agency like the Federal Deposit Insurance Corp. otherwise.
My question is: Since, in fact, 72 percent of the Nation's banks don't
now regard membership as an intolerable burden, despite which you
and I think that something more should be done to make monetary
control firm and forceable, can we really justify spending $500 million
or so of the Federal taxpayers' deficit-causing dollars in interest subsidies to all member banks without discriminating between those
banks for whom the cost of membership exceeds the benefits and those
for whom they don't?
I think that states my difficulty about as well as I can.
Mr. MILLER. Mr. Chairman, I don't believe there's anything about
power in our proposal.
It certainly makes no differC>nce to the Federal Reserve whether the
monetary problem is solved in terms of preventing withdrawal of members who are subject to our reserve requirements or legislating a national financial policy that imposes reserves on nonmembers; we would
prefer the latter. We do not seek to expand our regulatory control over
anyone, and there is no reason in the world that our monetary authority
could not operate-as it does in many countries-by merely requiring
that all institutions be subject to its monetary control; Federal Reserve
regulatory control is not necessary.
The other point I would make, Mr. Chairman, is that this is not an
exercise in trying to subsidize banks. The System as it was adopted by
Congress allows for optional membership and even allows for rechartering of national banks as State nonmember banks. All you have to do
is look at chart XI which compares the cost of trying to correct this
problem with the cost of not correcting it; you will see that the costs
converge and that we are not subsidizing anyone. After all, how could
it be called a subsidy when a bank that elects to leave us and take the
money we are holding could earn interest on that money at the full
market rate?
We are proposing to pay less than that. We are giving some benefit to
members, but we are not requiring that anybody become a member. We
would like the solution to be universal reserves. I am sure Congress
might want to couple a universal reserve requirement with payment of
interest--even to nonmembers-so that at least the earnings otherwise
foregone would not show up in the cost to their customers of doing
business. That would reduce the interest rates that banks and other

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financial institutions must charge and, therefore, work in favor of
some of the other objectives we all share.
The CHAIRMAN. Well, I thank you for your response.
I would just have one very quick question.
Do you agree with my fundamental search in these hearings for that
kind of a solution to the problem of a sound dollar which will have
the least possible deficit-increasing impact on the American taxpayer?
Mr. MILLER. That is correct. You and I, Mr. Chairman, have exactly
the same objective. We may approach it differently, and we may make
different predictions about the future. My guess is that without some
form of solution, the Treasury will have bigger deficits because there
will be loss of membership and loss of revenues from members. The
plate we pass around won't be so full.
But if we correct the problem, we will work in the direction of
avoiding larger deficits, and we will gain, I think, a better system; a
system more attuned to the eighties, nineties, and the 21st century; a
system that can evolve-that isn't revolutionary, hut evolutionary. We
need to recognize in a constructive way the competitive environment
that is developing and causing institutional changes in money and
credit; we need to respond to make it a healthy, workable, competitive
system.
The CHAIRMAN. Thank you, Mr. Miller. My time has expired.
Mr. ST GERMAIN [presiding]. Mr. Brown.
Mr. BROWN. Thank you, Mr. Chairman. Thank you, Mr. Miller, for
being with us this morning.
Chairman Miller, I have not had an opportunity to go over your full
proposals, but when you talk about universal reserve requirements,
when you then flesh that out by saying that maybe in connection with
the establishment of universal requirements, there could be something
done about mandating the payment of interest, it seems to me that
there is a component that is missing which has been incorporated in
other legislation, and that is the component of an advisory group to
the Fed which would consist of State banking agencies.
If we are going to, in effect, create an umbrella over all of our financial institutions and we are going to establish reserve requirements
for nonmember State banks, for all institutions, especially if you are
going to mandate the payment of interest, for instance, on reserve
requirements not held by the Fed, that then there ought to be some
kind of input from the other side of our dual banking system.
Does your proposal, or in your discussions have you thought about
that?
In the International Banking Act, of course, you know we do do
that.
Mr. MILLER. Yes, sir.
Congressman Brown, we have not studied that.
I would say, however, that there may be some misunderstanding.
Certainly, we are not proposing to mandate the payment of interest
on reserves other than required reserves held by the Federal Reserve.
We are not asking States to pay out money.
Mr. BROWN. I thought a minute ago just in your very last colloQuy
with Chairman Reuss that you said in connection with establishing
universal reserve requirements, that it might be well to provide for
the payment of interest even by nonmembers.

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Mr. MILLER. If the Congress adopted both of our proposals, we
would have both universal reserves and the payment of interest by the
Federal Reserve on the required reserves held with it; that is correct.
But neither proposal would require States to pay interest.
Mr. BROWN. I misinterpreted your last statement.
Mr. MILLER. I may have been a little fuzzy. I hope my statement is
clear now.
Mr. BROWN. But it seems to me, in connection with the establishment
of reserve requirements, you also have got to, in effect, define what is
an appropriate reserve, what it can be held in, and-or else your reserve requirements would be meaningless, and when you get into
those kinds of things, shouldn't you have some input from the other
side of the banking system?
Mr. MILLER. Under the present system, what is counted for reserves
is coin and currency held in the vaults, plus cash balances held at the
Federal Reserve. I don't think that system should change.
Mr. BROWN. But Chairman Miller, I am not talking about the Fed
members. I'm talking about the nonmembers who are going to have
universal reserve requirements. I understand that you would require
of all institutions, members or nonmembers, but then someone has to
determine what is a proper reserve, and States determine that presently for the nonmembers.
Mr. MILLER. Perhaps I am not being clear, but I am trying to
explain that under a universal reserve requirement there would not
be an option to hold reserves in interest-bearing securities. If the Federal Reserve had that provision now, we wouldn't have a problem.
You see, the burden on the Federal Reserve member as compared to
the State nonmember is that the nonmember may now hold reserves
in interest earning forms.
Mr. BROWN. Then your universal reserve requirement would be that
it would have to be held within the Fed system.
Mr. MILLER. Yes; held with the Fed, the same as for members. But
there would be no regulatory authority over nonmembers. Let me come
to the bottom line: I have no objection to considering your suggestion.
I have not done that but I would be glad to consider whether we need
to set up a consulting arrangement with the States.
By instinct I believe in coordination and in working together; I
have no problem with that. I don't know how your suggestion fits in
this context. I was trying to make clear that this proposal calls for
reserves to be held at the Fed.
Mr. BROWN. I was under the impression you were talking about
universal reserve requirements, otherwise the establishment of an
amount but not necessarily to be held by the Fed, and I understand
that now.
Mr. MILLER. Reserves would be held at the Fed.
Mr. BROWN. I think you in your statement said, that nonmembers
would not have access to'the discount window.
Mr. MILLER. That is correct, other than on the same terms as exist
under current law.
Mr. BROWN. Well. as I recall, in the International Banking Act,
when we said that all State or federally chartered must maintain reserves with the Fed, that we said that they would have access to all
Fed services in that legislation, did we not i

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Mr. MILLER. Yes; that is correct.
Mr. BROWN. Well, why would we say that a foreign bank shall, by
being required to maintain a reserve with the Fed, have access to
all services, including the discount window, but a domestic nonmember bank required to do the same thing would not have access?
Mr. MILLER. There is no reason why we could not decide that the
proper system would be to have universal reserves and universal access. If we did, I think the consequence would be to discontinue capital stock investments by members because they would be the only ones
doing that.
But there is nothing wrong with your line of reasoning.
Mr. BROWN. Thank you. I wish you would look at it.
Is there anything to stop the Fed in connection with its rendition
of services to, in effect, become competitive cost-cutting so as to move
commercial correspondent banks out of the business?
Mr. MILLER. Just the reverse would happen, I think.
What would be best-Mr. BROWN. Since the Fed doesn't have to make a profit whereas
commercial banks d o Mr. MILLER. Our proposal on pricing is to price competitively, but
not to undercut the market. Our view is that it is healthy to have the
Federal Reserve provide services so as to insure a secure system of
payments and the basic services that are essential to a safe central
bank. But we also look with favor upon the growth of optional, innovative, cost-effective techniques for handling services. And we think
pricing would bring about that trend and would probably increase the
participation of the private sector in the performance of the services.
Mr. BROWN. I still have a further question, Mr. Chairman, but my
time has expired, and I don't want to impose upon the Chair's generosity, unless the Chair will allow me one further question.
Mr. ST GERMAIN. Briefly.
Mr. BROWN. Just one final question.
As I recall, the studies I have seen say that small banks, small member banks, disproportionately use services compared to reserve requirements, which means that in connection with the service charge vis-avis earnings on reserves, the small banks would be impacted disproportionately to large banks.
Any comment 9
Mr. MILLER. I don't believe that is true.
Our studies indicate that the large banks use the services more ; they
use the access to Federal Reserve services to provide services for their
correspondents.
You will find that our services are actually used more by the large
banks.
Mr. BROWN. As a proportion of reserve requirements?
Mr. MILLER. I will put it another way.
U~der our proposal, net benefit-taking into account the reserve
reqmrement cuts, the compensation payment, and the charges for
services-will be proportionately greater for small banks than for big
banks.
Mr. BROWN. I guess we have been looking at different studies then.
Mr. MILLER. I will recheck that, but that is my impression.

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[ Chairman Miller subsequently submitted the :following information :for inclusion in the record o:f the hearing:]
To date, the evidence on what size bank receives more services per dollar of
reserves is incomplete and somewhat contradictory. There are at least three
studies which address the utilization of Federal Reserve services by size of
bank:
.
1. A Board staff study released in June 1977,1 found that while all sizes of
member banks suffered some burden of membership, the benefits of Federal
Reserve services were proportionately greater for large members than for small.
2. A study by the Federal Reserve Bank of St. Louis; based on a survey of
member banks in the Eighth Federal Reserve District, also concluded that the
implicit return on required reserves-calculated as the value of services used
divided by required reserves-increased with bank size.
3. However, a study by the Federal Reserve Bank of New York,3 based on a
sample of Second District banks, reached the opposite conclusion: that the
annual return on required reserves of small members was proportionately greater
than for large members.
The contradictory conclusions fro;n these studies are probably due in part
to the alternative methodologies employed as well as the different samples on
which the studies are based. In order to provide more information on this issue,
the Federal Reserve has conducted a System-wide survey of member bank
usage of check clearing services. The results of this survey will be available
in the fall.

Mr. BROWN. Thank you very much.
Mr. ST G1mMAIN. Mr. Miller, in addressing one o:f the questions
to Mr. Vento, you gave some statistics on bank :failures :from 1943 or
1945 to date.
I asked the staff subsequently to check something out :for me, and
o:f course, I have done a little work in my subcommittee on bank
:failures. It depends upon how you read the numbers, but the staff
confirmed to me-and your staff might want to check this out-that
o:f bank :failures :from 1975 to 1977, 86 percent o:f the assets o:f the
:failed banks were in member banks, so that I don't think we would
want to pin anything on the number o:f :failures o:f members as against
nonmember banks, because those numbers can be jumbled around to a
great degree.
Mr. MILLER. You could always pick a short enough period to answer
the question in the way you want; statistics are very convenient sometimes.
Mr. ST GERMAIN. That is right.
Mr. Lundine~
Mr. LuNDINE. I have two questions that I think are related.
First o:f all, cannot monetary policy be conducted solely by open
market operations~
·
Now, I am not asking i:f that is desirable; I am asking i:f it is
possible.
And the second question I have that I believe is related is: are
universal reserve requirements really necessary :for monetary control~
Mr. MILLER. To answer your first question, i:f Congress should take
away all o:f the other instruments o:f monetary policy, certainly open
1 "The Burden of Federal Reserve Membership, NOW Accounts, and the Payment of
Interest on Reserves."
• "Utilization of Federal Reserve Bank Services by Member Banks: Implications for
the Costs and Benefits of Membership," R. A. Gilbert, August 1977.
3 "A Study of the Relative Usage of Federal Reserve Services by Member Banks In the
Second District," S. R. Hume and K. S. Russell, January 1978.

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market operations alone would work. They would have to. So in terms
of, not desirability, but possibility, the answer is yes.
I have to footnote that by saying that, as far as whether that would
be desirable, everybody's view is to be very cautious about doing that.
We cannot predict future circumstances, and there certainly will be
times when other techniques should be used. As a matter of fact, I
think we should always be looking for better ways to conduct monetary
policy, and while ''the desk" has been the primary tool recently, it
may not always be.
I pointed out that if there were a low level of debt financing by
the Federal Government-if the Federal Government reduced its deficits and had less securities outstanding-it might be more difficult
to exert monetary control through the open market. We might need
reserve requirement changes as one of the means to put credit in and
take it out of the system.
Second, universal reserves would greatly aid in conducting monetary
policy, because they would reduce the degree of unpredictability of
the aggregates.
On chart X, we were endeavoring to give you some idea of the
fact that the greater the percent of deposits subject to reserves, the
more predictable the money figures. If we had universal reserves, the
point of unpredictability would be on the left side of the chart; that
is, the degree of variation in predicting M 1 and M2 would be quite
small. As you move to the right on that chart-that is, as the percent
of deposits not subject to reserve requirements increases-the degree
of unpredictability goes up very rapidly. That, of course, happens
because· as the transactions flow between member and non-member
banks, we have control only over the members, and it becomes more
and more difficult to exercise monetary policy because we are not
sure of its impact.
So the closer we come to universal reserves, the better our ability
to predict the consequences of our policies and therefore to make
more certain policy and more sound policy.
Mr. LuNDINE. On page 16 of your statement, you say that: "The
discount rate, too, has a useful role to play as a signal of policy. For
instance, it can be held back when market rates are rising to suggest
a certain caution about future rate developments to the market."
Several weeks ago the Board voted on discount policy, and it was
reported that you were voting in the minority in that case.
What kind of a signal were you trying to give at that time? And
what kind of a signal do you anticipate that the majority was trying
to give?
Mr. MILLER. The majority felt that the conditions of the market
were such and the conditions of the economy were such that the discount rate should be raised to aline it more closely with the Federal
funds rate.
At that time, I felt that we had already taken a number of steps to
tighten monetary policy and that it would be wise to get a week or
two more of data-actual reports of what was happening to the aggregates, where there is some lag in effect from our policy-before
making that decision.
I was not trying to signal to anyone. I was merely trying to wait
for a little more information before I made my judgment.

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Congressman Lundine, as far as using the discount rate as a signal-the point I make on page 16 of my testimony-just think back
to the credit crunch of 1974 and the kind of wild gyrations we had,
with an inverse yield curve and short term rates being higher than
long-term rates. That was a very unsettling period.
At that time, the Federal funds rate went up to 14 percent, I think,
but the discount rate never went over 8 percent. If the two were linked
together, you would have an erratic situation, and the ability to
manage a credit crunch would be greatly lessened. In 1974, on the
other hand, the Federal Reserve was able to make funds available to
insure liquidity at a discount rate that did not aggrevate the already
difficult circumstances. So I think there are periods when we need
that management ability.
Some countries have linked their discount rate to the market; I
know Canada did between 1956 and 1962, but has now uncoupled
the rates based on this experience. They felt they had lost something.
We talked to the Governor of the bank the other day and asked him
about this-since the issue was coming up here-and he said he
was one who favored getting back control over the discount rate.
As another arm of policy, he found it very helpful and, lacking it,
he found himself at a disadvantage. So Canada has reversed itself, one
example of ex;perience from which we might learn. The United
Kingdom has recently uncoupled its rates, too.
Mr. LuNDINE. Thank you, Mr. Chairman.
Mr. ST GERMAIN. Ms. Oakar.
Ms. 0AKAR. Thank you, Mr. Chairman.
Chairman Miller, throughout your testimony you have defended
membership in the Federal Reserve on the grounds that it appears
to insure safety and soundness of the banking system, but on the
basis of data, we find that from 1973 to 1977, 86 percent of the assets
in failing banks were in member banks.
Dollar for dollar, don't you think this attests to the relative safety
of independent, nonmember banks 1
Mr. MILLER. That was a very traumatic period, and of course, one
.or two large member bank failures in a period of very serious economic shocks could distort the figures. As was just mentioned, those
figures certainly would indicate that membership itself does not prevent bankruptcy; indeed, it doesn't and it shouldn't.
But what membership did, of course, was to insure tihat the seriousness of consequences to the banking system was minimized. The fact
that there was a very orderly way of handling that situation, with so
little disruption, was greatly aided by the immediate availability of
the window and the immediate possibility of using Federal Reserve
resources to make adjustments and reorganize.
So one view is to number the membership :failures, but the other is
to analyze the consequences of a :failure. When there is a failure, there
is the safety of the immediate availability of Federal Reserve resources.
Ms. 0AKAR. But you would agree that most of the failures happen to
be members.
Mr. MILLER. In that particular period, yes. Over a longer period,
no. And, of course, as I said, you just need to have a couple of failures
of banks with large assets-which you will rooall was the case during

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that period-to bring the ave,rage figure up, and so there is some statistical distortion for that period.
Ms. 0AKAR. Chairman Miller, it is true that the larger banks traditionally do belong to the Federal Reserve, and on that basis I want
to ask the following questions.
Can you tell me how the following payments would improve monetary control, promote equity, and help the membership problem. Just
using your estimates, which ·are based for some :mason on a Treasury
bill rate of 4.55 percent, the payments under your proposal, H.R. 13477,
would be $26 million to the Bank of America, $26.3 million to Chase
Manhattan, $15.2 million to Citibank-the 10 largest commercial banks,
$146.2 million, and all of this just in the first year of your plan, and
it appears tha,t it would grow as kind of ·a yearly gift to the biggest
banks.
So how would this promote equity 1
Mr. MILLER. The larger banks have been members of the Federal
Reserve because of the number of advantages we ha.ve mentionedthe discount window, our services, the availability of a complete package of benefits.
As you say, this payment is for the first year alone, and depends
upon the size of the bank and its deposit,s. But you must remember
that when one tries to alleviate an inequitable tax-a tax that £alls
only on members and not on others-one can't say that just because
a bank is large it should not get its proportionate share of relief. If
we had •a tax cut for corporations in America today, it would apply
to large corporations and to small corporations.
If there were a 1 percent tax cut in America today-the 1- or 2- or 3percent cut that is being looked at favorably now by CongressGeneral Motors would get more dollars' worth of tax reduction than
would a small corporation, but that's because General Motors is paying more taxes and therefore its 1 percent reduction is greater in
dollar terms. That is analogous to this proposal.
The Bank of America at the end of June 1977 had $1¼ billion
deposited with the Federal Reserve and it earned nothing on that
money. If it left the system it could pick up far more money than
under our proposal just by investing that amount.
So, Congresswoman Oakar, I hope that we won't let size distort
what is a natural consequence of simply trying to treat everybody
alike. Large banks, whether they are members or nonmembers, must
be treated the same way if we are going to have equity and fair
competition.
Ms. 0AKAR. Thank you, Mr. Miller.
Just one quick comment.
Using your analogy of larger corporations and the across-theboard approach and two-tiered taxation, larger corporations, however-large banks have other advantages, and I think that has to
play into the analysis, also.
Mr. MILLER. Of course; that is why we are proposing to pay only
2-percent interest above $25 million. Take the case of B:in.k of America. If we paid 6 percent, the return would be $75 million, but we
would be paying around $26 million under this proposal. If you were
a small bank, you would get 6 percent on all reserve balances.

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If you are the Bank of America, you get one-third of that on
reserve balances over $25 million. So we have already skewed payments toward smaller banks.
Ms. OAKAR. Thank you. My time has expired.
Mr. ST GERMAIN. Mrs. Fenwick.
Mrs. FENWICK. Thank you, Mr. Chairman.
Chairman Miller, I have sort of a basic question I would like to
ask you.
What is necessary for the sound dollar and the sound economy
of our country?
Does it serve it better to have homogeneous banking institutions,
or does it serve it better to have a variety of financial institutions
to serve different purposes?
Mr. MILLER. It serves our economy better to have a variety of institutions, provided we have equitable treatment and fair competition. If you have a homogeneous system, you may also find you have
a petrified one; I think we are in a living and changing world.
Mrs. FENWICK. I was thinking of regulation Q and all of that.
Mr. MILLER. Yes; this system should have equity but permit different institutions to compete.
My preference is to have more equal treatment, but to let different
forms of institutions succeed if they offer better service a better way.
Mrs. FENWICK. The second thing I would like to ask you, do you
think that interest rates are a more important cause of inflation or
is it the supply of money?
Mr. MILLER. Over time an excessive growth of money will be the
main cause of inflation. On the other hand, that growth of money
has to be controlled with due regard to interest rates and the effect
interest rates themselves have on cost and on the ability to sustain the
economy at a level that will provide for our national needs.
If we tried to control inflation, through zero growth of money for
the next 3 years, we would also have a recession or depression as the
price. On the other hand, if we can restrain money growth and lean
on it the right way and tolerate higher interest rates than we would
like for 3 years, we can still keep the economy going. While we might
still wish we weren't so tightly squeezed, we would know that we must
take that course if we are to restrain the inflationary forces that otherwise eat us up.
Mrs. FENWICK. So your answer, if I understand it correctly, is that
both have an influence, but that the long-term effect is the monetary
supply; the short-term is the interest rate; is that correct?
Mr. MILLER. That is an adequate summary.
Mrs. FENWICK. I want to hurry-Mr. MILLER. You said it so much quicker and better.
Mrs. FENWICK. I have a couple of others.
I am puzzled by the idea of the Federal Reserve paying interest on
deposits. Are we starting down the garden path when we do that kind
of thing? To change the rate, giving 6 percent below $25 million and
2 percent above brings in all sorts of complications. Wouldn't it be
simpler, and wouldn't you be able to fine-tune the economy better, if
there were simply nationwide reserve requirements?
And I was a little troubled to hear you say that you felt that you

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shouldn't say what the nature of those requirements would be. Why
not?
If we are thinking about a sound banking system in this country,
why wouldn't it make good, commonsense not to pour out more of the
taxpayers' money or cause them any expense but, instead, just require
that banks have certain reserves?
Mr. MILLER. I can't disagree with that, but let me correct one thing.
I said we would not specify the form of reserves; that is not true.
Reserves would take the form of deposits with the Federal Reserve.
Mrs. FENWICK. Well, you wrote here, "not putting any restrictions
on nonmembers."
Mr. MILLER. No; I was talking about not having regulatory powers
over banks regulated by the States, which is different. For example,
examination, regulation, and supervision would not be our responsibility; but reserves would be held as deposits at the Federal Reserve
Banks.
Mrs. FENWICK. Uniform?
Mr. MILLER. Uniform.
Mrs. FENWICK. All banks?
Mr. MILLER. You are absolutely correct that there is no reason in
the world why an equitable system could not be created merely by
establishing uniform reserves for all kinds of institutions on the same
kind of accounts without paying interest. I would merely point out
to you that opposition to that proposal will be heard in loud voices
from those who don't maintain reserves now.
Mrs. FENWICK. But Mr. Miller, you see, I understand that. You
must help us here to know what our duty is.
Now, whether we decide to do it or not is another matter.
Mr. MILLER. Your duty is to enact the Federal Reserve proposals.
[Laughter.]
Mrs. FENWICK. Thank you, Mr. Chairman.
Mr. ST GERMAIN. Mr. Mattox.
Mr. MATTOX. Chairman Miller, I appreciate the portions of your
statement that deal with the tax burden.
For the purpose of the record, I would like to have you explain
why it would not be a less onerous burden on the free enterprise system, and on the banking system, if we were just simply to allow the
member banks to ,maintain their reserves in some other manner than
in cash at the Federal Reserve.
Mr. MILLER. Congressman Mattox, that is an alternate way to go,
and I cannot disagree intellectually with the proposition that an
equally fair result would attain if we had universal reserves and if
those reserves could be maintained with the Federal Reserve in the
form of Treasury bills or some other form of income-bearing
certificate.
I cannot give you a reason why that would not be a fair solution. I
can tell you that, in effect, all deposits then would have the same
potential to earn the same amount. Since the impact upon Federal
Reserve earnings and loss of Treasury income then would be greater,
we thought that perhaps that was too bold a step to take. Your plan
would have 1a greater financial impact on the Treasury than the plan
we have suggested, which is a limited payment of interest. Interest

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would be earned in much the same way if institutions could maintain
reserves in income-bearing paper; it just would be at a higher rate.
Mr. MATTOX. Well, it seems to me that if the principal reason that
banks are leaving the System is because the nonmember banks can
maintain their reserves in interest-bearing instruments, then instead
of doing another evil, that is, paying interest, it would be much more
simple just to allow the member banks to hold their reserves in interest-bearing instruments. It appears to be a very simple solution.
I recognize that this would have substantial impact upon the income
of the Fed and also on the Treasury, but through our income tax laws
and in other ways, that impact, could be controlled, because we are just
going to tax back all of those profits anyway. And it appears to me
that instead of enacting another tax, a more simple method would
be to remove that burden.
I understand that it is a bold step, but for the sake of the banking
system and the free enterprise system-and probably for our economy
and moneta.ry systems-it would be a much more simple approach.
Mr. MILLER. The Federal Reserve would not object to that approach if the Congress and the Treasury were willing to accept it. The
Treasury would have to be heard on how that would impact upon
their income.
Mr. MATTOX. Thank you, Mr. Chairman.
Mr. ST GERMAIN. Mr. Patterson.
Mr. PATTERSON. Thank you, Mr. Chairman. Good morning.
I think the only thing we are maybe concerned more about than
the deficit is inflation, and it appears that, at least there is some
concern on the part of the administration as to what action the Federal Reserve might be taking in regard to keeping interest rates down.
I think a year ago you stated before the Senate that you would
see the economy slowing down this year, which I think it has, and
that that might mean interest rates would fall. And yet they seem to
be higher than ever at this point.
Can you tell us now why what you foresaw then has not come to
pass~
Mr. MILLER. Congressman Patterson, I hope it was not a year ago,
because I only came into office in March.
Mr. PATTERSON. Early this year, I guess it was then.
Mr. MILLER. I have felt-and continue to feel-that as the rate of
real growth of the economy slackens from its rapid pace of recovery
since the deep recession of 1974-75, and as fiscal policy is adjusted to
remove some of the stimulative impact that is no longer needed now
to reflate the economy, the pressures will abate and interest rates will
peak out and at some point turn down.
I don't recall suggesting that that could take place until later in the
year, because the lag in effect of the tightening in monetary policy
that the Fed has taken means that the restraining force shows up
months and quarters later. The discipline that I believe Chairman
Reuss mentioned-the change in tax plans and spending plans for the
next fiscal year-won't begin to have effect until the fourth quarter of
this year. We won't see any impact until we begin to spend less later
this year and early next year.
If I have misstated this before, I would like to correct myself. I see

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the lessening of pressure on monetary policy from a more disciplined
fiscal policy coming into play, but I only see it coming into play later
this year and early next year. I have hoped that interest rates would
peak in the next few months and that by next year we would see the
chance for a little easier conditions in that regard.
I hope at some other hearing I haven't inadvertently suggested an
earlier timetable, because I think that would be too optimistic. These
things just take time to work through.
I do commend the Congress for the action that has been taken on
the fiscal side, in working out less of a tax cut and less spending to
respond to inflationary pressures. The change since I arrived in Washington-from an expectation of a $60 billion deficit in fiscal year 1979
to the expectation now of a $44 billion deficit-is a monumental accomplishment, and Congress should be commended for responding so
quickly. Four or five months is a very short time in which to make that
kind of policy change.
Mr. PATrERSON. With that kind of change in fiscal policy, will this
alter plans that you might ha.ve in regard to monetary policy?
Mr. MILLER. Inevitably. It will make it easier to exercise monetary
policy and reduce the pressure on monetary policy from what it otherwise would have been. In that sense, yes; it will certainly make it
possible for monet3:ry policy to be operating more comfortably as these
changes take effect m due course.
Mr. PATrERSON. Charles Schulze and Alice Rivlin yesterday, I believe it was, both predicted that the economy would not plunge into a
recession next year, provided that the Federal Reserve Board does not
tighten credit so much and that Congress passes some administrationrequested tax cuts.
Could you comment on that?
Mr. MILLER. The economy should not go into a recession. There is no
intention and no desire on the part of the Federal Reserve to bring
that about, and neither the administration nor Congress seeks it. We
a11 seek to balance our policies and actions at this point so as to restrain the forces of inflation and, if necessary, keep the rate of growth
of the economy lower than we have experienced, but not to dip into a
recession. I don't believe that would contribute adequately to reducing- inflation, and it would have other undesirable side effects.
So it is a matter of intention, and we accept the challenge as
reflected in the statements you quoted.
As to terms and results, all of us will have to exercise extremely
sound judgment in the next few months to be sure we don't overshoot
in any direction and trigger either too much inflation or too much
slowdown-either one. So this is a very difficult period when we must
walk through a very narrow passage to get where we want to go.
Mr. PATTERSON. Thank you.
Mr. ST GERMAIN. Mr. Wylie.
Mr. WYLIE. Thank you, Mr. Chairman.
I must say, Mr. Miller, that I, as kind of a journeyman member of
this committee, feel very comfortable with you as Chairman of the
Federal Reserve Board. I was not sure that was possible for me after
Dr. Burns. But you have certainly handled yourself in such a way

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that you have instilled confidence in the American public that you are
competent.
Do you feel that the growth of wholesale banks would lead to a loss
o:f membershipi And I thought maybe Mr. Mattox would ask this
question or refer to this. He offered an amendment in committee to
the financial institutions regulatory bill which was adopted, that
would allow for the national banks to invest in the stock of Statechartered banks, and therefore form a wholesale bank.
Mr. MILLER. I think this could have an impact. You know, we do
have the experience now of multibank holding companies, where only
one or two of the banks are members of the Federal Reserve, but the
whole network receives the benefits. This does have a somewhat negative effect on membership and is perhaps a parallel example. If banks
could aggregate their activities in a way that reduces the need for access to the Federal Reserve services, and take a risk on liquiditywhich is maybe not a good thing to do, but given today's pressures,
institutions will do it-then there could be some possible risk to
membership.
Mr. WYLIE. Should we have an amendment to that section which
would prohibit the wholesale banks from joining the Federal Reserve
System, then, so that the retail banks-or they would be encouraged
to maintain, I should say, membership i
Mr. MILLER. I would have to look into that. It could be, because of
the way of handling correspondent business, that even such an amendment would not restrict the possibility of ''wholesaling membership,"
as it were. I am not, sure whether that would work; there might be a
way around it. Perhaps we should take a look at that problem. I had
not really been aware of a movement along those lines.
Mr. WYLIE. It is section 1411 in the financial institutions regulatory
bill which will be coming to the House floor very soon. I am not sure,
as I said a little earlier, that I don't want to talk about this. But I
thought this did come up during the discussion of that amendment.
Mr. MILLER. May I look into that, because it sounds like an important matter, and I just may not be up to date on it.
[Chairman Miller subsequently sent the following letter to Congressman Wylie and a similar letter to Chairman St Germain:]

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B □ AR □ □ F G □ VERN □ RS
OF"THE

FEOERALRESERVESYSTEM
WASHINGTON, 0. C. 20551

G, WILLIAM MILLEA
CHAI AMAN

August 14, 1978

The Honorable Chalmers P. Wylie
House of Representatives
Washington, D. C. 20515
Dear Mr. Wylie:
During hearings conducted by the House Committee on Banking,
Finance and Urban Affairs on membership in the Federal Reserve System
on July 27, 1978, you asked for our views regarding section 1411 of
the Financial Institutions Regulatory Act of 1978 (R.R. 13471). This
section would authorize national banks to purchase shares of stock
of a State-chartered bank, subject to certain limitations, where the
law of the State in which the national bank is located permits Statechartered banks to purchase such stock. The limitations are that:
(1) only up to five percent of any class of voting securities of such
bank may be purchased by any national bank; (2) the total amount of
such stock held by a national bank cannot exceed five percent of its
capital stock and paid-in and unimpaired surplus; (3) the Statechartered bank whose securities are purchased must be insured by the
FDIC; (4) the stock of such bank must be owned exclusively by other
banks; and (5) such bank must be "engaged exclusively in providing
banking services for other banks and their officers, directors, or
employees."
During the membership hearings, you raised questions concerning this section's effect on membership in the System and the
possible need for an amendment prohibiting such banks from joining
the Federal Reserve System.
This section applies to national banks only. Since all
national banks are required by law to be members of the Federal
Reserve System, allowing a national bank to own stock in such a
bank would not cause it to drop its membership. In fact, it should
remove any incentive to change to a State charter and leave the
System in order to participate in the ownership of such a bank.

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There would be cause for concer·n regarding such banks in
general .if such a bank were allowed membership in the System. It
could obtain access to Federal Reserve payment mechanism facilities
and other services for those banks that owned it. The owner banks
would then have an incentive to drop their membership, No additional
legislative authority is needed since it has been our policy to deny
such banks membership under the authority given us in section 9 of
the Federal Reserve Act for the following reasons: (1) the institution is not open to the public; (2) the shareholders themselves
are institutions eligible to become members; and (3) as a consequence
of admitting the institution, the institutional shareholders could
gain access to certain benefits of membership but remain outside of
the Board's regulatory authority.
We, therefore, have no objections ·to this section of the
Financial Institutions Regulatory Act of 1978.

32-972 0 • 78
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Sincerely,
(Signed) G. William Miller

• 11

154

BOARO OF GOVERNORS
OFTHE

FE □ ERAL

RESERVE SYSTEM

WASHINGTON, □ .

C, 20551

13. WILLIAM MILLER
CHAIRMAN

August 14, 1978

The Honorable Fernand J, St Germain
Chairman
Subcommittee on Financial Institutions
Supervision, Regulation and Insurance
Committee on Banking, Finance and Urban Affairs
House of Representatives
Washington, D,C,
20515
Dear Chairman St Germain:
During hearings conducted by the House Committee on Banking,
Finance and Urban Affairs on membership in the Federal Reserve System
on July 27, 1978, I was asked for our views regarding section 1411
of the Financial Institutions Regulatory Act of 1978 (H,R, 13471),
This section would authorize national banks to purchase shares of stock
of a State-chartered bank, subject to certain limitations, where
the law of the State in which the national bank is located permits
State-chartered banks to purchase such stock, The limitations are
that: (1) only up to five percent of any class of voting securities
of such bank may be purchased by any national bank; {2) the total
amount of such stock held by a national bank cannot exceed five percent of its capital stock and paid-in and unimpaired surplus; (3) the
State-chartered bank whose securities are purchased must be insured
by the FDIC; (4) the stock of such bank must be owned exclusively by
other banks; and (5) such bank must be "engaged exclusively in providing b.anking services for other banks and thsir officers, directors,
or employees,"
During the membership hearings, questions were raised concerning this section's effect on membership in the System and the
possible need for an amendment prohibiting such banks from joining
the Federal Reserve System.
This section applies to national banks only, Since all
national banks are required by law to be members of the Federal Reserve
System, allowing a national bank to own stock in such a bank would
not cause it to drop its membership. In fact, it should remove any
incentive to ·change to a State charter and leave the System in order
to participate in the ownership of such a bank,

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There would be cause for concern regarding such banks in
general if such a bank were allowed membership in the System. It
could obtain access to Federal Reserve payment mechanism facilities
and other services for those banks that owned it. The owner banks
would then have an incentive to drop their membership. No additional
legislative authority is needed since it has been our policy to deny
such banks membership under the authority given us in section 9 of
the Federal Reserve Act for the following reasons: (1) the institution is not open to the public; (2) the shareholders themselves
are institutions eligible to become members; and (3) as a consequence
of admitting the institution, the institutional shareholders could
gain access to certain benefits of membership but remain outside
of the Board's regulatory authority.
We, therefore, have no objections to this section of the
Financial Institutions Regulatory Act of 1978.

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Sincerely,

156
Mr. WYLIE. Apropos of that, I am rather interested in knowing
how we get here. And during our discussions of the International
Banking Act, we determined that other countries do not have membership in a central bank, of course. What do other countries do about
reserve requirements?
Mr. MILLER. As a rule they have universal reserve requirements;
all banks must maintain reserves. Of course, the United States, for reasons of its development as a federation of States in a Federal system
and because of State's rights and Federal rights, early on decided to
have a dual banking system. Having options worked quite well for a
while, when the scales were tipped in favor of being a Federal bank or
a national bank or part of the Federal system.
Now that the scales have tipped the other way, we see problems
arising. But most nations haves a national banking system. Every nation has a national currency, a national financial system, and a national monetary authority, and almost universally they have a national
requirement to adhere to that monetary authority.
Mr. WYLIE. Where are the reserves maintained and in what form?
Mr. MILLER. They are maintained with the central bank or with
regional banks or offices. Italy is the only major country in which required reserves 1tll take the form of interest-bearing deposits. In all of
the other countries banks must maintain reserves without receiving
any interest on them, so that the system is the same as we have, except
reserves are universal, and so they don't have the inequity that we
have.
Mr. WYLIE. Do you know offhand in what form they are maintained, Mr. Milled I mean, like Switzerland and the United Kingdom and maybe Japan?
Mr. MILLER. In the United Kingdom they do allow some interestbearing assets to be held as reserves. But most nations require reserve
balances held with the central bank or the central banking system.
Mr. WYLIE. Cash balances?
Mr. MILLER. Yes; with just a few slight variations as to what is
counted as reserves. You know, we count vault cash, and that is a small
variation. In Canada there is a slightly different variation in the form
of required reserves. But the general policy is to maintain balances
with the central bank.
Mr. WYLIE. Well, it has been a real hairshirt to me that we may
not require reserves of foreign branches operating in the United
States, as you know. and I wonder why we require reserves of our
own domestic banks if we don't require them for foreign banks. That
is more of an exclamation than a question, I quess.
Mr. MILLER. I am in favor of requiring reserves for forei~ banks,
as you know, and I am delighted with the progress made in the foreign
banking leg-islation, which will, I think, ge.t us to that point. And. of
course, I am in favor of universal reserves in this country. I think
that is the most equitable solution and would be the sounder;;t one..
But I also recognize that there are many forces at work, and that
there are some contrary opinions. While universal reserves is onr preferred r;;olution, we must look at othe.r solutions if that is not possible..
Mr. WYLIE. Thank you very much.
Mr. S'I' GERMAIN. Mr. Blanchard.

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Mr. BLANCHARD. Thank you, Mr. Chairman, and thank you, Chairman Mi1ler, for spending several hours here. I am sorry I missed your
testimony and many of the questions. I was down at the White House,
and a number of us were talking with the President about the problem
of working together in cooperation, especially in view of the fact that
there will be differences on important issues.
And that prompts me to mention that I think it is cooperation and
partnership that is equally important between you at the Federal
Reserve and the administration and the Congress. I have read several
articles and heard a few murmurs here and there about friction between you and the leaders of our committee and Congress. And I
think that has to be minimized.
I think it is essential for our system to work, for you and us to work
together, not prostitute ourselves on issues, but as best we can to work
together. And I think it would be most regrettable if friction grew into
hostility or disagreement expanded into unnecessary friction. And I
simply offer my hope and wish that there wiU be a, partnership and
cooperation, which I think our country desperately needs on a number
of fronts, but particularly with regard to economic policy.
Mr. MILLER. You are certainly correct, and I will do my best to see
that we work in harmony and partnership. We can't always agree on
policies and issues, but I know we all have the same purpose-to do
what is ·best for our country-and we can work in harmony to do that.
I find my own experience of 4½ months to be rather reassuring, in
the sense that I feel there has been quite an open and healthy dialog
with the administration, and certainly with the two committees of
Congress with which I have been working primarily. I feel that the
atmosphere is extremely herulthy and harmonious.
Mr. BLANCHARD. In browsing through your testimony, I notice you
indicate several times that you feel that the presence of the Federal
Reserve in bank supervisory and regulatory a,reas enhances the quality
of the banking system. I can understand how you might feel that way
and how perhaps all of us would serving at the Federal level.
But I am wondering if you have any concrete evidence that regulati_on by the Federa.J Reserve System is better in any way than the
regulation by the Comptroller or the FDIC or State banking
supervisors 1
Mr. MILLER. No; I don't think we would'want to suggest that our
examination is superior to that of the Comptroller, and we work veD7
closely with the Comptroller and coordinate very carefully with tlie
Comptroller and with the FDIC. Nor would we suggest that there is
any lack of quality in the State supervisory area.
I am talking more about a national regulatory presence. A national
regulatory authority is needed when it comes to interest rate ceilings
and to many other issues. If you have too much opportunity for variation and diversion from standards, then you get an uneven financial
system, and you end up with less than optimum or effective results.
In their context, my remarks were not meant to suggest any sense of
parochialism about our superiority; I would withdraw them if they
do. My context was a national mechanism for supervision and regulation. There are other functions of the Federal Reserve-monetary
control and liquidity and the insurance of a payments mechanism-

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that can't be conducted except by the Federal Government. They
could be conducted by any agency of the Federal Government, but
they have been assigned fundamentally to the Federal Reserve. If they
weren't assigned to the Federal Reserve, they would be assigned to
another agency that would be the same as the Federal Reserve; that is,
a central monetary authority.
Mr. BLANCHARD. But I take it your major concern really is to have
as comprehensive a climate as possible to conduct monetary policy
and not to regulate or supervise banks for the sake of having more
members and more authority.
Mr. MIILER. 'I could not agree more. We do not seek to examine or
regulate a single bank more through any of our proposals today. We
do not suggest that, if there were universal reserves, we should be
examining or regulating any more banks than Congress has already
mandated that we regulate. Congress has authorized us to regulate
bank holding companies, members and nonmembers, and that authority will continue to apply or else be given to somebody else. But
we are not seeking to gain one piece of turf in the regulatory field
from these proposals.
Mr. BLANCHARD. My time has expired. Thank you.
Mr. ST GERMAIN. Mr. Miller, I would say one thing to you.
You said Congress mandated or is mandating that you regulate and
supervise banks. Very frankly, you know, there are some of us who
put forth the proposition that the Fed indeed should not regulate and
supervise banks. So if you would like to get rid of that duty, I am
sure that we would be responsive immediately to move that legislation
along very expeditiously.
Mr. MILLER. Unfortunately, my time is up. [Laughter.]
I thought from something you said earlier, Mr. Chairman, that you
might raise that at some later date, and I hope you shall.
Mr. ST GERMAIN. Mr. Derrick?
Mr. DERRICK. Thank you, Mr. Chairman.
Mr. Miller, we are delighted to have you. I was also at the meeting at
the White House, and regret that I did not hear the first of your
testimony.
.
Assuming that the most important function of the Fed is its influence
on monetary policy, how many banks are there that are members of the
Fed today?
Mr. MILLER. There are about 5,000-6,000 member banks, of which
1,100 are State member banks. As you know, national banks are supervised and examined by the Comptroller. There are about 5,700 member
banks, to be more exact.
Mr. DERRICK. Well, out of the total number of banks in the United
States, which is 14,000, that is something less than 50 percent. Assuming that this committee and this Congress were to pass legislation that
would make it attractive enough for the banks in this country to increase their membership, say, to 90 percent, or a tremendous amount,
I would sug-gest that the logical thing would be that you would have a
greater influence by your input into monetary policy. And if that were
the case, and say that 80 or 90 percent of the banks were members today
of the Fed, what do you think you would be in a position to do with
monetary policy; what effect do you think you could have that you may
not be having today, and what would the probable consequences be?

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Mr. MILLER. CongressmQ.n Derrick, our proposalsMr. DERRICK. You do agree that if you had the additional membership, your impact would be greater i
Mr.MILLER. Yes,sir.
Let me just make one comment before I answer the substance of your
question, because you reminded me of something that I did not make
clear. The proposals that we have made are not intended to attract
members. I don't think the proposals we have made would attract
members. I think Congressman Stanton's proposal to pay a full market
rate of interest would attract members.
Mr. DERRICK. I understand that.
Mr. MILLER. We are just trying to stop the loss. Now, under our
universal reserve proposal, we would have reserves on about 80 percent
of transactions deposits, and that would very much enhance our capacity to control monetary policy, because it would enhance our ability to
measure the relationship between reserves and credit on a much larger
bundle of deposits and lessen the opportunity for divergence from our
monetary targets. We developed one chart-chart lO~which we discussed when you weren't here, I think. It is worth looking at because it
shows that the more reserves are outside our control, the more difficult
it is to predict the relationship between our actions and the growth of
the ag/:!I'egates.
Mr. DERRICK. The substance of my question, of course, is that, assuming we were to erase this liability for you, what do you think that you
could do that you are not now doing, and what do you think that the
results accruing therefrom would be 1
Mr. MILLER. What we could do, first, is to gather more accurate data
on the current money supply, which would make our policy decisions
sounder; we would be reacting with better knowledge of the facts.
Now we act on the basis of many estimates and best guesses. The closer
we get to currently reliable data, the more likely our judgments will
be sound and not cause erratic movements in the economy that come
about because of false or misleading information.
Second, the leverage of our actions on real results, would be more
direct. Therefore, our ability to push the throttle or retard the throttle
and achieve a certain consequence in the economy would be far more
direct. The result would be a much healthier control-less guessing,
and more likelihood of assurance, under conditions such as we have
today, for example, that we would not bring on a recession by mistake.
Today, with so much outside of our control and so much guessing,
we could inadvertently make a mistake. The probability of our being
wrong would be greatly reduced if we haid this control.
Mr, DERRICK. The results of your being wrong would also be more
catastrophic.
Mr. MILLER. The result of being wrong would be the same : the
economv would be in bad shape.
Mr. DERRICK. Let me ask a question in another area: Have you
thought that it might be necessary, if the Congress were to enact this
legislation or some <'lose facsimile, to restructure the gunning mechanism of the Fed~ What I allude to is the inclusion of more input from
savings and loans, credit unions, other members of the financial
community.

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After all, you are including them, in a sense, in your suggestions.
Mr. Mn,LER, I think that deserves consideration. To date, Congressman Derrick, we are only seeking to establish reserves on so-called
transactions accounts, and at this point that does not impinge fundamentally upon those otlier kinds of institutions. We might be mixing
apples and oranges, but I am not philosophically opposed to looking
at your question and seeing if better coordination would be desirable.
Mr. DERRICK. Well, I would suggest to you that if you do this I would
see it as a natural o:ntgrowth.
I thank you very much. And thank you for appearing before the
committee.
Mr. Mil.LER. Thank you.
Mr. ST GERMAIN. Mr. Grassley.
Mr. GRASSLEY. Thank you, Mr. Chairman.
I want to echo the compliment that Mr. Wylie, of Ohio, paid to you,
and say that I watch what the Chairman of the Federal Reserve
Board does more even than what the President of the United States
does, because I figure it is that important a position and can have that
much of an impact on our economy.
I have read some speculation in the newspapers to the effect that
you might be moving a little bit away from your independent position.
At this point, I am just going to consider that speculation, and I hope,
in fact, that that is not the case.
Mr. MlLLER. Let me assure you it is not the case now and will not be
the case.
Mr. GR.A.ASLEY. Mr. Miller, would you please tell us what actions,
if any, the Fed will take if the House and Senate fail to act on any of
these proposals during this session, the proposals that we are discussing here today~
Mr. MILLER. Mr. Congressman, I am rupproaching this issue with
great cooperation from the chairmen on both the House and Senate
committees and therefore with the high expectation that, because the
issues are not new and because there is such willingness to address and
resolve them, that we will get a resolution. I have not really addressed
the issue of alternatives, so I suppose I have to answer you by saying
that I do not know. The Federal Reserve would have to go back to the
drawing board and see if there were other things that could be done
in the national interest-to be sure that we do not continue to have
the adverse consequences of loss of members.
But I hardly want to think of what could be done and what would
be done, because I have to believe that we are going to get a resolution
from the Congress, which would be best.
Mr. GRASSLEY. Because there are only about 35 days left to work this
all out before we adjourn, you would not be taking any action before
next January and the convening of a new Congress 1
Mr. MILLER. You know that the timetable in our preliminary pr_oposal, attached to my testimony, was to make some reserve adjustments, within the statutory limits that now exist, at the end of this
year. We plan to introduce the first tranche of service c~arges on
July 1, 1979, and at that time to make the first payment of mterest at
a low rate. We could have the full plan in effect in 1980.
So I do not think we face any crunch here if there is an orderly
process. I know that substantial time is needed in order for us to get

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those mechanisms in place, so I am very hopeful that the Congress
will give us our marching orders before this year is out. But if they
do not, we will take the next step when it comes.
Mr. GRAsSLEY. At what point does the level of deposits under the
control of the Fed affect the Fed's ability to conduct monetary policy
efficiently?
Mr. MILLER. We are already at that level. We are already at a level
where the ability to measure impact and to have an adequate monetary handle has been substantially eroded. We already have so much
play in the controls that when we push we do not get as quick a response. Where the absolute trigger point is, I do not know. But, it has
ttlready, in my opinion, gone too far when you consider that we were
at 85 percent of deposits in 1950, that by 1965 we were still at about
85 percent, and then we suddenly dropped to 73 percent in the last 10
years. One begins to worry because it certainly is going too fast and
too far.
Mr. GRASSLEY. Following up on the question of the competitive
nature of your services versus those that would be offered by the private
sector. If the legislative proposals before us on the pricing of services
were to become law, would the accounting procedures at the Fed reveal
any cross-subsidization of the services provided, in order that we could
police the pricing of services so we do not get into the same problem
we have with the postal service?
The postal service says that they just cannot account for their ove1rhead, hence they will not accept the argument that first class subsidizes
fourtlh class. Therefore, we get into the argument over whether or not
parcel post is competitive with the United Parcel Service, as an
example.
So, I am asking the same question of you. Will your accounting
practices show up whether or not, in fact, there is any cross-subsidization?
Mr. MILLER. Congressman Grassley, the Federal Reserve is in the
process-we have gone a long way-toward developing a pricing system, and we are continuing to perfect it. I would say that, today, it
might be slightly inadequate for your purposes, but by the time this
plan is in effect the data would disclose what you would need to know
in that respect.
Let me say that "subsidy" is a difficult word, but I think you are
approaching the question correctly. First, let's see what the data
show; then, we can argue what "subsidy" is. We will be able to get
you the data.
You know, there are new technologies-automated cle,aringhouses,
electronic transfer of funds-and a nationwide deposit system. Like
any new product in busine,ss, there is a ]earning curve and an investment to start it. One does subsidize a new airplane when it is first built,
or a new automobile when it is first introduced, in order to get up to
a level of production that shows a profit. There will a.lways be that
kind of question: How do you price a new product so that when you
get up to speed it will be profitable, so to speak?
So I would not want to mislead you; we will always have tough
issues to face if we are going to be a living, breathing, moving organization that is trying to be creative.

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Mr. GRASSLEY. Thank you, Mr. Chairman.
The CBAIRMAN. Mr. Pattison.
Mr. PATTISON. Thank you.
I notice we have a quomm call we have to answer, so I will try to
be brief, and perhaps you can also be brief in your response.
In your statement you indicate that under the Federal Reserve
proposal, H.R. 13476, nonmember depository institutions would have
to report on their deposits and certain other items to the local Reserve
bank for monetary management purposes.
As far as monetary control is concerned, wouldn't this access to
that datia essentially obviate t:Jhe need for imposing Federal Reservedetermined reserve requirements on nonmembe,r banks and thrift
institutions?
Mr. MILLER. The availability of data along the lines we have suggested-or Chairman Reuss has suggested-would be very helpful in
giving us, at least, the current situation. It would not help us, however, in terms of the degree of error tJhat exists as the impac.t of our
actions in reserves works its way through the system and reflects
itself in money and credit.
We would gia.in by being able to read history, but we would not be
able to predict as well what the next move should be. It would be a
step forwa.rd, but not as complete ,a, step as we would prefer.
Mr. PATTISON. Thank you.
Mr. ST GERMAIN. Mr. Mitchell.
Mr. MITCHELL. Mr. Miller, you have been very patient with us, and
it is almost noon, but I do have two other questions, however. In the
interest of time and my schedule and your schedule, I will submit
those two questions to you in writing and request prompt reply.
Mr. MILLER. We will be delighted to reply promptly.
[Congressman Parren Mitchell submitted the following question in
writing to Chairman Miller to be answered for the record :J
Question. On page seven, you say that the cushion provided by the discount
window "facilitates implementation of a restrictive monetary policy in a period
of inflation demands." What does this mean? It sounds like you want banks to
obtain reserves at the discount window when you are draining reserves via open
market operations? What's the point of doing something with your left hand
which offsets what you're doing with your right? The philosophy you are revealing here gives me a clue as to why we have so much inflation.

[Chairman Miller subsequently furnished the following response:]
Answer. During a period of credit tightness, the availability of the discount
window provides individual banks with the time needed to make orderly adjustments in their lending and investment policies. The availability of the
window does not mean that total reserves will be larger than desired. Rather.
it helps insure that the distribution of a given amount of total reserves supplied
to the banking system is determined in part by the needs of individual banks
for adjustment-type credit. This facilitates the implementation of monetary
policy by minimizing the risk of severe liquidity strains and abrupt changes in
lending policies by individual banks that might unsettle local depost and credit
markets, and in the case of large institutions, national markets.

Mr. MITCHELL. While I do have the mike and the recognition of the
Chair, I would like to comment on your candor in responding to
questions. Without deprecating anyone's past performance as Chairman of the Fed, I find it very refreshing- that we get answers from
you within 5 minutes or less. I recall some experiences where I raised

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a question with a former Chairman of the Federal Reserve, and I got
an answer in approximately 35 minutes, and by that time I had forgotten what the question was.
I just want to compliment you on your candor and your brevity.
Thank you, Mr. Chairman.
Mr. ST GERMAIN. Mr. Vento, I understand you have one question.
Mr. VENTO. Mr. Chairman, I do have a question.
My able colleague, Mary Rose Oakar, raised a question and pointed
out the large profits that would accrue to Citibank, Chase Manhattan,
and so forth, under both the Fed proposal and the Stanton proposal
unamended. And the answer came back something like reflecting the
fact that they would pay back a significant amount in their tax
burden.
I have in front of me the "Tax Analysts and Advocates," a very
reputable document that talks about what the large average is fo1
U.S. rate on worldwide income of the 10 largest banks. It is 3.6 per•
cent. That is what we are collecting now on that.
And I wonder, in light of that and in view of that if Mr. Miller
would like to consider that in terms of what the cost is of the Fed
proposal or the unamended Stanton bill. I think it is very difficult
for a Member such as myself, looking at budget problems and so forth
that we have, and taking into consideration what the chairman of
this committee and the Chairman of the Board of Governors said was
the goal of what they are trying to accomplish with this bill, and then
looking at what the impact is.
And I hope that the committee will continue to bring forth information like this and that each of us can modify our positions to attainment of that laudable goal.
And maybe there is a response or answer to what the effective tax
rate is and what the cost impact is, but I think that it is something,
certainly, that should be brought up in light of the question and in
light of the large payout to these banks.
My judgment is, Mr. Miller, that they are there for the services
that they receive, and they have done an analysis to determine whether
or not they lose or gain more by being members of the Fed with regards
to their correspondent accounts that they maintain and so forth. And
I would be very happy with a brief response at this time to this point.
Mr. MILLER. Congressman Vento, I am not a tax expert, as you know.
It is my understanding that the estimate of the loss of revenue to the
Treasury-a measure of the difference between loss in Federal Reserve
earnings and potential tax recoveries as increased earnings work their
way through banks-was developed jointly by our staff and by the
Treasury Department, and that the Treasury Department is in agreement with the figures.
And so, I have accepted their estimates as being the ones-Mr. VENTO. Do I understand your figure as being the highest tax
rate, 48 percent?
Mr. MILLER. The fi~re takes account of the corporate tax rate on
banks, plus the fact that there would be an expected increase in personal income from dividend payouts. I am not an expert on this, but
I understand it came outMr. VENTO. We end up with that 48 percent figure being tossed

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around a lot, but the effective rate on capital gains is about 18 percent.
That is what it is, in reality. And hardly anyone pays that 48 percent.
And what the worldwide rate is, the U.S. rate in worldwide income, is
3.6 percent on the various banks right today, so that is the rate they are
going to be paying.
Mr. MILLER. No; you 'have to be care£ul with that reasoning. A
bank may be paying a low rate based upon £oreign tax credits. Any
marginal income would be taxed at the 48-percent rate. On an additional dollar of U.S. income, the bank would not pay 3.6 percent; it
would pay 48 cents.
You have to remember that quite often those calculations are complex. The addition of income to a bank that is paying whatever rate
is taxed at the marginal rate of 48 cents on the dollar.
Mr. VENTO. That assumes that they are not going to increwse expenses that they will not have any other 1!1eans of writing off.
Mr. MILLER. They would deduct those many case.
Mr. VENTO. Well, of course, they do. But if they have the income,
they also have the option to do what they choose with it, and not just
declare it as excess profit. They can build i they can go into a variety
0£ things in terms of tax credits. There 1s a whole myriad 0£ ways
that they can move. I mean, if you assume that they are static, yes;
then, 0£ course, they are not going to do anything. But I assume they
are not static, that they are thinking, that they are investing their
money, and, as a consequence, they are going to be paying what they
are paying, in essence, today, or one-tenth 0£ a percent difference.
Thank you.
Mr. ST GERMAIN. Mr. Miller, I would like to wind up-Mr. MILLER. I was just paissed a note, so that I do not mislead you.
I was talking about corporate tax rates, but my staff tells me that the
average marginal tax rate on banks in the United States is 35 percent.
I was using the corporate rate 0£ 48 percent.
Mr. VENTO. I tJhink I used the 48 percent, and not the chairman.
Mr. ST GERMAIN. I would suggest sometime looking at the Philadelphia Fed study that occurred about 3 or 4 or maybe 5 years ago on
what banks actually indeed pay in taxes. It is very interesting.
I would like to wind up with this question. On page 10, you made
re£erence to the fact that many problems would arise if a correspondent hank, a large one, experienced substantial operating difficulties with liquidity problems. Now, this is conceivably the caise.
However, I do not think that the legislation before us would deal
with that in any manner, and we, I think, can agree that the risk of a
large correspondent J;>ank 'having difficulties does. indeed, exist today.
I am wondering, by putting that in your testimonv-I am trying
to word this very nicelv for you-were you suggesting in a very subtle
manner that we should prohibit private clearing banks i It seems to
me that would be the only way to solve the problems that you point up
on page 10.
Mr. MI1;-LER. Mr. Chairman, my point in the testimony was that
we are seemg more and more larger banks leave the System, and that
as we begin to see large banks leave the System there are more and
more instances where clearing by a nonmember-without the same
access to the window as a member-could be a problem.

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I anticipated no other legislation addressed to your question, but
was merely pointing out that if we continue to lose large banks, we
will have more and more possibility of difficulty. That was my sole
point.
Mr. ST GERMAIN. Also, I hope that your staff took note of the fact
that-and I am sorry Mr. Mattox is not here-but Mr. Wylie 'brought
up the amendment to the rather substantial piece of legislation that
we will be getting to the floor in the near future, and there were no
hearings on it. An amendment was introduced on a particular day,
_and it was held in abeyance for a little further work to 'be done on it.
We did receive a communication from the Comptroller's Office, but
we did not receive anytJhing from the Fed, to the oost of my recollection. So, you might well want to look at that.
Mr. MrLLER. Yes; I think we would want to look at that.
Mr. ST GERMAIN. Mr. Chairman, the staff is a very excellent staff,
and they could keep feeding me questions from now until 5 p.m. this
evening, but I have some appointments to meet, and I ·am sure that
you would welcome a break at this point.
I, too, want to echo the sentiments of many of the members, No. 1,
on the success with which you have taken over the enormous duties
as Chairman of the Federal Reserve Board. Of course, I am doubly
happy about that, due to the fact that we come from the same area of
this great country, and, of course~ you are transplanted, but we think
of you as a Rhode Islander.
But also, I want to compliment you on the manner in which you
have handled the questions this morning, because really and truly,
it is unbelieveable that we are able to wind up at this time of day,
considering the fact that a great many members did, indeed,
participate.
So, I want to thank you, and I am sure there will be quite a few
members who will be submitting some additional questions in writing.
Mr. MILLER. Mr. Chairman, I appreciate your courtesy this morning. The attendance was rather exciting, from my point of view.
Many members did come and participate; I thank you, and I thank
them.
Mr. ST GERMAIN. Thank you.
The full committee will be in recess until Monday, July 31, 1978, in
this same room.
[Whereupon, at 12 :05 p.m., the committee was adjourned, to reconvene at 9 a.m., on Monday, July 31, 1978.]

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MONETARY CONTROL AND THE MEMBERSHIP
PROBLEM
MONDAY, JULY 31, 1978
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,

Washington, D.O.
The committee met, pursuant to notice, at 10 a.m., in room 2128,
Rayburn House Office Building, Hon. Henry S. Reuss (chairman of
the committee) presiding.
Present: Representatives Reuss, Moorhead, Annunzio, Mitchell,
Derrick, Hannaford, Pattison, Vento, Stanton, Grassley, Fenwick, and
Steers.
Mr. MITCHELL. This hearing will now come to order. Good morning,
ladies and gentlemen.
Today we continue our hearings on the efficiency of monetary control and Federal Reserve membership. We have before us three bills
and an amendment to one of these bills: H.R. 1347.6, H.R. 13477, Federal Reserve proposals submitted by request; H.R. 12706, the Stanton
bill; and an amendment to the Stanton bill.
Our witnesses today will be:
Ray Campbell, president, Oberlin Savings Bank, representing the
Independent Bankers Association; Gov. Philip E. Coldwell, Board of
Governors, Federal Reserve System; Beryl W. Sprinkel, executive vice
president and economist, Harris Trust & Savings; Richard D. Hill,
chairman, First National Bank, Boston, representing the Association
of Reserve City Bankers; and, Frank Morris, president, Boston Federal Reserve Bank.
Gentlemen, welcome.
Before proceeding, I will ask if any of my colleagues have an opening statement. There appears to be none.
For convenience, I think it would be well to divide today's witnesses
into two panels. I am going to ask Mr. Campbell and Mr. Hill to
serve on our first panel. We will hear from Mr. Campbell and then
from Mr. Hill. Then we will proceed to question both of you at the
same time, if that is satisfactory.
Governor Coldwell, Mr. Morris, and Mr. Sprinkel will then be
our second panel. I understand you have a Board meeting, Governor,
and we will try to put you on first on the second panel. We are anxious
to hear from all of you. We are most grateful that you could be here.
I wish to note that we have received a statement from Milton Friedman, professor of economics at the University of Chicago and senior
research :fellow, Hoover Institution, at Stanford University, on the
questions before the committee today. Among other considerations,

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Professor Friedman supports elimination of the Federal Reserve discretion both in fixing reserve requirements and in fixin~ the discount
rate, on the grounds that these are "clumsy and unpredictable instruments of monetary policy." I ask that his statement be included in the
record at this point.
[Professor Friedman's statement follows:]

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STATEMENT ON !LR. 12706 AND OTHER LEGISLATIVE MATTERS
SUBMITTED BY
MILTOU FRIEDMAN
PROFESSOR ECONOMICS, THE UNIVERSITY OF CHICAGO
SENIOR RESEARCH FELLOW, HOOVER INSTITUTION,
STANFORD UNIVERSITY

TO
COMMITTEE ON BP.NKING, FINANCE AND URBAN AFFAIRS
U. S. HOUSE OF REPRESENTATIVES
JULY 24, 1978

four basic reforms incor-

I strongly support in principle

porated in H.R. 12706 and the proposed amendment thereto.

However,

I regard them as seriously incomplete unless accompanied by a fifth
reform, namely elimination of the prohibition of the payment of
interest on demand depos1ts.

In addition, I differ somewhat with

respect to the best way to institute some of the reforms.
consider in turn each of the five reforms

I shall

two proposed in

H.R. 12706, the one that needs to be added, and the two proposed
in the amendment to H.R. 12706.
A.

H.R. 12706
1.

·Pricing of services rendered by Federal Reserve Banks.

This is highly desirable in order to promote the efficient use of
such services and to prevent the waste that arises from the absence of specific charges for them.

It is desirable also to elimi-

nate a special subsidy that is now being granted to member banks

32-972 0 • 78
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• 12

170
of an amount not directly subject to Congressional control.

The

specific provisions as incorporated in H.R. 12706 seem well designed
to achieve the desired objective.
2.

reform.

Payment of Interest on Reserves.

This is a long overdue

The present system in effect imposes a special tax on

banks that are members of the Federal Reserve System by requiring
them to lend funds at a zero interest rate to the Federal Reserve
Banks and thereby indirectly to the U.S. Government.

If it is

desired to levy a tax on member banks, that should be done explicitly
by Congress, not implicitly by the Federal Reserve System, and the
rate of tax should be determined by the Congress, not by either the
discretion of the Fed in setting reserve requirements, or the accidents of the market in determining the interest yield sacrificed
on reserves.

·Moreover, it is hard to see any justification for a

discriminatory tax on member banks.
In combination with pricing of services by the Fed, the payment of interest on reserves could eliminate both the s~osidy and
the taxes now implicitly arising from Federal Reserve actions and
from the vagaries of the market.
However, the specific provision of neither H.R. 12706 nor
the proposed amendment thereto with respect to the payment of interest would eliminate Federal Reserve imposed taxation.

To achieve

that objective, the rate ·of interest paid on reserves should be
set by statute equal to the level specified by H.R. 12706 as a
maximum, namely, the average rate paid during the preceding calendar quarter on U.S. Treasury bills with maturities of three months.

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If it is desjred to raise revenue from a tax on banks, that
should be done via explicit tax legislation imposing a tax on all
banks, not simply member banks.
B.

The Missing Reform
3.

Payment of Interest on Demand Deposits.

The preceding two

reforms would replace the present net tax on member banks with a
net subsidy

exchanging one evil for another -- unless they are

accompanied by removal of the present legal prohibition of the payment of interest on demand deposits.

Remove that prohibition, and

competition will force banks to pass on the interest they receive
on reserves to depositors.
Removal of the prohibition of interest on demand deposits
is urgently called for by other considerations as well.

Few legal

provisions have done as much harm to the efficient operation of
both the financial system and monetary policy as this one.

Had

interest all along been payable at competitive rates on demand deposits, there would have been no massive shift

back and forth from

time to demand deposits, no proliferation of indirect methods of
paying interest on demand deposits, no development of NOW and POW
and COW accounts.

Much of the needless dispute among commercial

banks and thrift institutions would have been eliminated.

The

monetary aggregates would have retained a more consistent meaning
and would have been more useful for monetary policy.
Competition and the ingenuity of the market have made the
prohibition almost meaningless, and nearly the final blow will be
struck by the Federal Reserve regulatory change due to go into ef-

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172
feet on November 1 of this year.
It is long past time to remove this major obstacle to an
efficient financial system and to effective monetary control.
C.

Proposed Amendment to H.R. 12706
4.

Statutory Reserve Requirements.

I strongly approve the

elimination of Federal Reserve discretion in fixing reserve requirements.

Changes in reserve requirements are a clumsy and unpredict-

able instrument of monetary policy.
However, the proposed schedule of requirements seems to me
undesirable.

What is called for is a fixed percentage requirement

on deposits, the same for all banks, all amounts of deposits, all
kinds of deposits, whether so-called transactions deposits or time
or savings deposits.

Differential requirements simply introduce

unnecessary random variations into the relation between total reserves available and the total money supply as a result of shifts
of deposits between different banks and different categories of
deposits.

With interest paid on reserves, as proposed in point 2,

and on deposits, as proposed in point 3, a uniform reserve requirement is strictly neutral among banks and depositors.

It performs

the one function of serving monetary policy by enabling the Fed to
control the quantity of money more accurately.
5.

Discount Rate Linked to Market Rate.

I strongly approve

also the elimination of Federal Reserve discretion in fixing the
discount rate.

This, too, has been a clumsy and unpredictable •in-

strument of monetary policy.
determined by the market.

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It would be far better to let it be

173
As Congressman Reuss said in his statement to the House of

July 14, 1978, "Monetary policy can be conducted exclusively through
open market operations and discounting" -- and I would add, without discounting as well.

The record of failure by the Federal Re-

serve in controlling the money supply

its record of swinging

widely from one extreme to the other, of not achieving its own
stated targets, of permitting sharp and erratic movements from
week to week and month to month -- none of this

derives from the

absence of the necessary knowledge, or of insufficient power

its part, or of lack of information about non member institu:_ions.
These are all excuses not reasons.

As I have argued in a recent

Newsweek column (appended hereto), the Fed's failure derives from
its unwillingness to adapt its procedures to its changed

objec-

tives -- a striking example of the law of bureaucratic inertia.

In conclusion, I wish to commend the Committee for its farsighted proposals, and for holding these hearings, as well as for
the constructive steps it has taken earlier, ranging from Concurrent Resolution 133 to its recent communication to the Fed with
respect to lagged reserve requirements.

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By Milton Friedman

'!'

Inertia and the Fed
Every large bureaucracy, government
or private, is certain that 'tlie way it
conducts its affairs is the only way that
they can be condti~ted.
government, this universal truth is
In effectively
challenged only at a time

of real crisis-when something simply
111ust be done differently. In business,
the bottom line of profit provides a far
more effective and frequent challenge.
Business bureaucrats who insist on operating in accordance with this belieflose
their jobs. That is a much-p.eglected advantage of the private market. Government bureaucrnts may be just as perceptive as private entrepreneurs, just as
wise, just as innovative·in deciding what

projects to undertake, but there is nO
mechanism for terminating unsuccessful
experiments; instead, they tend to be
expanded to bury small failures in a large
failure. A private business that undertakes an unsuccessful experiment has no
choice: it recognizes its mistake or goes
bankrupt-unless it can get government
to subsidize it. That is why the loss
component of the profit and loss system
is far more important than the profit
co1?ponent.
THE IRS VS. WITHHOLDING

I was first impressed by the l~w of
bureaucratic inertia during World War
It when, as a junior bureaucrat in the
U.S. Treasury Uepar~f""''", I helped to
devise a system to collect income taxes at
sburc-e. My wife has still not forgivim me
for participating in that project. •
We consulted German refugees who
knew the German tax system. They described in detail their method of withholding at source and assured us that it
was the only feasible way. We consulted
British experts. They assured us that the
very different method followed in Britain was the only feasible way. We decided that both were models of what to
avoid, not to imitate.
If today you were to ask a high Internal
Revenue Service official whether income
taxes could be collected without a•withholding system, he would consign you to
the loony bin. But in 1942, when we wert
devising our syst~m. the IRS was the
chief obstacle to its adoption. Its bureaucrats ini;isted that the way they were
collecting the income qlx was the only
feasible way; that we were starry•eye<l
theorists to suppose that withholding at
source was administratively feasible.
My longest continuous experience
with the law of bureaucratic inertia has

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been with the Federal Reserve System:
as a monetary historhn', a constant critic,
~;

~~~~1~~~~1f~:l~~~~~~f:h~ ti::~!di!~3!

academic advisers, a member of a system
committee, a teacher some of whose stu•
den is have worked at the Fed, and a close
personal friend-and, I may say, admirer-of many high system officials.
NO ADMISSION OF ERRORS

In its 65-year history, to the best of my
knowledge, the Federal Reserve Board
has never admitted error in any official
statement-though some courageous officials at regional banks have done So.
Doubtless there are exceptions-perhaps Sen. William Proxmire should establish a Golden Purse award for authors
of such admissions. Changes in policy
and procedure have of course occurredmostly as a result of crisis pressures from
outside; occasionally, of changes in personnel; even more rarely, of cumulative
self-generated change growing out of the
work of the board's own able professional staff or the able professional staffs at
some of the regional banks.
In three decades of personal involvement with the system, I have often
written, or sent memorandums, to the
chairman or other members of the board
suggesting changes in policy, regulations or procedure. Every reply, even
When it was personal and not a form
letter, deff'i.Jed curre,.~ iJrocedurci and
explained wh,y my suggestions were im.:
practical. Requests from Congressional
committees or individual congressmen
asking the system to comment on testimony I had given to the committee or on
one of my published articles have uniforml)' elicited cleverly written briefs for
the defense, never admitting any mistake, never accepting any suggestion,
explaining all adverse developments as
resulting from forces outside the system's control, and selecting from availp.ble evidence only those items supporting the system's position.
In 1970, it was suggested to the board
that it appoint h\'o committees of outside
experts: one, on the measurement oftl1e
monetary aggregates, which had been
coming under increasing criticism for
inaccuracy; the other, on alternati\'e
methods of controlling the monetary aggregates. The first committee, of which I
was a member, was finally appointed
four years Jater. We htrned in our final
report hvo years ago. Our recommendations have not yet been implemented!
The second expert committee was nev-

er appointed, even
though the Fed's
failure to modernize
its operating procedure is little short
of a disgrace. A decade ago, under enormous pressure, the
Fed shifted its intermediate policy target
from primary stress on "money.market
conditions" (i.e., interest rates) to primary stress on the growth of monetary aggregates. This shift was strongly reinforced by Congressional Concurrent
Resolution 133 in 1975 (since incorporated in the Federal Reserve Act), requiring
the Fed to report quarterly to Congress
its targets for the growth in monetary
aggregates for the coming year.
STICKING TO OBSOLETE METHODS

Yet, despite internal committees that
have been established to examine the
Fed's operating procedures, those procedures are stilJ the same as the ones that
were developed to control "money-market conditions." Most economists specializing in money and banking agree that
those procedure::;, however well adapted
for the earlier purpose, are poorly adapted to control monetary aggregates. Their
continued use explains the highly erratic
behavior of monetary aggregates from
week to week, ancl the tendency for the
growth rate of monetary aggregate~ to
swmg from one extreme to the other.
An alternative operating procedure has
been subject to extensive study and research, js entirely feasible administratively-indeed much simpler than the
present procedure-and has been recommended to, and by, Congressional coni•
mittees. I am confident that it would be
regarded as superior to the present procedure for controlling monetary agbrrcgates
not only by outside experts but by a
majority of economists on the research
staffs ofthe Federal Reserve Board and its
regional hanks. Yet, in a decade, not the
slightest step has been taken to move to
this alternative technique. On the contrary, the Fed has adopted a series of
measures that have made the present
procedure even less effective.
We have a new chairman at the Fed.
He comes from the business world
where the bottom line has forced him to
fight tl1e law of bureaucratic ine1tia. WiJI
that background enable him to do so alsO
in government? Or wiJI he, like his predecessors, become a capti\'e of aml
spokesman for the hureaucrn.cr he sup•
posedly commands?

Newsweek. July 24, 1978

175
Mr. MITCHELL. The Chair wishes to thank the chairman of the full
committee for permitting me to chair the hearings last week and
this morning. However, I do have to make an apology. The Budget
Committee on which I also serve has a meeting scheduled at 10 :30.
a.m. At that time I will turn the Chair over to the chairman of the full
committee, Chairman Reuss.
Gentlemen, thank you very much, and let us start with Mr. Campbell and Mr. Hill, to lead off.
STATEMENT OF RAYMOND D. CAMPBELL, PRESIDENT, OBERLIN
SAVINGS BANK, OBERLIN, OHIO, FIRST VICE PRESIDENT, INDEPENDENT BANKERS ASSOCIATION OF AMERICA, REPRESENTING
THE ASSOCIATION, ACCOMPANIED BY RICHARD PETERSON,
CHIEF LEGISLATIVE COUNSEL

Mr. CAMPBELL. Thank you, Mr. Mitchell.
Chairman Reuss, members of the committee, my name is Raymond
D. Campbell. I am first vice president of the Independent Bankers
Association of America--IBAA-and president of the Oberlin Savings Bank Co., Oberlin, Ohio. With me is Richard Peterson, our chief
legislative counsel.
Our association appreciates the opportunity to testify on this legislation. However, I should point out that the constraints imposed
by the timing of these hearings has limited our ability to assess fully
the effects of these proposals. Therefore, I should like you to view our
comments as first impressions.
We share the concern of the Federal Reserve Board's Chairman
that attrition of both banks and attrition of membership in the Federal Reserve System has accelerated in recent years, and that the
failure to halt membership attrition may have severe implications
for the Federal Reserve Board to conduct monetary policy.
However, we are not persuaded that legislative remedies proposed
by the Federal Reserve Board will provide the necessary inducements
to attract nonmembers to join the Federal Reserve System or persuade
members to remain in the System.
Let me turn, then, to specifics.
First, H.R. 13476 ism effect a mandatory universal statute requiring commercial banks, mutual savings banks, savings and loan associations, and credit unions to maintain reserves at Federal Reserve
banks against demand deposits and all other transaction accounts.
IBAA has long been opposed to legislation which would make it
mandatory for all banks to maintain reserves in the Federal Reserve
System. Although national banks comprise about 27 percent of IBAA'n
membership, 73 percent are State-chartered banks, of which a small
minority are members of the Fed. State-chartered banks :favor the freedom to join or not to join the Federal Reserve System.
Furthermore, the exemption purportedly provided for the first $5
million in transaction accounts is purely illusory in that there is broad
statutory authority given the Board to impose reserves on even these
deposits.
Another proposal in this package of legislation is H.R. 13477, which

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would authorize the payment of interest on reserve balances held in
an_y Federal Reserve bank.
The cost to the U.S. Treasury of such interest payments could be a
very high price to pay to induce State-chartered depository institutions to become members of the Federal Reserve System.
On the other hand, a strong case has not been made to demonstrate
that the payment of interest on reserves as proposed will in fact solve
the problem of attrition.
Since the purpose of the payment of interest on reserves held at the
Fed is to make Fed membership more attractive and halt membership
attrition, the amount of income derived from such payment would have
to be equal to or exceed the earnings on reserves presently available
under the State reserve regulations.
A recent study of the burden of Fed membership revealed that the
heaviest burden is borne by member banks with deposits under $100
million, and that banks with deposits over $1 billion appear to experience a net benefit from System membership.
Thus, smaller member banks may operate at a competitive disadvantage relative to the larger ones.
This suggests that unless interest payments on reserves are equated
with the burden of membership, interest payments are not likely to
be an effective instrument to attract new members or in reducing membership attrition.
A backdrop to the proposed legislation is the prospect of paying
for Fed services.
The regulatory proposal to make explicit charges for Fed services
could create problems for smal banks; that is, those with assets of $50
million or less.
Most of these banks would be exempt from the reserve requirements, and presumably under our reading of the statute would not be
receiving any interest payment from the Fed. However, they, as members, would be assessed charges for services provided by the Fed.
Under these circumstances, small banks are not likely to be attracted
to membership in the Fed since they would probably opt for obtaining these services through their correspondent banks. Fed services may
be attractive, but if a bank can obtain all of those services plus many
more from its correspondent, it would be sacrificing earnings to be in
the System.
The only unique service offered by the Fed is access to the discount
window, but a large number of banks have found that this service is
not an adequate inducement to remain members.
The thrust of the proposed legislation appears to be directed at holding in the Federal Reserve System the 1,003 State-chartered members
of the System and inducing the remaining 8,600 State-chartered nonmember banks to join the System.
Most nonmember State-chartered banks are relatively small institutions as revealed by the fact that in 1976 there were 11,800 banks
with assets under $50 million accounting for 82 percent of all banks in
the United States.
If, as some studies have shown, small banks bear a heavier burden
of Fed membership than larger banks, the inducements offered to the
smaller banks to join or retain membership in the Fed should take

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account of these differences of membership burden. We do not believe
the proposed legislation meets this requirement.
Turning next to H.R. 12706, which would provide for the pricing
of Federal Reserve System services and the payment of interest on reserves, we believe the bill attempts to give sufficient study to the proposal before putting it into effect. Of course, this implicitly precludes
any prospect of explicit pricing until the studies are concluded.
While authorizing the Fed to pay interest on reserves, the bill requires the Board to prepare a feasibility study and transmit it to Congress not later than July 1, 1981. We believe this is a constructive
approach.
H.R. 12706 will hamstring the Fed in pricing services by mandating
explicit pricing to include both direct and indirect costs. This could
make membership very unattractive, especially if the Fed could not
respond to market pressures caused by other correspondents providing
like services.
The proposed amendments to H.R. 12706 seek to address some of the
concerns we have identified above.
First, by reducing the amount of interest to be paid to income and
earnings, there would be no drain on the U.S. Treasury.
Second, there would be no universal reserve requirements imposed
on nonmember banks,,and there would be a statutory exemption of the
first $10 million in transactions accounts, both consistent with the goal
of reducing the burdens of membership and enhancing the competitive
posture of small independent banks.
Third, a universal reporting requirement would be imposed to provide current reliable information in order to effectuate monetary
policy.
We question whether or not an enhancement of the current reporting
program involving nonmember banks will provide all the information
necessary without imposing a new regulatory paperwork burden on
small banks.
On the other hand, we believe more attention needs to be given to the
proposed amendments which wrenches from the Fed the flexibility to
set reserve requirements and the discount rate.
On balance, we cannot endorse any of the bills proposed under consideration since we are not convinced that they will achieve the stated
objectives.
Furthermore, we are not convinced that such legislation is necessary
to prevent System attrition or that the Fed's ability to manage monetary policy requires that all depository institutions maintain reserves
in the Fed.
To improve the Fed's capability to manage monetary policy it may
only be necessary to authorize it to obtain summary statistics on assets
and liabilities of all depository institutions as proposed in an amendment to the Stanton bill.
Another proposal which warrants consideration short of the sweeping proposal of the Fed is that offered by the board of directors of the
Federal Reserve Bank of Kansas City.
This proposal would allow member banks to invest a portion of their
required reserves in Government securities owned by the Federal Reserve. Individual banks would be allowed to choose specific issues from

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178

the variety of maturities in the Federal Reserve's portfolio of U.S.
Government securities.
All purchases and sales of securities for reserve purposes would be
made with the Federal Reserve at money market prices. The securities
would be held by the Federal Reserve in a safekeeping account maintained for reserve purposes. The proposed amendment requiring a
feasibility study of such a proposal seems appropriate.
Another proposal suggested the creation of a new type of affiliated
membership, which would make membership more attractive, particularly to smaller banks, by reducing some of the burdens of membership.
Under this proposal the requirement to purchase stock in the Fed
would be eliminated; access to the discount window would be provided
at a rate above that charged full members; and the reserves required
would be based on a clearing formula but not above those requirements
for members.
If Congress is concerned that the Fed may take precipitous action
in the event no legislation passes before the end of the session, the
answer to us is to pass a resolution putting this first on next year's
agenda while prohibiting any implementation.
There will be time to have the Congress, the Fed and all the various
interest groups analyze the impacts and identify unreasonable courses
of action.
We believe that if the Fed is sincere in enhancing membership, there
is one free way to do it.
Over the years many members of our association have gotten the
impression that there is a deep-seated Fed prejudice against small independent banks. These prejudices have been manifested in a number
of ways.
In a study done by this very committee it is clear, for instance, that
the boards of the district banks are heavily weighted in favor of individuals sensitized to big banks rather than small banks.
Furthermore, a historical review of the administration of the Bank
Holding Company Act suggests a nonrecognition of the importance of
this corporate structure as a means of transferring bank ownership.
In short, you can catch more flies with honey than with vinegar.
If there is any message that we urge on the members of the committee today, itis to go slow.
Certainly it is appealing to many of our member banks to receive
interest on reserves. Yet a concern of the unknown, pricing, suggests
caution.
If the Congress would seek to enhance membership rather than just
give the Fed the tools necessary to effectuate monetary policy, ·an the
costs should be known. We have not seen the specific proposals, and
we understand the committee has not, either.
If a package of proposals will achieve the result, they should all be
carefully studied, not rushed through. The vast majority of our member banks are the purported beneficiary of these proposals. They have
not had•a chance to understand what has been proposed, much less respond to either us or the committee directly.
In all fairness, they need the chance to reflect and we urge you to
give them that opportunity.
Our doubts as to the effectiveness of the proposed legislation in

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179
meeting the attrition problem are heightened by the facts revealed in
a study analyzing Federal Reserve System attrition since 1960.
That study found the principal factors contributing to Fed attrition to be a tendency of de novo banks to remain outside the System,
and a pattern of more mergers and absorptions of member banks than
nonmembers with most of the merged and absorbed banks having been
acquired by other member banks.
The bulk of deposit attrition has been due to a more rapid rate of
internal deposit growth on the part of the nonmember sector, including the growth of de novo nonmember banks chartered since 1960, resulting in a relative increase in the average size of nonmember banks.
The study concluded that without any reduction in the burden of
Fed membership, the pattern of net system withdrawals, as well as
the preference of de novo banks for nonmember status, may be expected to continue.
Moreover, recent withdrawals of member bank subsidiaries by several multibank holding companies portend increased withdrawal activity on the part of multibank holding companies.
Given the large size of multibank holding company member banks,
such an increase in withdrawal activity could mean a further acceleration of deposit attrition.
To slow and possibly turn around the pace of aggregate deposit attrition, the burden of System membership, according to the study,
must not only be eliminated but must be converted to a net benefit in
order to encourage both ongoing nonmembers and de novo banks to
join the System.
Our analysis of the proposed legislation leads us to the conclusion
that it will not meet this test.
Thank you.
[The prepared statement of Mr. Campbell, on behalf of the Independent Bankers Association of America, follows:]

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STATEMENT OF THE
INDEPENDENT BANKERS ASSOCIATION OF AMERICA

H.R. 13476, THE RESERVE REQUIREMENTS ACT OF 1978
H.R. 13477, THE INTEREST ON RESERVES ACT OF 1978
H.R. 12706, THE FEDERAL RESERVE MEMBERSHIP ACT OF 1978

BEFORE THE
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS

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Federal Reserve Bank of St. Louis

OF THE
HOUSE OF REPRESENTATIVES

JULY 31, 1978

181
Mr. Chairman, my name is Raymond D. Campbell.

I am first

vice president of the Independent Bankers Association of America,
and president of the Oberlin Savings Bank Company, Oberlin, Ohio.
I appreciate the opportunity to appear before this Committee
on behalf of the 7,300 members of IBAA to present our views on
the proposals relating to the payment of interest on reserves
held by the Federal Reserve banks and the explicit pricing of
Federal Reserve System services.
IBAA is comprised of a large number of relatively small community banks.

More than 80 percent of our banks have assets of

$25 million or less and over two-thirds are located in towns of
under 5,000 population.

Most of our members are found in the mid-

dle third of the country comprising the major agricultural states,
consequently our banks are deeply involved in meeting the credit
needs of agriculture, small business, rural housing and the consumer.

In 1976, for example, commercial banks with assets of $25

million or less supplied almost half the credit extended to agriculture by all of the nation's commercial banks.

Thus, by sup-

plying a major share of bank credit to rural communities, our banks
make a considerably larger contribution to the nation's economic
well-being than their size and share of commercial banking assets
might suggest.
We appreciate the opportunity to testify on the proposed legislation to enable the Federal Reserve Board to pay interest on
reserves held at Federal Reserve Banks and to sanction the payment
of explicit charges rendered depository institutions by the Federal

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182
Reserve System.

However, I should point out that the con-

straints imposed by the timing of these hearings has limited
our ability to assess fully the effectiveness of these proposals in stemming the attrition of Federal Reserve System
membership and their impact on the banks comprising our membership.

Therefore, I should like you to view our comments as

first impressions.
We share the concern of the Federal Reserve Board's chairman that attrition of both banks and deposits of membership in
the Federal Reserve System has accelerated in recent years and
that the failure to halt membership attrition may have severe
implications for the ability of the Federal Reserve Board to conduct monetary policy.

However, we are not persuaded that legis-

lative remedies proposed by the Federal Reserve Board will provide the necessary inducements to attract non-members to join the
Federal Reserve System or persuade members to remain in the system.
Let me turn, then, to the specific pieces of legislation
being considered by this Committee.

The first proposed bill, H.R.

13476, would amend the Federal Reserve Act to provide for the
maintenance of reserves against transaction accounts in Federal
Reserve Banks by all federally insured depository institutions.
It is, in effect, a mandatory universal reserves statute requiring
commercial banks, mutual savings banks, savings and loan associations and credit unions to maintain reserves at Federal Reserve
Banks against demand deposits and all other transaction accounts.

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The bill would exempt from the reserve requirements, subject
to such rules and regulations as may be adopted by the Board,
the first $5 million of transaction accounts of a depository
institution.

Reserves meeting the statute's requirements are

to be in the form of balances in the Federal Reserve bank of
which it is a member or at which it maintains an account; or
balances maintained by a non-member depository institution in
a member bank or in a Federal Home Loan Bank maintaining such
funds in the form of balances in a Federal Reserve bank of
which it is a member or at which it maintains an account.
IBAA has long been opposed to legislation which would make
it mandatory for all banks to maintain reserves in the Federal
Reserve System.

Although national banks comprise about 27 per-

cent of IBAA's membership, 73 percent are state chartered banks,
of which a small minority are members of the Fed.

State chartered

banks favor the freedom to join or not to join the Federal Reserve
System.

Furthermore, the exemption purportedly provided for the

first $5 million in transaction accounts is purely illusory in
that there is broad statutory authority given the Board to impose
reserves on even these deposits.

It is our deep concern that the

mandatory reserve requirement would superimpose federal regulation
over state chartered depository institutions and so erode state
regulation as to ultimately lead to complete federal control.
Another proposal in this package of legislation is H.R. 13477,
which would authorize the payment of interest on reserve balances
held in any Federal Reserve bank.

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Federal Reserve Bank of St. Louis

It would authorize the Federal

184
Reserve banks to pay a total amount of interest in any one year
up to the sum of:

(a) total receipts from the recipients of such

interest for services rendered by Federal Reserve banks; and (b)
7 percent of the total net earnings of the Federal Reserve banks
computed without regard to the payment of such interest; but with
a ceiling rate of 2 percent per annum on reserve balances· in excess of $25 million.

As to the latter (b), the Board is now seeking

deletion of this section.

The cost to the U.S. Treasury of such

interest payments could be a very high price to pay to induce
state chartered depository institutions to become members of the
Federal Reserve System.

There is no assurance that the rate of

interest to be paid on reserves will constitute sufficient inducement for non-member institutions to join the Fed or to enjoin Fed
members from defecting.

A strong case has not been made to demon-

strate that the payment of interest on reserves as proposed will,
in fact, solve the problem of attrition.
Since the purpose of the payment of interest on reserves held
at the Fed is to make Fed membership more attractive and halt
membership attrition, the amount of income derived from such payment would have to be equal to or exceed the earnings on reserves
presently available under state reserve regulations.

A recent

study of the burden of Fed membership revealed that the heaviest
burden is borne by member banks with deposits under $100 million
and that banks with deposits over $1 billion appear to experience
a net benefit from system membership.

Thus smaller member banks

may operate at a competitive disadvantage relative to the larger

ones.

This suggest that unless interest payments on reserves

are equated with the burden of membership, interest payments are
not likely to be an effective instrument to attract new mem1 Robert E. Knight, "Comparative Burdens of Federal
Reserve Member and Nonmember Banks", Monthly Review,
Federal Reserve Bank of Kansas City, March 1977, p.27.

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185
bers or in reducing membership attrition.
The lack of precise data on the net costs of this proposal
to the Treasury leads us to urge caution in setting the permissible
interest rate limits too high.

On the other hand, the setting of

rates of return on reserves too low would make membership unattractive and thus defeat one of the basic purposes of the legislation.
A backdrop to the proposed legislation is the prospect of
paying for Fed services.

The regulatory proposal to make ex-

plicit charges for Fed services could create problems for small
member banks, i.e.,those with assets of $50 million or less.
Most of these banks would be exempt from the reserve requirements
and presumably, under our reading of the statute, would not be
receiving any interest payment from the Fed.

However, they as

members would be assessed charges for services provided by the
Fed.

Under these circumstances small banks are not likely to be

attracted to membership in the Fed since they would probably opt
for obtaining these services through their correspondent banks.
Fed services may be attractive but if a bank can obtain all of
those services plus many more from its correspondent it would be
sacrificing earnings to be in the system.LI The only unique
service offered by the Fed is access to the discount window but
a large number of banks have found that this service is not an
adequate inducement to remain members.
The effect of the payment of service charges on small banks is
difficult to predict since it cannot be determined whether they
would continue to obtain most of these services through their
correspondent banks as an offset against compensating balances or
2 Ronald D. Watson, Donald A. Leonaid, Nariman Behravesh,
"The Decision to Withdraw: A Study of Why Banks Leave
the Federal Reserve System," Federal Reserve Bank of
Philadelphia, Research Paper No. 130, Sept. 1977.

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Federal Reserve Bank of St. Louis

78 • 13

186
whether the correspondent banks would pass these explicit charges
through to their respondents in addition to the income earned on
compensating balances.

It seems certain that correspodent banks

would be likely to adjust their compensating balance requirements
upward to pass through some of the explicit charges assessed
against them by the Fed for services.

Thus small banks are not

likely to obtain any benefits from the payment of interest on
reserves but could be required to pay more for services performed
by the Fed.
The thrust of the proposed legislation appears to be directed
at holding in the Federal Reserve System the 1,003 state chartered
members of the system and inducing the remaining 8,600 state
chartered non-member banks to join the system.

Most non-member

state chartered banks are relatively small institutions as revealed by the fact that in 1976 there were 11,800 banks with assets
under $50 million accounting for 82 percent of all banks in the
U.S.

If, as some studies have shown, small banks bear a heavier

burden of Fed membership than larger banks, the inducements offered
to the smaller banks to join or retain membership in the Fed should
take account of these differences of membership burden.

We do not

believe the proposed legislation meets this requirement.
Turning next to H.R. 12706, which would provide for the
pricing of Federal Reserve System services and the payment of
interest on reserves we believe the bill attempts to give sufficient
study to the proposal before putting it into effect - of course this
implicitly precludes·any prospect of explicit pricing until the
studies are concluded.

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187
While authorizing ~he Fed to pay interest on reserves the bill
requires the Board to prepare a feasibility study and transmit
it to Congress not later than July 1, 1981.

We believe this is

a contructive approach.
H.R. 12706 will hamstring the Fed in pricing services by
mandating explicit pricing to include both direct and indirect
costs.

This could make membership very unattractive, especially

if the Fed could not respond to market pressures caused by other
correspondents providing like services.
The proposed amendments to H.R. 12706 seek to address some
of the concerns we have identified above.

First, by reducing

the amount of interest to be paid to income and earnings, there
would be no drain on the U.S. Treasury.

Second, there would be

no universal reserve requirements imposed on non-member banks,
and there would be a statutory exemption of the first $10 million
in transactions accounts, both consistent with the goal of reducing
the burdens of membership and enhancing the competitive posture
of small independent banks.

Third, a universal reporting re-

quirement would be imposed to provide current and reliable information in order to effectuate monetary policy.

We question

whether or not an enhancement of the current reporting program involving non-member banks will provide all the information necessary without imposing a new regulatory paperwork burden on
small banks.
On the other hand, we believe more attention needs be given
to the proposed amendments which wrenches from the Fed the flexability to set reserve requirements and the discount ;rate.

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188
Indeed, the proposals before this committee are a mixed bag
of monumental import.
On balance we cannot endorse any of the bills proposed under
consideration since we are not convinced that they will acheive
the stated objectives.

Furthermore, we are not convinced that

such legislation is necessary to prevent system attrition or that
the Fed's ability to manage monetary policy requires that all
depository institutions maintain reserves in the Fed.

To im-

prove the Fed's capability to manage monetary policy it may only
be necessary to authorize it to obtain summary statistics on
assets and liabilities of all depository institutions as proposed
in an amendment to the Stanton bill.

Another proposal, short of

the sweeping proposal of the Fed which warrants consideration, is
that offered by the Board of Directors of the Federal Reserve Bank
of Kansas City.

This proposal would allow member banks to invest a

portion of their required reserves in government securities owned
by the Federal Reserve.

Individual banks would be allowed to

choose specific issues from the variety of maturties in the Federal Reserve's portfolio of U.S. government securities.

All pur-

chases and sales of securities for reserve purposes would be made
with the Federal Reserve at money market prices.

The securities

would be held by the Federal Reserve in a safekeeping account maintained for reserve purposes. LI

The proposed amendment requiring

a feasibility study of such a proposal seems appropriate.
Another proposal suggested the creation of a new type of
"affiliated" membership, which would make membership more attractive
3 "A proposal for Enhancing the Attractiveness of Membership in the Federal Reserve System." A report by the
Board of Directors of the Federal Reserve Bank of
Kansas City, June 1977.

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Federal Reserve Bank of St. Louis

189
particularly to smaller banks, by reducing some of the burdens of
membership.

Under this proposal the requirement to purchase stock

in the Fed would be eliminated;

access to the discount window

would be provided at a rate above that charged full members; and
the reserves required would be based in a clearing formula but not
above those requirements for members.
At this juncture we feel that the point and counterpoint that
seems to be rushing this legislation along ought to be resisted.
We feel ·the issues have been blurred and the net losers will be
those who are intended as beneficiaries.

Important questions need

be asked such as whether the immediate goal is to enhance Fed
membership or to provide the Fed with the tools necessary to
effectuate monetary policy.
cross purposes.

Some of the proposals seem to be at

In short, what is the rush?

If Congress is concerned that the Fed may take precipitous
action in the event no legislation passes before the end of the
session, the answer to us is to pass a resolution putting this
first on next year's agenda while prohibiting any implementation.
There will be time to have the Congress, the Fed and all the
various interest groups analyze the impacts and identify unreasonable
courses of action.
We believe that if the Fed is sincere in enhancing membership,
there is one free way to do it.

Over the year many members of

our Association have gotten the impression that there is a deep
seated Fed prejudice against small independent banks.
prejudices have been manifested in a number of ways.

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Federal Reserve Bank of St. Louis

These
In a study

190
done by this very committee it is clear, for instance, that the
boards of the district banks are heavily weighted in favor of
individuals sensitized to big banks, rather than small banks.
Furthermore, historical review of the administration of the bank
holding company act suggests a nonrecognition of the importance
of this corporate structure as a means of transferring bank ownership.
In short, you can catch more flies with honey than with vinegar.
If there is any message that we urge on the members of the
committee today, it is to go slow.

Certainly, it is appealing to

many of our member banks to receive interest on reserves.
concern of the unknown--pricing--suggests caution.

Yet a

If the Congress

would seek to enhance membership rather than just give the Fed the
tools necessary to effectuate monetary policy, all the costs
should be known.

We have not seen the specific proposals, and

we understand the committee has not either.

If a package of proposals

will achieve the result, they should all be carefully studied-not rushed through.

The vast majority of our member banks are the

purported beneficiary of these proposals.

They have not had a

chance to understand what has been proposed much less respond to
either us or the committee directly.

In all fairness, they need

the chance to reflect and we urge you to give them that opportunity.
Our doubts as to the efficacy of the proposed legislation in
meeting the attrition problem is heightened by the facts revealed in
a study analyzing Federal Reserve System attrition since 1960.
That study found the principal factors contributing to Fed attrition to be a tendency of d e ~ banks to remain outside the system;
and a pattern of more mergers and absorptions of member banks than
non-members with most of the merged and absorbed banks having been

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Federal Reserve Bank of St. Louis

191
acquired by other member banks.

The bulk of deposit attrition

has been due to a more rapid rate of internal deposit growth on
the part of the non-member sector (including the growth of de nova
non-member banks chartered since 1960), resulting in a relative
increase in the average size of non-member banks.
The study concluded that without any reduction in the burden
of Fed membership, the pattern of net system withdrawals, as well
as the preference of de
pected to continue.

banks for non-member status, may be ex-

Moreover, recent withdrawals of member bank

subsidiaries by several multi-bank holding companies portend
increased withdrawal activity on the part of multibank holding
companies.

Given the larger size of multibank holding company member

banks, such an increase in withdrawal activity could mean a further
acceleration of deposit attrition.

To slow and possibly turn around

the pace of aggregate deposit attrition the burden of System membership according to the study must not only be eliminated but must
be converted to a net benefit in order to encourage both on-going
4

non-members and de nova banks to join the System.-

Our analysis

of the proposed legislation leads us to the conclusion that it will
not meet this test.

4 · John T. Rose, An Analysis of Federal Reserve System
Attrition Since 1960, Federal Reserve Board Staff
Economic Study, December 1977.

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192
Mr. MITCHELL. Thank you very much. Mr. Hill.
STATEMENT OF RICHARD D. HILL, PRESIDENT, ASSOCIATION OF
RESERVE CITY BANKERS, CHAIRMAN, THE FIRST NATIONAL
BANK OF BOSTO;N
Mr. HILL. Thank you.
Mr. Chairman, members of the committee, I appreciate this opportunity to present my views to your distinguished committee on three
quest'ions which you have posed in connection with your examination
of the membership problem within the Federal Reserve System.
The Association of Reserve City Bankers was organized in 1913,
shortly after the passage of the legislation which established the
Federal Reserve System. Its membership is comprised of nearly 400
executive officers from over 160 banks located in the principal cities
of the United States, usually called reserve cities.
The vast majority of our members are members of the Federal Reserve System, and they all conduct a correspondent banking business.
While I believe my views are reasonably representative of those of
a majority of the members of our association, you should understand
that contrary to the popular perception of bankers as possessing herd
instincts, they are, indeed, difficult to corral on legislative matters.
The first question has to do with the need for membership in the
System. We all agree that the membership base is eroding, but is this
truly harmful to the public interest i
The Governors of the Federal Reserve Board believe that this erosion of membership hampers the exercise of monetary policy and I
think we all agree that the proper exercise of monetary policy is an
indispensable portion of their responsibilities.
Learned economists disagree among themselves as to the relationship between member bank reserve balances and control over the
money stock. Some say there is none, some attribute a partial relationship and others consider it essential.
These same economists, incidentally, express widely different opinions with respect to the effects of monetary policy on the country's
economy and, of course, they rarely achieve a consensus with respect
to the actions of the Open Market Committee.
I take comfort in the historic record of general stability in the
banking system since the establishment of the Federal Reserve System
compared to that which existed before. This leads me to place a high
value on the purpose and structure of this institution which, with all
its faults, has served us well.
The structure is based upon widespread membership of commercial
banks accounting for a major share of transaction deposits and upon
the exercise of monetary policy through their reserve balances.
Therefore, I conclude with utter simplicity that. until we be ready
to reexamine the entire purpose and structure of the. System, and this
would take several years, we should be deeply concerned with the erosion of membership and should try to arrest it.
There is, of course, another important aspect to the membership
problem, and that has to do with the availability of the discount window. Small- and medium-sized banks having decided to leave the Sys-

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Federal Reserve Bank of St. Louis

193
tern are able to obtain lines of credit from correspondent banks but
they are assured of their correspondent's ability to obtain their
liquidity, if needed, from the lender of the last resort-namely, a Federal Reserve bank.
There are ways for loans to be made to nonmembers, but these are
at higher rates and somewhat cumbersome as they require a vote of the
Board of Governors. The ghost of Federal Joans or guarantees of
Lockheed and the city of New York may well hover over these decisions whereas member bank access to the discount window is usually
quite routine.
My comments on explicit charges for Federal Reserve services and
on the pricing of these services are based on the following conclusions:
One, consideration of pricing should only be made after a decision
has been reached on interest on reserve balances. To charge member
banks for Federal Reserve services without offsetting the cost burden
of holding non-interest-bearing reserves would only heighten the
problem of membership.
Two, as a matter of principle, it should be unnecessary for the
Federal Government or any agency thereof to compete with the private sector unless the private sector is unable or unwilling to provide
an essential service to society.
Three, the principle of unbundling costs and benefits is sound in
that it eliminates the subsidization of any economic activity. It allows
benefits and prices to flow in an objective and equitable basis and in
the long run allows the free market to function properly.
Four, the services to be priced are those presently being offered by
the System; namely, check collection. currency and coin, wire transfer,
noncash collection -and safekeeping of securities.
The Federal Reserve should price its services on a full cost basis,
including variable costs, fixed costs and overhead costs as well as a
reasonable return on capital, and there should be a complete description and cost for each service.
In pricing the check service, consideration must be given to not only
price but ·also the availability. of funds. The Federal Reserve should
not allow the further creation of float by giving availability; that is,
investable funds before they have received good funds -from the
paying bank.
The payments systems today-by that I mean the check system as
well as currency and coin-functions either through the correspondent
bank network or throu~h the Federal Reserve System with a great deal
of interaction between the two.
It allows users to choose between institutions offering these services
to enable them to maximize their benefits in the payments system.
Tlrnt choice should remain.
Obviously there will be an impact on the correspondent banking
svstem and bankers presently offering these services for cash or demand deposit balances will be atfected in varying degrees.
However, we are a resourceful industry and we have had many
yen.rs of experience meeting competition and adjusting our services
qn;cklv to the needs of our customers.
. Jn other words, we do not fear this threatened competition except
to the extent that prices are subsidized to levels below those set in
free competition among the market participants.

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194
It must be obvious from these remarks that it will be difficult to
rally widespread support from our members for the Federal Reserve
proposals under discussion until the pricing policies are clearly
enunciated •and understood.
In general, however, we support the principal of unbundling and
of separating the benefits from the costs.
Finally, I have been asked to comment on the proposal to pay interest to member ham.ks on required reserves. This is, of course, the
key to the solution of the membership problem and is an issue which
should have been resolved many years ago when the apparent cost
to the Treasury would have been de mmimis and the consequent
political difficulty much less an obstacle than it is today.
In effect, the marketplace has overtaken the inequilibrium in our central banking system and more and more banks are turning to their
other choice; namely, a more economically feasible State system.
Congress could stop this by fiat but again the political realities surrounding our dual banking system will make this difficult, if not
impossible.
Bankers have long urged recognition by the Board of the equity of
paying for reserves which, after all, are valuable deposits on which the
Federal Reserve earns a great deal of money.
They have felt-and still do-that inasmuch as the reserves are based
upon their own liabilities, most of which they solicited from customers
by their own efforts, they should have the economic reward accruing on
them instead of paying it as an extra tax for the right to conduct a
banking business.
While we very much support the principle advanced in the Federal
Reserve proposal we have to say that the suggested stratification of interest to be paid-namely, a market rate on the first $25 million of required reserves and a much, much lower rate on the excess-is a concession to politics rather than to the equity of the matter.
Studies conducted for the Federal Reserve System seem to say that
the cost of membership weighs more heavily on the small banks than
on the larger ones, and this is the published rationale for favoring the
former in the allocation of interest payments.
Part of the argument was based upon a mistaken idea that in accepting demand deposits from respondent banks in payment for services,
there was a residue of these deposits over and beyond the amount necessary to provide adequate compensation to the correspondent.
I,n today's competitive market,. this is simply not so. In fact, the
accounts are often inadequate.
A recent study just completed by Prof. George Bentson, of the University of Rochester, which shortly will be available to this committee,
rather strongly refutes the premise of a proportionally greater burden
of membership on the smaller banks.
I do, therefore, urge the Congress to give heed to the fairness doctrine in deciding how to allocate the interest payments.
Thank you for permitting me to make these observations on behalf
of the association which I represent. I will be happy to answer any
questions within the scope of my limited knowledge of this sometimes
abstruse subject.
[Mr. Hills' prepared statement, on behalf of the Association of Reserve City Bankers, follows:]

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Federal Reserve Bank of St. Louis

195
PREPARED STATEMENT OF RICHARD D. HILL

I appreciate this opportunity to present

iey

views to your distinguished

carmittee, Mr. Chairman, on three questions which you have posed in
connection with your examination of the nenbership problem within the
Federal Reserve System.

While I believe

iey

views are reasonably

representative of those of a majority of the melri:lers of our Association,
you should understand that contrary to the popular perception of
bankers as possessing herd instincts, they are, indeed, difficult to
corral on legislative matters.

'!he first question has to do with the need for membership in the

System.

all agree that the membership base is eroding-but is

this truly hannful to the public interest?

The

Governors of the Federal Reserve Board believe that this erosion

of rrerrbership hampers the exercise of m:inetary policy and I think
we

all agree that the proper excercise of m:inetary policy is an

indispensible portion of their responsibilities.

Learned econanists

disagree anong themselves as to the relationship between member bank
reserve balances and control over the money stock.

Sare

say there is

none, sane attribute a partial relationship and others consider it
essential.

These

sa!l'e

econanists, incidentally, express widely

different opinions with respect to the.effects of m:inetary policy
on the country's econany and, of course, they rarely achieve a
concensus with respect to the actions of the

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I take can.fort in the historic record of; general stability in the
banking system since the establishment of the Federal Reserve System
caq,ared to that which existed before.

This leads

ll'e

to place a high

value on the purpose and structure of this institution which, with
all its faults, has served us well.

The structure is based upon

widespread membership of carrrercial banks accounting for a major
share of transaction deposits and upon the exercise of 11Dnetary
policy through their reserve balances.

'Iherefore, I conclude with

utter sillpicity that until we are ready to re-examine the entire
purpose and structure of the system (and this would take several
years) we should be deeply concerned with the erosion of membership
and should try to arrest it.

'!here is, of course, another important aspect to the membership
problem and that has to do with the availability of the discount
window.

Small and rredium-sized banks having decided to leave the

ey,stem are able to obtain lines of credit fran co=espondent banks
but they are assured of their co=espondent's ability to obtain
their liquidity, if needed, fran the lender of last resort, namely
a Federal P.eserve Bank.

There are ways for loans to be made to

non-nerbers but these are at higher rates and sarewhat cimberscme ,
as they require a vote of the Board of Governors.

The ghost of

Federal loans or guarantees of I.o::kheed and the City of New York
nay well hover over these decisions whereas rrember bank access to
the discount window is usually quite routine.

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1:fy'

ccmnents on e,cplicit charges for Federal Reserve services and

on the pricing of these services are based on the following conclusions:
1.

Consideration of pricing should only be made after a
decision has been reached on interest on reserve
balances.

To charge member banks for Federal Reserve

services without offsetting the cost burden of holding
non-interest bearing reserves would only heighten the
problan of membership.
2.

a matter of principal, it should be unnecessary

for the Federal government or any agency thereof
to ~ t e with the private sector unless the private
sector is unable or unwilling to provide an essential
service to society.
3.

'lll.e principal of unbundling costs and benefits is
sound in that it eliminates the subsidization of any
econanic activity.

It allows benefits and prices

to fla-, in an objective and equitable basis and in
the long run allows the free market to function

properly.
4.

The services to be priced are those presently being

offered by the Sytan--nanely, check-collection, currency
and coin, wire transfer, non-cash collection and

safekeeping of securities.

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The Federal Reserve should price its ser:vices on a full cost basis,

including variable costs, fixed costs and overhead costs as well as
a reasonable retuni on capital; and there should be a canplete
description and cost for each service.

In pricing the check service,

consideration must be given to not only price but also the availability
of funds.

The Federal Reserve should not allow the further creation of

float by giving availability; i.e. , investible funds before they have
received good funds fran the paying bank.

The payroonts system today, by that I m:an the check system as well as

=rency and coin, functions either through the co=espondent bank
network or through the Federal Reserve System with a great deal of
interaction between the bio.

It allows users to choose betl--een

institutions ·offering these services to enable them to maximize their
benefits in the payroonts system.

That choice should rerrain.

Obviously there will be an im;iact on the co=es=dent banking system
and bankers presently offering these ser:vices for cash or derrand

deposit balances will be affected in varying degrees.

However, we

are a resourceful industry and we have had many years of experience
m:eting canpetition and adjusting our services quickly to the needs
of our custan:rs.

In other words we do not fear this threatened

canpetition except to the extent that prices are subsidized to
levels below those set in free canpetition arrong the market participants.
It must be obvious from these rerrarks that it will be difficult to rally

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widespread support fran our members for the Federal Reserve proposals
tmder discussion tmtil the pricing policies are clearly enunciated
and tmderstood.

In general, however, we support the principal of unbundling and of
separating the benefits fran the costs.

Finally, I have been asked to corment on the proposal to pay interest
to member banks
to

on required reserves.

This is, of course, the key

the solution of the membership problem and is an issue which

should have been resolved many years ago when the apparent cost to
the Treasury would have been de minirois and the c ~ t political
difficulty IIU.lCh less an obstacle than it is today.

In effect the

market place has overtaken the inequilibritnn in our central banking
system and m:,re and m:,re banks are turning to their other choice,
nanely a m:,re econanically feasible state system.

Congress could

stop this by fiat but again the political realities surrounding our
dual banking system will make this difficult, if not i.rcp:)ssible.
Bankers have lorg.urged recognition by the Board of the equity of
paying for reserves which, after all, are valuable deposits on which
the Federal Reserve earns a great deal of noney.

They have

felt--and still do-that inasmuch as the reserves are based upon
their own liabilities, m:,st of which they solicited fran custaners
by their own efforts, they should have the econanic reward accruing

on them instead of paying it as an extra tax for the right to conduct
a banking business.

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While -we very IIDlCh support the principle advanced in the Federal
Reserve proposal -we have

to say that the suggested stratification of

interest to be paid, namely a market rate on the first $25 million of
required reserves and a IID.lCh, IIDlCh lower rate on the excess is a

concession to politics rather than to the equity of the matter.
Studies =nducted for the Federal Reserve System seem to say that
the cost of membership weighs irore heavily on the small banks than
on the larger ones, and this is the published rationale for favoring
the fo:cner in the allocation of interest payments.

Part of the

a.rgunent was based upon a mistaken idea that in accepting demand
deposits fran respondent banks in payment for services, there was a
residue of these deposits over and beyond the anount necessary to
provide adequate c:arpensation to the correspondent.

In today' s

canpetitive market this is silllply not so, in fact, the accounts
are often inadequate.

recent study just cc:rrpleted by

Professor George Benston, of the university of Rochester, which
shortly will be available to this Ccmnittee, rather strongly refutes
the premise of a proportionally greater burden of membership on the

smaller banks.

I do, therefore, urge the Congress to give heed to the fairness
doctrine in deciding how to allocate the interest payments.

Thank you for pennitting me to make these observations on behalf of

the Association which I represent and I will be happy to answer any

questions within the scope of my limited knowledge of this saretimes
abstruse subject.

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The CHAIRMAN. Thank you very much, Mr. Hill.
This concludes the testimony from this panel.
Mr. Moorhead?
Mr. MOORHEAD. Thank you, Mr. Chairman.
It seems to me that from this testimony, a clear point of difference
seems to emerge. Mr. Campbell says the burden of membership in the
Fed weighs more heavily on the small banks than on the large ones.
Whereas, Mr. Hill, you seem to challenge that statement.
How can you rationalize your differences and explain them? I must
say that at first blush, since the larger banks tend to have a. higher membership percentagewise than the smaller banks, the layman's view
would favor Mr. Campbell's conclusion.
I would like to be educated further on that.
Mr. HILL. In view of the fact that it is the large banks that are still
largely in the System, I will answer it first.
The larger banks are really captives to the System, Mr. Moorhead.
Those who offer correspondent banking services really need entry to
the Federal Reserve System in order to provide entry for their
customers.
'
Furthermore, quite a number of the large banks historically were
national banks, who must be members. There is a great deal of imagery
resistance in giving up a national bank charter.
There is also in some States possibly a concern about the quality of
State banking regulations which the large bank would be inheriting.
Mr. MooRHEAD. Gentlemen, let us make the assumption, with which
you may not agree, but just for purposes of argument, that it would be
good national policy-I am not talking about independent bankers or
reserve city bankers-but good national policy to discourage the attrition of membership and to encourage membership.
Making that assumption, what would you recommend? I know, Mr.
Campbell, you said one clear one was the negative attitude of the Fed
toward the smaller banks. That is a little hard to legislate, but I would
think possibly larger membership might achieve that result. Maybe
that is the chicken-or-egg argument.
But what concrete proposals would each of you make from possibly
different vantage points? What would induce smaller banks to enter
the System? What would discourage larger State-chartered banks
from withdrawing from the System?
We can start with you, Mr. Campbell.
Mr. CAMPBELL. The primary reason, Mr. Moorhead, that small banks
do not belong to the Fed is because of the cost of membership. That is
the primary reason.
If some type of structure can be put together whereby a bank could be
compensated and have a net benefit through a system of payment of interest on reserve balances and explicit charging, I think that membership would gain in the Fed.
I happen to be a State-member bank. I recognize that there are costs
involved with that membership. However, we have maintained our
membership in the Fed because we believe that we do derive benefit
from the association that we have.
The Federal Reserve Bank in Cleveland, and the people at that particular Fed, have been very cooperative. They understand our special

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needs. They have been ·very helpful over the years. For those reasons,
Oberlin Savings Bank has not withdrawn.
Mr. MoorumAo. Mr. Hill?
Mr. HILL. Mr. Moorhead, I believe the reason is, as Mr. Campbell
says, purely ,an economic one. There is ,a clear bottom line choice for the
middle-sized to larger banks which are in ,a position to withdraw from
the System.
Under the State systems th~y a.re able 'tJO keep their reserve balances,
ei1Jher witlh correspondent blanks, for which they receive services, or
in U.S. Government obligations on which they receti.ve a full market
ralte of interest.
In the Reserve System, of course, there ,are none of these benefits
except that we do get all of our check handling, wire transfer services
and coin handling services, for nothing.
The difference between the ma,rket value of interest on our reserves
and the 00$t of the services rendered by the Fed is fairly substantial.
It may be for every $100 of cost of services we are giving up $200 in
interest payments. So, there is a $100 differential there.
So, it seems ,to me thrut the clearest way to stop this attrition is to
recognize the monetary value of those reserves, which at one time was
quite small, to recognize the value of this and pay it.
I very strongly support that aspect of the solution to this problem.
Mr. PETERSON. Mr. Moorheiad, I think that one of the difficulties that
we have tried to address in our testimony relates to ,the matter of pricing and the confusing studies that have been done. There have been
quite a few of them in the last 3 years-on where burdens lie, what
kind of pricing will do what, how much interest is required to compensate £or general charges-go right hack to our central point.
We don\ want to buy a pig in a poke. That is the problem in answering your question.
Mr. :MOORHEAD. My time has expired. When it comes around ,again,
I may ask you about whether we address that question you posed,
whether we actually need membership in the Fede<ral Reserve System,
Mr. Hill.
Thank you, Mr. Chairman.
The CHAIBMAN. Thank you.
Mr. Stanton?
Mr. STANTON. Thank you very much, Mr. Chairm,an.
Gentlemen, I wish to welcome you here. I apprecialte your cooperation with the committee on this very important subject.
Mr. Chairman, I would be remiss-we always do traditionally-if
I didn't ext.end a special welcome, as is my prerogative, to my friend
from Oberlm, from tihe greiat State of Ohio, Mr. Campbell.
No re,flection, Mr. Hill, but we ·are neighbors, to a degree, in the
suburbs of Clevektnd, although Mr. Campbell is in a little bit different
direction from Cleveland than I :am. But we are very happy to have
you here.
Mr. CAMPBELL. Thank you, Mr. Stanton.
Mr. 'STANTON. I think Mr. Moorhead asked philosophically ,an interesting question that I will not wait until we get hack to 'him to ask
you both.
Just how important, forgetting about the position of the independ-

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ent bankers and the Reserve bankers, is the Federal Reserve System to
our country 1
This idea of membership, is it worth fighting for or is it not 1 Is it
not possible that the Fed could a:ffoot monetary policy without any
members at all, or ·a significantly lower number of members1
Do you think it is an important subject matter that we are now conducting these hearings on; that is, the loss of membership in the Fed i
Is it worth saving, or are we wasting our time 1 I would like to have
general comments from bdth of you on that.
Mr. CAMPBELL. :Mr. Stanton, Mr. Chairman, we certainly feel :that
it is worth saving. Even though we do not borrow from the discount
windows, we 1always react to discount window changes because our
community is a well-read community, being a collage community, and
our people in our community know immediately when there has been
a change in the disoount rates.
They do reaet in their buying habits. They look at the overall economy very carefully. I think th-at the Fed has a very, very, definite
responsibility in monetary policy.
However, I could not evaluate how far down in numbers in Fed
members we could go without the Fed being a:ffected. But I certainly think that we could be reaching too low in Fed membership
if that is necessary.
Mr. STANTON. Mr. Hill.
Mr. Hn,L. I agree very much with that. Obviously the primary job
of the Fed is to conduct monetary policy and-the Fed believes it
would be hampered by loss of membership.
As I sa,id in my testimony, you could get a whole range of arguments
from learned economists. It is a very albstruse series of arguments.
Some say there is no connection between membership, reserves, and
monetary policy. Others say there is a partial connection. Others say
it is a very tight connection, and very necessary.
I believe that because of the strubility that has existed in our banking
system since the formation of the Federal Reserve System, that it
would !be unwise to tamper with this unless we conduct a detailed study
of the purposes and structure df the Federal Reserve System, and that
this would take several years to do properly.
In the meantime, the ship is shinking. So, we probably should plug
the hole for the time being.
Second, the existence of ,the discount window is very important. We
saw this demonstrated during a few crises which took place during
the recession, and we also saw how these crises were met very promptly
without loss to depositors.
Third, the Federal Reserve does play an extremely important part
in the whole payments system. Admittedly, they have competitors:
namely, correspondent banks.
But there ·are a great many services provided, not unlike the Rural
Electrification Administration, which provides electricity to areas
which the utilities simply cannot handle economicaUy.
This is the same with the Fed payments system. They provide a great
many services-check handling, clearing services-to areas which economically cannot lbe received by the private sector.
They rulso are in the forefront of helping to design new systems for

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the future. The Federal Reserve had a great deal to do with the establishment of automated clearing houses, which is a beginning of a reduction in the paperibased system, working toward the eventual elimination
of checks with their tremendous economic cost.
So, I think in these areas that the Fed is extremely important to our
system, 'and I draw the simplistic conclusion from that that we do need
membership to support it.
Mr. STANTON. One last question this time around, Mr. Hill. This
question is asked basically because of your location with.in our country.
The problem, you know, has accelerated in recent years, of the drop
of membership in the Fed. Of course, your area of New England has
led this exodus. In fact, to an alarmingly so rate within the last year,
and especially as we get into those banks of $100 million and over.
The question comes up that we have not seen anything yet compared
to what is going to happen, that there has been, due to this legislation
or talk of possible legislation, a holding back of present members leaving the System, until we do see how we do come out.
Is this a prevalent attitude, in your opinion, of many members, now
members of the System who perhaps are holding back, and who if we
have no legislation at all, or we pass over this subject for the time
being2 will be leaving the System~
Mr.-HIIL. I ibeilieve from things I have heard in the New England
area that ,there are several more banks giving serious consideration to
leaving and that possibly they are being persuaded to hold off until
Congress makes up its mind as to how to solve the problem.
The reason, perhaps, for the larger exodus in New England was that
amazing compromise which was achieved for paying interest on checking accounts, which, as you recall, was confined to Massachusetts and
Vermont as an experiment.
This created a severe economic hardship on a number of banks-the
transition did-and caused them to reexamine their bottom lines very
carefully.
Also, I think it is fair to say that because New England has not
achieved the growth of much of the rest of the country, because of its
mature economy, the recession bore much more heavily on the New
England ibanks. Levels of loan losses were considerably higher, and
that had an impact on earnings as well.
Mr. STANTON. Thank you.
Thank you, Mr. Chairman.
The CHAmMAN. Thank you, Mr. Stanton.
Mr. Annunzio.
Mr. ANNUNZIO. Thank you, Mr. Chairman.
Mr. Hill, you know, this proposition of the Federal Reserve Board
losing membership is nothing new in this country. Labor unions are
losing membership. Fraternal organizations, among the great ethnics
of this country-we can't get the young people interested in joining
these old line fraternal organizations. They are just not joiners.
Now, as you know, the national banks ·are members of the Federal
Reserve System. Wbat the Federal Reserve is attempting to do is to
increase their membership in the Federal Reserve System by g-etting
these State banks to join their System. As I see this thing, they are
holding out some carrots to pay interest rates.

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I am chairman of the Consumer Affairs Subcommittee. Will you
tell me, Mr. Hill, in the first place, why ,all these banks have to be
members of the Federal Reserve System? I don't see the importance
of that at all.
And tell me, by paying interest rates on deposits to national banksand I know in my own State of Illinois most of the other banks, correspondent banks, have an affiliation with larger banks-how does the
consumer fare in all this?
Every time we do something in Government it costs you, as a consumer, money. It costs me money. We are notorious for that. How is
the consumer going to come out?
Mr. HILL. Mr. Annunzio, if our premise is correct, that the Federal
Reserve is doing a good job or is supposed to be doing a good job in
helping to stem inflation m our country, and if membership is required
to help them do this, then I think it is a primary benefit to the consumer, to have a central banking system, which can make its proper
contribution toward stability in our prices.
Mr. ANNUNZIO. Pardon me. You said membership is required?
Mr. HILL. Membership, as you know, sir, is required only for national banks.
Mr. ANNUNZIO. National banks, right.
Mr. HILL. But there are many State banks which are members of
the Federal Reserve System.
Mr. ANNUNZIO. Right.
Mr. HILL. But it is purely voluntary.
Mr. ANNuNz10. Right.
Mr. HILL. What I am saying is that I believe if the erosion of membership which is taking place now is going to hamper the exercise of
monetary policy on the part of the Fed-therefore, it should be our
total concern to try to stop that, so that the Fed can exercise its major
responsibility.
Mr. ANNUNZIO. Will you explain to me, on the erosion of membership, how we are going to stop this? You are talking now about a
closed shop membership.
I can see the day will come to Congress when we will have to have
a relief for these bankers who object to the closed shop.
Mr. HILL. No, sir.
Mr. ANNUNZIO. We are voting all the time here on labor unions.
Mr. HILL. This would still be voluntary. This simply holds out a
carrot to those who are considering leaving membership, or to those
who are not in it.
Mr. ANNUNZIO. Let us talk about that carrot. What is that going to
cost the consumers?
I am going to vote on this. I am not the banker and the expert. You
are going to teach me today. You are going to tell me why I should
vote to give the Fed the authority to sign up these banks who are not
members of the Federal Reserve System.
How is that going to benefit the consumer? It will benefit the Federal Reserve. They will have more banks. But how is that going to
benefit the American public? How is that going to benefit the
taxpayers?
Is it going to wind up costing them more money? These are the

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answers I must have if we pass this legislation, I must go back to my
district.
Anything as extensive as banking will reflect on the members of this
committee first. Convince me as a member of this committee why I
should wind up signing myself as an organizer now for the Federal
Reserve System. That is what I am doing.
Mr. HILL. First, Mr. Annunzio, there should be relatively little
economic effect on the banks that are now in the State system and
decide to join the Fed.
What this is attempting to do is equalize the economic benefits between the cost of being in the Fed and the cost of being in the State
system.
So, this would simply have the effect of holding the present members so no more would leave. How many new ones would be attracted
I cannot say.
Mr. ANNUNZIO. What happens to the correspondent banks now?
Mr. HILL. The correspondent banks, which I represent, will be
affected by this bill. They will 'be affected if the Federal Reserve prices
its services below the market price-we are going to lose correspondent
ban~s who will say we will use the services of the Fed instead of your
services.
So, it will affect us. But that is a factor of pricing and competition.
All we ask is that the Fed prices recognize the same economic factors
that ours do, and that is our cost of doing business.
Mr. ANNUNZIO. My time has expired, Mr. Hill. Thank you.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Mr. Annunzio.
Mr. Hyde of Chicago.
Mr. HYDE. Thank you, Mr. Chairman.
Mr. Campbell, what is the impact of the reduction in reserve requirements proposed by the Fed? Do small banks find it attractive? If not,
why not?
Mr. CAMPBELL. We could find that reduction attractive, Mr. Hyde.
But we still cannot accept a proposal without knowing more about
the pricing of the services that will accompany this change. We are
most concerned about the explicit pricing.
Mr. HYDE. Does your position reflect the sentiment of all the small
banks, Fed members and nonmembers, as far as you know?
Mr. CAMPBELL. Again, Mr. Hyde, this legislation is new. We haven't
had an opportunity really to determine what the feeling of our members across the Nation might be.
Mr. HYDE. How much time do you think that would take, to get a
good feeling or a good reaction from your members?
Mr. CAMPBELL. We would think that 1t would be April of next year
before we could have any conclusive answer.
Mr. HYDE. Thank you. I have no further questions.
The CHAIBMAN. Mr. Derrick?
Mr. DERRICK. Thank you, Mr. Chairman.
Mr. Hill, what part of the erosion do you feel could be attributable to
the situation where a large bank chooses to remain in a holding company, subsidiaries drop out, and the large bank enjoys the services of
the Fed, while also passing that on to the subsidaries?

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Mr. HILL. Well, this has been taking place. Some bank holding companies with one or two large members in the System-Mr. DERRICK. We are aware that it has.
Mr. HILL [continuing]. Have caused their subsidiaries-Mr. DERRICK. What effect do you feel it might have on the erosion
of membership?
Mr. Hn,r,. I think that is very much a part of the reason, but their
decision is a purely economic one.
Mr. DERRICK. I understand that. What they are doing is getting a
free ride, so to speak.
Mr. HILL. No; the lead hank is the member of the Fed, and is paying !I' heavy price for Fed membership, and then is charging for its
services.
Mr. DERRICK. Would not the total cost to all of those banks within
the holding company be much greater than the price that the one large
bank would be paying?
Mr. HILL. If they were all members, yes.
Mr. DERRICK. So that would be a loss to the Fed. It is certainly a
loss in membership.
Mr. HILL. That is right.
Mr. DERRICK. Do you have any suggestions as to what might be done
to cure this ?
Mr. HILL. Mr. Derrick, I think the suggestions that are before usnamely, interest on reserves and specific pricing-would solve that
problem. I don't think that kind of a problem should be solved by fiat
or by law.
.
I don't think the law should be passed saying that bank holding companies must not allow their banks to leave the Federal Reserve System.
Mr. DERRICK. You think that it should be economically advantageous-Mr. HILL. I think it should be a free market decision.
Mr. DERRICK. Thank J:OU very much.
Mr. Campbell, I don t understand your reasoning in that you feel
that the Fed can manage monetary policy just as well with a decreasing membership, or that it is not necessary for membership, the
participation of their reserves.
I happen to think that the Fed serves a tremendous purpose, as a
counterbalance with the Congress in making economic policy.
I go to Mr. Annunzio's question, and I appreciated Mr. Hill's re•
sponse because certainly the consumer, all of us, would be at a great
disadvantage if we did not have this counterbalance, in my opinion.
I don't see how you can-would you enlighten me~
Mr. CAMPBELL. Mr. Derrick, I did not intend to say that I felt that
we could operate without monetary control from the Fed. We do think
it is important. I did state earlier that I had no way to evaluate how
f,ar in reduced membership we can go without the Fed losing control
although it seems to be getting to be a more serious problem.
Mr. DERRICK. On page 8, you say:
1

Furthermore, we are not convinced that such legislation is necessary to prevent System attrition or that the Fed's ability to manage monetary policy requires that all depository institutions maintain reserves in the Fed.

I understand that you put "all" in there, but where do you put-

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Mr. CAMPBELL. We are referring to this specific legislation, Mr.
Derrick. We would be concerned about a tremendous decrease in Fed
membership and in the dollars which they control through the Fed
System.
Mr. DERru:cK. But do you agree, then, that the larger memberslup
does give the Fed a more direct impact on monetary policy~
Mr. CAMPBELL. I would agree; yes.
Mr. DERRICK. And that erosion would cut back that impact~
Mr. CAMPBELL. Certainly the erosion could be serious, but we are not
convinced that this legislaition is the practical way to approach that
problem.
Mr. DERru:OK. So it is not a, question of whether membership has
the impact; it is just the manner in which you approach it, that you
disagree with~
Mr. CAMPBELL. That is correct, especially from the standpoint of
rushing into these corrections. We feel there should be a delay period
for additional study.
Mr. DERRICK. I have never found this committee to rush into anything. So I think you can rest easy on that.
Mr. PETERSON. Mr. Derrick, I think we have gone over-The CHAIRMAN. Would the witness identify himself~
Mr. PETERSON. I am Richard Peterson, legislative counsel of IBA.
We have gone over the studies, going one way or another, as to
whether membership attrition really has an impact on the ability of
the Board, the Open Market Committee, and the Federal Reserve bank
presidents to manage monetary policy. Almarin Philips and his brethren say that membership does not, while a number of others say that
it does.
I do think, though, that we are in agreement with a statement that,
I believe, was made by Chairman Burns last year that the real problem
at the Fed is a political one. In short, should membership attrition
proceed at a much faster pace, cause unhealthy deterioration in this
counterbalance that you were talking about. So we certainly look at
it as a political problem.
Mr. DERRICK. I thank you very much.
Mr. Hill, you referred to several economists with varying opinions
on this matter. I have not had the advantage of seeing their views.
Would you furnish them 1
Mr. HrLL. I will try to. You may be asking for trouble because there
is an awful lot of it.
Mr. DERRICK. Well, that is all right, I will look at it just the same.
Thank you.
Has my time expired 1
The CHAIBMAN. Your time is up. Thank you, Mr. Derrick.
Mr. Hannaford.
Mr. HANNAFORD. Mr. Chairman, I regret that I was not here for
the statements, and I have just one brief question.
H.R. 13477 proposes to pay interest on reserves. Is it not true that
this legislation would benefit the large banks that are not dissatisfied
wiith the Fed and would not do very much good for the smaller banks,
and therefore perhaps would miss the mark which is the intended
purpose of this legislation.

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Mr. Hill, would you respond i
Mr. HILL. One of my complaints in my own testimony, Mr. Hannaford, was that the proposal as offered by the Federal Reserve System,
that is the payment of market rates of interest on the first $25 million
worth of reserves, and a 2-percent rate on the remainder, favors the
small banks as opposed to the large banks, and that I believe that the
burden of membership lies equally on both the large banks and the
small banks.
So I think that the legislation, the various bits and pieces of the
legislation, suggestions we have before us, basically do favor the small
banks, proportionately more than they do the large banks.
Mr. HANNAFORD. I have no further questions, Mr. Chairman.
The CHAIRMAN, Thank you, Mr. Hannaford.
Mr. Grassley.
Mr. GRAssLEY. Thank you Mr. Chairman.
I, too, want to echo the words of Mr. Stanton and say we appreciate
your coming out on this Monday morning to testify and give us your
judgments on these important bills that are before us.
I want to start out by asking Mr. Hill, referring to a statement on
page 4 of his testimony. On the fourth line from the bottom, you say:
In other words, we do not fear this threatened competition except to the extent
that prices are subsidized to levels below those set in free competition among
the market participants.

I appreciated what you say and probably everybody else does. What
the bankers in the private sector fear from the Federal Reserve is that
there will be subsidization, or cross subsidization of some of the services in the Federal Reserve to a point where they will be priced so
low as to be unfair competition to the private sector i
Mr. HILL. That is precisely correct, Mr. Grassley.
Mr. GRAssLEY. Well then, maybe I misunderstood that sentence. I
assumed that you fear that the pricing between the correspondent
banks and the smaller banks is going to be such that there will not
be any business for the Federal Reserve. That is not what you are
saying here i
Mr. H1LL. No. What I am saying is that we recognize that the
Federal Reserve, in effect, is in competition now with the correspondent
banking services that we offer, and we have, I think, competed effectively with them over the years. If they start pricing for the services,
which we do-we charge our correspondents explicit prices for the
services we provide-if the Federal Reserve institutes a pricing system
which is substantially below their costs of doing this business, then
we think it would be unfair competition. We could be priced out of
business.
Mr. GRASSLEY. OK.
Mr. HILL. We do not think any government agency should offer
services that can be offered by the free enterprise systems on a subsidized basis below the cost of production.
.
Mr. GRAsSLEY. OK. Then we are in agreement on that position. This
leads me to this Question: From your perspective then, do you see that
we have the ability to determine, in a very finite way, what certain
costs are in the Federal Rese,rve System so that we can in fact price
them so that they are competitive and do not undercut private service

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fees so that we do not have an a{)Counting problem as we do with, for
instance, the Postal Service i In the Postal Service, first-class mail is
probably subsidizing fourth-class mail and basically it is because the
Postal System says that they cannot really account for a lot of thefr
overhead so that they can categorize just exactly what the costs arc
for first-class mail versus fourth-class mail. We do not want to get
into that same problem with the Federal Reserve.
Do you think their accounting system is such that they will be able
to delineate those costs i
Mr. HILL. Yes, I think they can. In the first place. you have to
remember there is a large body of banks in the private sector now
offering these services and we have finally, it has taken us a long time,
but we have finally learned how to determine our own costs. So I think
we know almost down to a single check how much it costs us to
handle these transactions. Therefore, we could very quickly spot any
attempt on the part of the Fed to seriously subsidize these costs because
we think we know their costs reasonably well. We know the costs of
computers; the systems do not vary widely.
I think where our differences of opinion would' come would be on
assigning the capital costs of the Fed to these transactions. We have
to assign them to our own transactions. That is a difficult pa.rt, but we
know how much it costs them to operate, we know what their direct
costs are.
Mr. GRAsSLEY. Therein may be a problem 8Jld an excuse that would
lead to cross subsidization, though not intended, and it probably will
not even be very visible. Is that a possibility~
Mr. HILL. That is a possibility, but I think you will have available
very many panels of objectors in the private banking system who
understand the costs.
Mr. GRASSLEY. Let me suggest to you that Thursday Mr. Miller
said in commenting on this same point that they are fast approaching
that point in cost accounting at which they will be able to make a
determination. But he also suggested that for a period of time, and I
think it was in terms of a few years-maybe that is not fair for me
to make that determination myself without going back over the
testimony-but for a period of startup time there may be some costs
that are not going to be quite allocable and that may be, in a sense.,
the start of 8Jl unintended subsidization, that it may be difficult to
move away from as time passes.
Mr. HILL. Yes, that is a danger. And I recognize that if the Fed
were to charge its full costs at the outset, because of their heavy
capital cost, that the price they would have to charge using our
system of charging could be as much as twice what we charge; there
is that possibility. If they were to do that immediately, it would bring
about a widespread erosion of their own staff, their check-handling
staffs. I think thev would like to phase that in over a longer period
of time.
•
My concern would only be if they price their products clearly
below the market level; if they price their products competitively with
ours, we will be able to meet the competition.
Mr. GRASSLEY. I thank you for your comments.
My time is up, Mr. Chairman.
The CHAIRMAN. Mr. Pattison.

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Mr. PATTISON. Let me follow up on that problem of pricing, because
it is very interesting to me. Right now, what is the status of competition
between correspondent banks?
How do you set your own prices? For instance, do you have correspondent banks who deal with you on the basis of your own prices
for your services? Do banks switch around between different correspondent banks? If one correspondent bank raises its prices, is it
easy for a bank to say well, your price is too high, I am going to go
to bank X. Do you really have a competitive situation so.that you cannot raise your prices when somebody else is charging less?
Mr. HILL. Yes. It is quite easy to change a correspondent bank
relationship, and they do. We adjust our prices periodioolly based on
our costs and a reasonable profit, and then adjust them aga.in to the
marketplace.
Mr. PATTISON. So if correspondent bank X is operating inefficiently
and mises its prices to its correspondents, one of those correspondents
could easily say, you have raised your prices but correspondent Y has
not raised its price, so I am going to deal with correspondent Y.
That obviously keeps the price in line.
How do you get a similar kind of mechanism going with the Fed
when you do not have that competition; when the Fed-could we
have a system, for instance, where a Fed member could say, I am not
going to deal with the Fed any more. I will be ·a member of the Fed
with explicit pricing but I will go to correspondent bank X to handle
my services; I will do away with my discount window?
Mr. HILL. At some point the checks would have to enter the Federal
Reserve System and go through a correspondent Federal Reserve
member bank who would have to pay whatever the price may be. There
are competitive systems outside t:he Fed.
Mr. PATrISON. I understand that. What you are saying is, everything has to go through the Fed ultimafoly.
Mr. HILL. For settlement purposes and a large number of checks
which can.not be handled in any other way but through the direct
sending route.
We can clear a large number of checks that come into our hands in
Bo$1:on outside the Federal system through direct sending. Then we
settle the balances between t:he two banks through the Federal Reserve
System.
•
Mr. PATTISON. For that you would now under this scheme be pa,ying some explicit charge?
,
.
Mr. HILL. Well, the charge for settlement between accounts m the
Fed would be very minimal.
Mr. PATTISON. So I guess the question is, suppose the Fed became
very inefficient, raises its prices, based upon its costs, based upon a
good accounting system but it is very inefficient, how do you control
that price? There is no competition, there is no other place to go.
Mr. HILL. Of course the Fed would offset the benefits of paying
interest on deposits if they raised their prices through inefficiency
well above the market price. They would wipe out the economic benefits
of membership in the Fed.
Mr. PATrISON. So what you are saying is that the major device
for controlling the explicit pricing for services on the basis of the
Fed would be membership?

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Mr. HILL. That will be a very strong factor.
Mr. PATTISON. Perhaps even stronger than their costs?
Mr. HILL. Yes.
Mr. PATTISON. And the accounting system?
Mr. HILL. We are concerned that they might use that competitively
too much; in other words, subsidize the price too far berlow their
cost of service. That is the one matter that the entire correspondent
banking industry will be watching very closely.
Mr. PATTISON. Right. So you watch them closely. What do you
do about it if there is no legislative requirement that they charge
whatever the market is, whatever tha,t means?
Mr. HILL. Well, I guess we are suggesting that there be some legislative requirement that their cha,rges, prices be based on their costs,
fully determined costs.
Mr. PATTISON. Thank you. I have no further questions.
The CHAIRMAN. Mrs. Fenwick.
Mrs. FENWICK. Thank you, Mr. Chairman.
I notice on page 3 you speak of "un:bundling costs and benefits."
Could you help me with th&t; unbundling the costs and benefits? I
hope you did not go into it earlier when I was at anotlher mooting.
Mr. HILL. Let me draw an analogy, Mrs. Fenwick.
The most famous unbundling exa,mple was conducted by IBM
Corp.; when they sold a computer, the price of the computer involved
the cost and profit to them of the computer as well as the cost of
servicing the computer and providing software. When they unbundled
they sepamted these. They said, you will pay one price for the computer and you will pay explicit prices for the services.
Mrs. FENWICK. I see.
Mr. HILL. This is what we are talking about here. It is a bit of
ja,rgon that crept into our language since IBM days.
Mrs. FENWICK. Right. Now I would like to explore a little further
the carrot Mr. Annunzio referred to.
The carrot would be the interest paid on the reserve deposits, right i
Mr. HILL. Yes.
Mrs. FENWICK. As I understood Mr. Miller the other day, and if
I am not correct I hope the chairman or one of my colleagues will
correct me, he suggested that the Federal Reserve would pay the cost
of the first few years.
Now, there are two or three things I would like to know here. Does
this mean that the Federal Reserve has hundreds of millions of
dollars in its •account that it is not using now that it could use to
subsidize these interest payments? Or does it mean that they would
come out of the U.S. Treasury funds, tax funds, would therefore be
a burden on the taxpayer?
How does that operate? I did not have a chance to ask him when
it was my turn.
Mr. HILL. Mrs. Fenwick, there will be more qualified witnesses
from the Fed to discuss this, but I believe what he meant was that
because the payment of interest, net of collecting the cost of services,
will reduce the earnings of the Federal Reserve System which hitherto
have been passed on to the Treasury, that for some period of time
the Treasury will try to ease their burden by paying out of their sur-

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plus some extra funds. In other words, they will pay a larger dividend
to the Treasury than they actually earn ·and take it out of their
surplus.
Mrs. FENWICK. In other words, you are saying then that the Federal Reserve has a surplus account in the Treasury, is that iH
Mr. HILL. No. You have to look at the Federal Reserve as a separate corporation which has its own balance sheet, assets, liabilities,
capital, and surplus.
Mrs. FENWICK. Yes.
Mr. HILL. And I believe the intention is for some period of time
to allow their surplus to be reduced.
Mrs. FENWICK. What I am trying to-Mr. HILL. But these are funds not in the Treasury but funds under
their own ownership.
Mrs. FENWICK. So the'y have a separate account. They do not, in
other words, when they make money, put it into the General Treasury
fund; they keep it in a separate account, is tJhat right?
Mr. HILL. I think I will defer to a subsequent witness on the accounting at the Fed. I think-Mrs. FENWICK. What I am trying to find out about are the several
hundred millions needed to pay for the carrot, to provide the carrot
Mr. Annunzio was talking about.
When they are used to pay interest to the banks, does that mean
that the Treasury receipts will be lower and therefore that the deficit,
unless compensated for by other tax, will be higher? Or does it mean
that this will have no effect on the deficit or on the Treasury receipts
because the money that the Federal Reserve gets from its member
banks is kept in a separate account?
That is what I am trying to find out. Who is going to pay for all
this?
Mr. HILL. Well, first the impact of this would normally be felt
on the Treasury, because the Federal Reserve turns over its earnings
at the end of the year to the Treasury.
Mrs. FENWICK. So therefore reduceMr. HILL. I think they propose, their proposal is to have their
earnings reduced by approximately 7 percent, which is somewhere
between $450 and $600 million; I cannot remember the figure.
Mrs. FENWICK. Right.
Mr. HILL. And that amount of money would not be paid to the Treasury and therefore, ¢ven no other factor, would increase the budget
deficit of the United States.
Mrs. FENWICK. That is what I wanted to know.
Mr. HILL. However, a portion of that, of course, would result in increased taxes paid by the banks back to the Treasury; because of
higher earnings, they would pay a higher income tax.
Furthermore, a strong argument can be made that if this carrot is
not held out, then as more and more banks leave the Fed, the Fed's
earnings will decline and therefore the Treasury is going to lose this
money anyway, as well as losinp;-Mrs. FENWICK. I understand, that was very well explained by Mr.
Miller.
Mr. HILL. But the last part of it, which is the way the Fed has
chosen to ease the transition burden on the Treasury, using surplus

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funds, I would prefer to defer to Federal Reserve witnesses who are
here who a,re far more expert than I.
Mrs. FENWICK. When you refer to surplus funds, what are you talking about; funds that they do not turn over to the Treasury? In other
words, do they divide their receipts into something called surplus
funds and something that goes directly to the Treasury?
Mr. HILL. Well, these are capital and surplus funds and how the
surplus funds arose over th() years I do not know.
Mrs. FENWICK. OK, we will have to inquire from Treasury on that.
But I wondered, how would it be if instead of all these complicationswith the Treasury losing money-the Federal Reserve, together with
the banks, simply decided on some nationwide reserve requirements?
Instead of paying interest on reserves, suppose there were uniform
requirements so that banking would be sound, without costing the
taxpayers anything? How about that?
Mr. HILL. Well, that would solve the problem if every bank in the
United States which had transaction balances were required to keep
equal reserves with the Fed. Then the problem of inequality between
the State banks and nonmember banks and member banks would disappear.
I did say in my testimony, however, that I believed that politically
that would be very difficult to achieve.
Mrs. FENWICK. Why?
Mr. HILL. Because of the strong feelings of those who espouse the
dual banking system, the Conference of State Bank Supervisors, the
State Governors. They would believe that this is removing preroga,tives from State government and moving it to Federal Government.
Mrs. FENWICK. My time has expired. Thank you very much.
The CHAIBMAN. Thank you, Mrs. Fenwick. Mr. Steers.
Mr. STEERS. Mr. Hill, in answering Mr. Pattison's questions on the
subject of how you price your services, you indicated you charge cost
plus a reasonable profit. If the Fed offered prices at cost, how could
you compete?
Mr. HILL. Mr. Steers, I believe-I think the Fed is concerned, and
this is hearsay, I am not sure whether hearsay evidence is allowedI believe that the Fed is concerned that if they priced their product
at their full cost, including- all of their oapital costs. that they would
become very noncompetitive with the banking system and that they
would tend to lose even more membership.
Mr. STEERS. Do you mean because they are less efficient? Why would
the Fed with its huge resources be less efficient?
Mr. HILL. I do not necessarily think they are less efficient. I really
do not know, Mr. Steers, but each Federal Reserve bank does have a
fairly elaborate building in each one of its reserve cities and subreserve cities, and it was a matter of policy to build these buildings in
downtown urban areas, in some cases to help support the local economies rather than build an efficient. pure operating center outside in
the suburbs, which many commercial banks have done.
So I think the Fed has the cost burden of those fairly large downtown buildings within their structure. Now we have them too, but
we have a great many more services, including international loans,
installment and wholesale loans over which we can spread those costs.

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Mr. STEERS. Thank you, Mr. Chairman. That is all I have.
The CHAIRMAN. Thank you, Mr. Steers.
I just have a couple of questions.
Mr. Hill, you are chairman of the First National Bank of Boston?
Mr. H1LL. That is correct.
The CHAIRMAN. When I last resided in Boston, that was a safe and
sound institution and I presume it still is.
Mr. HILL. It was Friday night when I left.
The CHAIRMAN. You also speak on behalf of the Association of Reserve City Bankers¥
Mr . HILL. Yes, sir.
The CHAIRMAN. Those are largely correspondent banks, are they
not?
Mr. HILL. Yes, sir. It was orginally formed in 1913 for that purpose.
The CHAIRMAN. How many members do you have now?
Mr. HILL. We have about 400 members, Mr. Chairman, individual
members.
The CHAIRMAN. The Governor of the Federal Reserve, Mr. Philip
Coldwell, in his testimony before the U.S. Senate on May 25 of this
year said, and I quote :
This erosion of membership threatens to weaken our financial eystem as more
and more of the Nation's payments and credit transactions are handled outside
the safe channels of the Federal Reserve.

Now, do you consider you and your correspondent banking channel
an unsafe channel?
Mr. H1LL. No, sir. If I had-The CHAIRMAN. Or would you take issue with the Federal Reserve on
that characterization?
Mr. HILL. I would have just left out the word "safe"-The CHAIRMAN. Well, that is Switzerland without the Alps, is it
not?
Mr. HILL. I see no difference between operating the payment system within the Fed or without the Fed.
The CHAIRMAN. I should perhaps confess to something of a conflict
of interest here because my father and grandfather were correspondent bankers and they were eminently safe, I can assure you of that.
Mr. HILL. As you know, I have a conflict of interest too, because I
am a director of the Federal Reserve Bank of Boston this year.
The CHAIRMAN. Now, on just that point, when a member bank
posts reserves with the Federal Reserve, it gets, under the present system, zero interest on those posted reserves, does it not?
Mr. H1LL. That is correct.
The CHAIRMAN. When a member bank of your correspondent system posts reserves with you, you are prohibited from paying interest
to him?
Mr. HILL. That is correct.
The CHAIRMAN. If the proposal to pay interest on Federal Rese~
reserve-posted requirements went through, your correspondent banking system would be placed at a considerable additional competitive
disadvantage, would it not?
Mr. HILL. Yes, it would be, there would be additional competition,
Mr. Chairman. But we would try to offer services, efficient services,

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and hopefully priced properly so the correspondent bank would stay
with us and would keep enough deposit balances with us to earn the
services which we would provide for him.
The CHAIRMAN. Still and all, it might enter his cranium at some
time to say, well, the First National Bank of Boston sure does paperwork for us nicely, but they do not pay anything on our correspondent
balances and the Fed does, so we will go with the Fed.
Mr. HILL, But under the new system, the Fed would also charge
for explicit services, as we do now, except we are paid for it in deposit balances.
The CHAIRMAN. True, but that is a rough equation, indeed, and the
fact would remain that under the Fed's proposal, as opposed to the
amendment offered by so many of the members of this committee, you,
under the new dispensation, would be competing with an institution
which would be allowed, indeed mandated, to collect something like
7 percent of its total receipts by way of payment of interest on. reserves and disburse them to the banks and you would have no eqmvalent method of sweetening your pot; it that not so?
Mr. HILL. That_ is correct, except the 7 percent is net of payment of
the services that the Fed provides.
The CHAIRMAN. Oh, surely.
Mr. HILL. And if our services are competitive with the Fed's, then
we will try to keep our correspondent banks dealing through us, even
though they may maintain reserves with the Fed because they will be
paid fully for the reserves they keep with us in terms of services that
we give them.
The CHAIRMAN. Thank you.
.
I have one question of Mr. Campbell, who comes here with the blessing, not only of our distinguished ranking member Mr. Stanton, but of
a former Congressman, Mr. Mosher, who is a particular friend of
mine and I understand is very close to you.
I must confess to a little disappointment in the testimony of the
Independent Bankers Association of America. For example, the Federal Reserve's proposal, first, as you know, is for universal deposit
reserves. Well, that says your tiniest member bank must plunk down a
7-percent interest fee with the Fed. Under the proposed amendment
offered by so many members of this committee, and which will be
considered as a perfecting amendment to the Stanton bill, independent banks are the particular darlings of that proposal.
For example, they would be exempted entirely from any reserve
requirement-:' 'Yhatsoever on their first $10 ~ill~on_o_f _demand deposits.
It 1s a fact, 1s 1t not, that the average deposit hab1hties of your member banks is on the order of $10 million?
You can consult Mr. Peterson if you want.
Mr. CAMPBELL. Yes, somewhat on that order, maybe slightly more
on the average.
The CHAIRMAN. Here we are giving you everything, the proposed
amendment gives you free and unlimited, without touching your forelock, access to the discount window, no matter how small you are.
I would not quite say, oh, how sharper than a serpent's tongue is an
ungrateful independent banker, but I hope when you think about it a
little more, you draw a distinction between those who are trying to keep

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alive an independent banking system in this country and those who can
think of nothing better than to up the deficit of this Nation now by
more than half a billion dollars a year and give most of the benefit to
the very large banks, against which I have nothing, but at least I
think some attention to the independent banks could have been the
subject of a sentence or two in your testimony.
Mr. CAMPBELL. Mr. ChairmaJ1, we do appreciate the efforts of members of this committee to provide benefits for the small banks by excluding the first $10 million in transaction accounts. We are primarily
concerned with the explicit pricing. We feel that is such an unknown
factor and such a complex problem that we would be remiss in representing, as officers of our association, that our rank-and-file people
could accept these proposals. It is primarily a problem of timing.
The CHAIRMAN. The purpose of these hearings is not to get anyone
to ingest every item of a complex proposal; it is to get views on different parts.
I take it then that your testimony, as amended, is that the independent bankers would favor the inherent progressivism of the reserve requirement provision contained in the so-called amendment to the Stanton bill?
Mr. CAMPBELL. Yes, we would so favor.
The CHAIRMAN. But on the business of charging for services, you
say, in effect I believe, hold everything in abeyance until the Fed actually tells us what the charges are going to be and then proceed.
Mr. CAMPBELL. That is correct, Mr. Chairman. I happen to be a supplier of correspondent bank balances rather than a buyer of such balances. I realize that there is a lot of difference between the pricing
methods of various banks. We rarely agree with their methods of pricing of services.
We rarely provide the balances that they think we should. But invariably, if we suggest withdrawing by closing our account, they invariably say no; we want you to stay with us.
.
The CHAIRMAN. The 400 correspondent banks of Mr. Hill's organization, whatever else may be said of them, have to compete against
other correspondent banks i
Mr. CAMPBELL. Yes, that is correct.
The CHAIRMAN. And do they not all 'have nice guys going around
their market area i I heard the words "three martini lunches" and
that will be stricken from the record. But do they not go around being
pleasant, ingratiating people who try to sell you a service because
they know they have lots of competition and there are other people
that can do the same paper-pushing job i
Mr. CAMPBELL. Certainly, Mr. Chairman, they do visit us; they are
kind and they are also very helpful. We have been tremendously helped
by the major banks in this country, in systems and services and, even
though we complain about their charges at times, most generally they
are fair. But we are still concerned about the pricing of services
through the Fed.
The CHAIRMAN. I think you should be, a.nd I will just close this
panel by saying that it is not the purpose of the Banking Committee to
do in either the independent bankers or the·correspondent bankers. We
view them as necessary parts of a very complex system.

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Thank you for your help this morning.
We will now hear from our second panel, Gov. Philip E. Coldwell of
the Federal Reserve, Frank E. Morris, and Beryl W. Sprinkel of
Chicago.
·
Governor Coldwell, I understand you have at least a modest time
problem. Can_you tell us what it is?
Governor Cor.nwELL. As you probably know, we are shy of Board
members, and the Board is waiting for me because I am the quorum
member this morning.
The CHAIRMAN. It is meeting this morning?
Governor COLDWELL. Yes.
The CHAIRMAN. Then if there is no objection, I am going to ask Governor Coldwell to proceed and the questioning of Governor Coldwell to
proceed, and then we will examine the other two witnesses.
Governor Coldwell.
Governor COLDWELL. Thank you very much, Mr. Chairman.
The committee staff has requested that I summarize the presentation
before you. I will do so under the assumption, of course, that the entire
statement will be in the record.
The CHAIRMAN. Your statement is, under the rule and.without objection, received in the record.
STATEMENT OF HON. PHILIP E. COLDWELL, MEMBER, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM

Governor COLDWELL. I will make a very short statement then, Mr.
Chairman.
I appreciate the opportunity to come here and elaborate further on
some of the proposals of the Federal Reserve. I would like to specify
two particular areas of concern: one on the basic membership question and the other on the pricing of the Federal Reserve services.
With regard to the membership issue, there is a lot of discussion
about the degree to which the Federal Reserve can afford to have
membership continue to erode. I do not think any of us has a specific
point in mind at which Federal Reserve monetary policy becomE>s excessively difficult because of the erosion. But I do think there is a
broader point to be made, ·which is that the Federal Reserve is making
monetary policy for the Nation as a whole and in that effort it should
be accorded as much strength and support as it can get in terms of the
overall policy for the United States.
I do not think anyone really believes that monetary policy is developed just for banks or a limited number of member banks, but if they
do, I hope we can disabuse them of the idea.
On the pricing question, there are some things which the committee
has already discussed with the prior panel to which I would like to
address myself.
First, I think it is a mistake to consider Federal Reserve payments
mechanism services as being precisely those services which the correspondent banks provide. The correspondent banks that I know anything about have a whole kit full of services which they render, which
the Federal Reserve does not render-items such as the encoding of
checks and the demand deposit accounting of those checks.

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Many of the correspondents with whom I have talked also use their
payment systems roughly the same as the Federal Reserve does in the
sense that there is a gross, overall total of correspondent balances to
be maintained in the correspondent bank, and the individual costs of
each of the services rendered are seldom specifically spelled out.
Mr. Hill said he knows precisely what his costs are. I am pleased to
know that, because I have run into too many other banks who do not
know that.
Another point with regard to Federal Reserve payµients mechanisms
is the purpose for which the Federal Reserve is in this field. It is quite
true that we do have an operational presence in the payments mechanism, and we do some of the things which the correspondent banks do,
b~t we also do a number of other things which I think the committee
should bear in mind when we talk about pricing ;federal Reserve
services.
We operate a regulatory device, partlv through an operational presence but partly through the basic regulation of the payments mechanism. We help enforce standards on MICR encoding and routing
number systems, and we help insure that funds' availability are set
with regard to the schedule of payments. If our operational presence
were reduced entirely, somebody would have to do these public interest jobs. We think it is more desirable for a public body to be in
this field and do the job of regulating by such an operational presence.
We admit that we could be removed from that, but only at the cost and
burden of an excessively tight regulatory examination, investigation,
and enforcement program.
We are not interested in enlarging our correspondent bank network
efforts. We think our operational presence is adequate now and see no
reason to enlarge it. But neither do we see the desirability of handing
over to a limited number of large correspondent banks the entire
operati?nal efforts in the payments mechanism without very careful
regulat10n.
One of the things that the correspondents perhaps miss is that we
maintain a certainty in the payments flows, occasioned by the Federal
Reserve's presence in that system, and the check collection float which
is the difference between the value of the credit for deposits given by
the Reserve banks and the value of the checks collected.
If the private sector were to assume the responsibility of passing
credit for col1ection in the same schedule, that expense of financing the
float would, of course, be a substantial cost to the banking system.
I think it is vitally important that the Nation have available a fast,
reliable, accurate payments network to support this Nation's monetary
policy as well as the needs of banking and commerce.
Implementation of monetary policy is facilitated through the Federal Reserve's payments mechanism. We obtain some information
through that mechanism which is important in the establishment and
continuing handling of monetary policies. A substantial reduction in
the role of the Federal Reserve could have an impact on Federal Reserve payments services provided the Treasury, also.
If we are going to reduce our personnel, equipment, and manpower,
when the commercial bank checks and other payments mechanisms are
priced out from under us, as Mr. HiJl suggested, then somebody must

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take over the handling 0£ the Treasur:y collection and transfers which
we presently handle with the same eqmpment and personnel.
Similarly, the Federal Reserve uses a very complete courier service
to deliver all 0£ these checks and electronic funds transfer tapes. I£
we are to cut back on our operational presence, then clearly the courier
service is going to have to be provided by somebody else.
I want to make it clear that I have no problem with using price, for
example, to define the terms of access to services, bring about more
efficient use of these services, or even to determine the role 0£ the Federal Reserve in the payments mechanism as long as we do not provide
such a concentration as to create problems for the Nation.
I do not believe it would be in our best interest to have the payments mechanism in the hands of a severely limited number of financial institutions. We have already been through this once in this century, and I would hope we would not repeat our error there.
It is not absolutely necessary for the Federal Reserve to price £or
many of its services in order to allow the private sector to compete.
Their competition with us is clearly available already, as the witnesses
have indicated on·the prior vanel. They do compete with us right now,
in both correspondent bankmg services that we render and, in a much
broader sense, other correspondent banking services.
My recommendation to the committee, Mr. Chairman, is that we
take a very cautious approach toward the pricing of these services so
that we do not unduly affect the performance of the payments mechanism. I believe it is important for us to see how pricing works and
£or the Federal Reserve to gain experience in pricing before we become bound to a formula which might do more harm than good.
I a.Ppreciate the committee's attention and will try to answer any
questions, Mr. Chairman.
[Governor Coldwell's prepared statement follows:]

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Statement by
Philip E. Coldwell
Member, Board of Governors of the Federal Reserve System

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before the
Committee on Banking, Finance and Urban Affairs
House of Representatives

222
I am pleased to testify today on two important issues, membership
in the Federal Reserve and pricing of Federal Reserve services.

First, I

would like to express my concern about the continuing erosion of membership in the Federal Reserve and the need to solve this problem.

Next, I

want to discuss the issue of pricing for Federal Reserve services,

Most

of my testimony will be devoted to discussing pricing because of its
potential impact on membership and on the nation's payments mechanism.
Congress should be fully aware that pricing for services without reducing
the burden of membership will further contribute to banks leaving the
Federal Reserve.
As a member of the Board and former President of the Federal
Reserve Bank of Dallas, I have observed the withdrawal of banks from the
Federal Reserve System for nearly 27 years.

At first the banks with-

drawing from the System were generally rather small.

But in recent years

larger--even large correspondent banks and frequent users of Federal
Reserve services--have found the burden of membership too great to justify
remaining in the System and others have indicated intentions to withdraw
unless the burden of membership is relieved.
Over the years, the Board has expressed it3 concerns to
Congress about the loss of member banks and has recommended ways to
reverse membership loss.

Chairman Miller again stressed this concern

in his testimony last week.

In his testimony he explained the reasons

why banks are withdrawing from the Federal Reserve System.

I want to

stress the point that increased competition for transaction accounts-particularly interest bearing transaction accounts--has forced all
financial institutions to become increasingly cost conscious,

In turn,

member banks facing this and other challenges to profitability,_have been
forced to carefully weigh the costs of retaining their membership.

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In addition, his testimony provides a review of the adverse
implications that declining membership has for monetary management and
the quality of the banking system.

Chairman Miller stressed the importance

of bringing equity among financial institutions.
factors he mentioned.

Let me emphasize two

First, the ability of the Federal Reserve to guide

innovation and foster constructive competition in the payments mechanism
among financial institutions will be enhanced.

Secondly, at such time as

all financial institutions are bearing an equitable reserve burden, there
will be no unfavorable economic effects to allowing uniform access to
Federal Reserve services at equal costs and under equal conditions.
It is important for the United States to have a strong central
bank and certainly in the current economic situation steps should be taken
promptly to offset any contrary trend.

I am sure that Congress is as

concerned as we are about the inflationary pressures evident in our
economy and therefore will be interested in assuring the strength of one
of its primary agents for resisting inflation.
This line of thought leads me to hope that Congress will be
willing to stop the erosion of membership.

The most evident and clear-

cut support Congress could enact would be legislation requiring universal
reserves.
It is essential for everyone to understand that monetary policy
is not developed for banks or even the limited number of member banks,
so there appears to be no good reason for the nation's central bank to
operate under the shackles of a voluntary membership structure.

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can debate a specific monetary policy on its merits, but from any
standpoint, I can see no public purpose to be served by limiting the
effectiveness of the central bank.

Monetary policy is made for the

entire nation, not a limited sector of the banking co111111unity.

All

depository institutions are chartered in the public interest and all
should be directly supportive of and participants in the implementation
of policy.
I would like to express my views on the part of the Board's
plan and the parts of the proposed legislation that deal with charging
for Federal Reserve services.

I will explore with you possible impacts

charging will have on the nation's payments mechanism.
You are no doubt aware that the System has been considering for
over two years the subject of charging for its services.

As studies have

progressed, we have become increasingly aware that there are problems
in the application of the theory that pricing should result in a more
efficient allocation of total resources to payments mechanism activities.
I believe there is a much more important goal than attaining optimum
allocation of resources.

That goal should be the continuing ability of

the Federal Reserve to assure the Congress and the nation of a smoothly
functioning payments mechanism.
In considering pricing legislation, the Congress should be fully
aware that the Federal Reserve has no intention of enlarging its role in
the payments mechanism to the exclusion of the correspondent banks of
the nation.

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Neither, however, does it intend to allow a few very large

225
private sector firms to dominate services now provided by the Federal
Reserve.

This could result, ultimately, in problems similar to those in

existence when Congress created the Federal Reserve System and gave it
the power to establish clearing house services.
In its proposal to the Congress, the Board made the following
statement:
"In order to assure continued efficient functioning
of the payments mechanism and to avoid major disruption
during the transition to a more competitive environment,
the Board would follow a conservative and flexible approach
in establishing charges for Federal Reserve services. To
this end, the System has concluded that its charges should
be competitive with those for comparable services (when
available) in the private sector. However, the Board would
retain flexibility to alter charges or service policies in
order to meet its responsibilities to maintain a satisfactory,
basic level of service for the nation as a whole and to
encourage innovations."
I would like to elaborate on this statement and explain why the Federal
Reserve believes it has a responsibility to retain an ability to perform
a "basic level of service" nationwide in payments activities.
Payments mechanism activities are an important aspect of the
functioning of the nation's economy.

The Federal Reserve through its

currency and coin distribution, check collection, funds transfer, and
U.S. Government security transfer services is actively involved in all
vital components of money supply and money movement through the nation's
payments system,
The payments mechanism of the United States functions quite
well today.
each day,

Enormous amounts of money flow among financial institutions
Much of the nation's business is carried out with check pay-

ments and as you know the Federal Reserve is a major participant in the

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check collection system.

Orderly markets in federal funds and government

securities are important to the government and the banking indus.try and
to monetary policy.

The Federal Reserve Conanunications System plays a vital

role in supporting these markets.
The government in protecting the public interest has a substantial concern with the smooth functioning of financial markets and
payments mechanism activities.

I believe those interests can be pro-

tected in only two ways,either exclusively through regulation or through
limited regulation and an operational presence such as the Federal
Reserve currently has in the check collection system.
If the Federal Reserve operational presence in payments
mechanism functions were materially reduced, then regulation of payments
operations probably would be needed to protect safety and soundness of
depository institutions or to avoid payments practices that are contrary
to the public interest.

Who, for example,wouldenforce standards such

as MICR encoding and routing number systems?

Who would ensure that funds

availability is maintained at a reasonable level so that checks would
remain as acceptable as they are today?

If Federal Reserve operational

presence were reduced, it would be necessary to establish a body of
regulations and examination, investigation, and enforcement mechanisms
to ensure an efficient and equitable payments mechanism.

The costs and

burden of such a program should be a significant factor in determining
the pricing and operational posture of the Federal Reserve.
We believe that Congress looks to the Federal Reserve to protect
the public interest in payments mechanism functions and we believe that

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the public interest can best be served by continued operational functions
that are performed by the Federal Reserve Banks.

Therefore, while pricing

of Federal Reserve services is intended to bring about efficient allocation
of resources, there is a need for sufficient pricing flexibility for the
Federal Reserve to maintain its operational presence in payments operations.
In particular, the Federal Reserve should continue to provide a basic level
of service and protect the public interest in the safety and soundness of
the nation's payments mechanism.

As an example, consider that through

the participation of both the Federal Reserve and the private sector the
check collection system has evolved into a system with the following
desirable features:
1)

Certainty - Checks and other cash items drawn o~ any
financial depository institution are collectible.
There is almost universal payment for checks at face
value by paying banks.

Speed - Checks represent money to the payee and the
collecting bank. Current arrangements allow for
availability of funds to collecting banks for any
checks in 2-3 business days. Rules also exist to
assure prompt notice of nonpayment of items.

Accuracy - The incidence of error is relatively small
and not readily visible to the public. Procedures exist
to assure maintenance of sufficient records to correct
mistakes (lost items, missent items, etc.).

Efficiency - For items drawn on distant banks the Federal
Reserve collection system helps assure a minimum number
of institutional handlings. Balances maintained solely
for settlement are also minimized because of the use
of reserve accounts for settlement.

Optional collection channels available - It is possible
for a bank to collect items through a number of options
in the current system. Federal Reserve collection
channels are used primarily by member correspondent
banks. Smaller banks, both members and nonmembers, use
a correspondent bank as their primary collecting agent.

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6)

Nationwide scope - A similar level of service is available to all collecting and paying banks wherever located.
In operating the collection service, a public institution can

assure that all regions of the country are provided a basic level of
service at a reasonable price.
collection system assure
areas.

Federal Reserve operations in the check

that clearing time is relatively fast to all

And, they assure that terms of access to the check collection

system are equitable.

However, this is _done by providing subsidies to

low-volume and remote financial institutions.

The private sector could

provide such cross-subsidies only if it earns excessive profits in high
volume, high profit regions.
The Federal Reserve Banks pass credit to depositors on a predetermined schedule that is intended to approximate collection times for
the items deposited.

The fact that these schedules are fixed provides a

firm basis upon which depositing banks can plan their cash positions and
manage their funds.

This certainty also provides a way for commercial

banks to pass credit to their depositors in an orderly fashion without
accepting undue costs or risks.
This certainty-is financed by the quantity known as Federal
Reserve check collection float, which is the difference at any time
between the value of credit for deposits given by the Reserve Banks
and the value of checks collected.

If the private sector were to assume

the r~sponsibility of passing credit for checks on the same schedule
as the Reserve Banks, the expense of financing the float would be a
substantial cost to the banking system that it does not now bear.

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If the Federal Reserve is not given the flexibility to adjust
its prices to the marketplace, there is a possibility that the private
sector will skim off only the most profitable services leaving the
Federal Reserve with the least profitable services and significantly
higher average costs.

For example, in the check area the Federal

Reserve could be left collecting checks drawn on low-volume and remote
banks.

Since the cost of providing only this service would be extremely

high, it would then have to be decided whether users of Federal Reserve
services should be subsidized in order to assure continued acceptability
of these checks.
It is vitally important that the nation have available a fast,
reliable and accurate payments network to support the nation's monetary
policy as well as the needs of banking and commerce.

Implementation of

monetary policy is facilitated through Federal Reserve payments mechanism
operations.

For example, the wire transfer of funds and securities capa-

bilities of the System provide a fast, reliable and accurate vehicle for
the effects of open market operations to flow across the banking industry.
Our extensive involvement in check collection operations allows us early
warning of bank liquidity problems which become evident when settlement
for checks presented each day appears to be increasingly difficult for
a bank.

Also, •if normal payments mechanism services are interrupted by

severe weather or other emergencies, these circumstances are reported to
the open market staff who can forecast monetary policy implementation
strategy utilizing data derived from internal operating reports.

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A substantial reduction in the role of the Federal Reserve in
the check collection system could have an impact on Federal Reserve
payments services provided to the Treasury Department.

Currently, the

Federal Reserve provides many services that facilitate the payment of
Government obligations.

Financial institutions deposit Treasury checks

with the Federal Reserve for payment.

The largest number of these checks

are Social Security and other benefit payments.

For the most part, these

checks are issued and cleared during the first few days of each month.
The Federal Reserve uses employees and equipment which are employed in
processing commercial checks to assist in processing Government checks.
If commercial check vol1,1111e were reduced to a point where employment and
equipment is cut back, these resources would no longer be available to
assist in processing Government checks.
The Federal Reserve uses the same courier service to deliver
Treasury electronic funds transfer payments that it uses to deliver
checks to financial institutions.

If the number of banks to which we

deliver commercial checks were reduced, the courier service would also
be reduced.

Without the courier service, the Treasury would have to

rely on other means for delivering Federal Government payments.
Given the Federal Reserve's role as a provider of a basic level
of service nationwide, which I believe is a major factor contributing to
the smooth fu~ctioning of the payments mechanism, let me caution against
any constraining legislation which could disrupt money flow operations.
A provision in the Stanton bill, H.R. 12706, would require the Federal

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231
Reserve to adhere to a fixed formula in setting prices,
which requires the Federal Reserve to base its prices

The provision
on direct and

indirect costs as well as costs that would have been incurred by a
private firm might place the Federal Reserve Banks at a competitive
disadvantage in relation to private firms.
their prices bound to a fixed formula,

Private firms rarely have

It is my impression thst complete

cost accounting in the banking system is a little used procedure when
pricing individual services,

In most cases, adjustments are simply made

to prevailing market prices, with the only price constraint being coverage
of all costs in the long run,

It is a common practice for correspondent

banks which provide services somewhat comparable to those offered by the
Federal Reserve to cross-subsidize their service lines.

Banks may suffer

losses on payments services, for example, while recovering those losses from
earnings from other bank services such as lines of credit and loan participations.

concern is that unless the Federal Reserve utilizes similar

flexibility, it will not be able to adjust to the realities of the
competitive marketplace and may be forced to reduce or abandon its role
as the provider of a basic level of service nationwide.
Let me make it clear that I have no problem with using pricing
to define the terms of access to Federal Reserve services, to bring about
a more efficient use of those services, or even to determine the role
the Federal Reserve should play in the payments mechanism as long as

do not allow private concentrations to be substituted for the Federal
Reserve.

I do not believe that it would be in the best interest of our

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232
country to have the payments mechanism in the hands of a severely limited
number of private institutions and I suspect that this concern is shared
by a great many smaller banks and other·nonbank financial institutions.
It is not absolutely necessary for the Federal Reserve to price
for many of its services in order to allow the private sector to compete.
The private sector is able to compete with the Federal Reserve because
we have exercised restraint in our involvement in the.payments mechanism.
For example, correspondent banks and service organizations offer
significantly broader check processing services including dollar amount
encoding, proof of deposits, transit check processing (including both
collection of some checks and routing others on for collection through
other banks and the Federal Reserve) and demand deposit accounting
(posting of checks to customer accounts).

In providing transit check

processing, the organizations are frequently able to improve upon Federal
Reserve funds availability by direct routing of checks to banks.

should be made clear that Federal Reserve check clearing operations and
connnercial bank operations currently differ in many respects.

A con-

siderable proportion of Federal Reserve expense is related to delivery
of checks to all banks in the nation each day and to transportation of
checks among zones nationwide.

Connnercial banks expedite collection of

checks based on the dollar amount of the items while the Federal Reserve
generally does not discriminate based on dollar value.

The Federal

Reserve sets rather stringent pre-sorting requirements on depositing
banks and requires all items to be fully encoded prior to deposit while
connnercial banks are much more liberal in sorting requirements and will
perform encoding operations for a price.

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My reco11Unendation is that we take a cautious approach towards
pricing of Federal Reserve services so that we do not unduly affect the
performance of the payments mechanism.

I believe that it is important for

us to at least see how pricing works and for the Federal Reserve to gain
experience in pricing before we become bound to a formula which may do
more harm than good.

I think this argues for flexibility in establishing

prices so that pricing can help bring about a more efficient use of
payments services while at the same time acknowledging the role of the
Federal Reserve to continue to set the rules of the road and to provide
a basic level of service nationwide.

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78 • 16

234
The CHAIRMAN. Thank you very much, Governor Coldwell.
I appreciate what you say on page 3, that the Federal Reserve System has been considering for over 2 years the subject of charging for
its services. Now I do not want to brag too much about the Banking,
Finance and Urban Affairs Committee, but we, on July 11, scarcely 2
weeks ago, were for the first time given by the Fed its statement of
what it wanted, and two bills.
Governor CoLDWELL. Right.
The CHAIRMAN. Those bills were introduced by me, Mr. Coldwell, 4
days later; immediately hearings have been scheduled, of which this
is one, and we hope to complete our hearing process within the next
few days, because when the Fed tells us something is imperative, we
believe the Fed.
But we have just heard a respected witness from the Independent
Bankers Association and a respected witness from the Association of
Reserve City Bankers say that they cannot really get a grip on this
thing until they know what you are going to chargr. for your services.
You have been at it for 2 years, you have 800 economists and God
knows how many computers.
Can you get up here by next Monday what you are going to charge
for your services? It would help Mr. Stanton, who I think made a
valiant attempt in his bill to set forth what he thought was a reasonable, just and fair basis for charging. So why do you not let us in on
these arcane secrets and then perhaps we can be accommodative?
How about Monday? If not Monday, how about Tuesday?
Governor COLDWELL. Mr. Chairman, we do appreciate the committee's prompt attention to this.
The question of pricing is a very serious one to us, on which _we
frankly did not have a lot o:f help. Our past background, as now, 1s a
nonpricing environment. So we have been looking at the pricing question with a great deal o:f care, and there are a number o:f unresolved
questions: for example, should pricing be on the basis of individual
office, individual check, or a correspondent balance type approach?
Should pricing be in terms of the individual functions which we perform, such as the balancing of accounts or settlement; and should
correspondent services be priced separately?
Should we price for encoding checks? Should we make prices based
on our present services that we provide, or should we change those
services?
Right now we are not competitive with the correspondent banking
system in terms of the services that we are rendering. We demand encoded checks from our banks, whereas correspondent banks permit
nonencoded checks. They do the encoding for the respondent bank.
These are all problems we have been wrestling with for 2 years and I
will quickly admit to you that we have not put this on the "front
burner" largely because of the question of the membership issue, and
you will recall that pricing was not a membership issue to us. We were
considering primarily how to relieve the burden of membership and
pricing adds to the burden of membership; it doeF> not relieve it.
The CHAIRMAN. We are somewhat in the position that confronted
the legislature of Kansas some years ago. I am told, when faced with
an increasing number of railroad at-grade collisions, they passed that
famous law which said, when two railroad trains shall approach each

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235
other at grade, each shall stop and shall not proceed until the other
has passed.
You are not going to do anything with interest rates until you get
this price thing settled? We are not going to do anything on the interest
rate thing until we know how badly we are going to fleece the taxpayers, who very seldom get mentioned at these hearings.
When can we get together? We have worked hard. Our staff has
been working every weekend on this, most nights; many members on
both sides of the aisle have worked very hard. I would like a date from
you when you are going to be able to bring forth, to hand this committee-and, if you wish, to concurrently publish it in the Federal Register, that is entirely your privilege-your proposed pricing schedule.
Governor COLDWELL. Mr. Chairman, as of last week I saw my first
listing of a preliminary schedule of costs. We will be holding a meeting on that within a week or two, at most, to refine those figures.
I hope that within a period of 3 weeks we can send you and others
a look at the "first cut" of pricing.
Now I recognize that this is going to be approximate at best, because we do not know where we stand on the pricing mechanism. We
cannot tell you precisely whether the charge that we make for processing a check is going to be a charge that is reasonable in the light of
your considerations. We do know what our costs are, both direct and
indirect. Our accounting system gives us even the allocation of the
last element of overhead cost of a bank.
The CHAIRMAN. If you have that, you have rounded third base and
are heading home.
Governor CoLDWELL. Well, we are headed home with the exception
that the correspondent banking, or I should say the reserve city banking, groups would like to have us add a capital cost on top of that.
The CHAIRMAN. Have you heard them on that? You have heard
from them on this?
Governor COLDWELL. Oh, yes, we have heard from them.
The CHAIRMAN. Well, you are the, you know, you are where the buck
stops, 14-years, independence, tennis courts, everything. You really
ought to decide whether the correspondent banks are right-I do not
know what their position is-or wrong. Put it on paper. We will give
them an opportunity to be heard, and I am sure you will too.
Governor COLDWELL. I am perfectly willing to do that, Mr. Chairman.
The CHAIRMAN. I have to remind you of our congressional schedule.
It was my hope that we could complete action and report out to the
floor and get a rule before we go into a rather brief recess on August 18.
We return for duty on September 7 and adjourn for the year on
October 7.
I want to see legislation on this broad, broad subject passed this
year because I take the Fed seriously whem the Chairman of the Board
and the Governors come up and say this is a situation that demands
immediate attention. But if you are not even going to give us your
proposed pricing schedule until after we go into recess on August 18, I
think you doom the Fed's request for prompt action.
So I must tell you that our staff stands ready to assist yours in
preparing those regulations: we have become knowledgeable about

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236
many of these subjects ; members of this committee will be glad to sit
at mght with your people after we get through with our schedule.
But let us not delay this matter which the Fed itself has placed before
us by saying that that which has been before you for 2 years is now
going to take another 3 weeks or so to present to us.
Mr. Moorhead.
Mr. MOORHEAD. Thank you, Mr. Chairman.
Governor, one of the next witnesses will be Mr. Sprinkel who says in
his written testimony :
It can be demonstrated that the Federal Reserve could regulate the money supply with zero reserve requirements so long as it is able to determine the monetary
base.

Do you agree with that statement, sir?
Governor COLDWELL. No, I do not.
Mr. MOORHEAD. Could you give us the reasons why? I think it is
fairly important.
Governor COLDWELL. Well, I think this gets back to a lot of relationships between reserves and the £unctions of money and the demand
therefore.
I will not defend Mr. Sprinkel's position. There are equally competent economists who will tell you that some base £or which monetary
policy can act is necessary £or an effective and efficient monetary
policy.
What Mr. Sprinkle is saying, in effect, is that we do not need a base
to operate on, that we can increase the amount of reserves or decrease
them without a base to work on.
Mr. MooRHEAD. It seems to me that issue is important because I think
probably then the greatest discouragement 0£ membership is the idle
reserve requirement which you can correct either by eliminating the
reserve requirement or by paying interest on it; would that be correct,
sir?
Governor COLDWELL. Or making it a universal requirement for
everyone, any one of the three.
Mr. MOORHEAD. Now, on the pricing mechanism, to follow up on the
Chairman's request, it seems to me that the Fed is in an extremely difficult position which became quite apparent with the previous witnesses; it is in the interest of many 0£ the members 0£ the Independent
Bankers Association, and the Fed, to keep those charges as low as
possible to attract IBA and other banks into the system, but of course
the correspondent banks want to keep it as high as possible so that
they will not be driven out of business.
You are between a rock and a hard place, are you not, sir?
Governor COLDWELL. Well, I think the correspondent bankers have
one question they need to answer. I£ they are able to compete with us
now when we do not char~e at all, why should the problem of charging
something create a big difficulty £or them ?
We do not presently charge our member banks, except by the sterile
reserves, which all members must pay for.
In terms of the new charging arrangement, I am sure that we will
charge at least our direct and probably our indirect costs as we have
them isolated. What we need to do is to be careful that we do not put
ourselver;i in a position where the remote or very small commercial

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bank is in effect charged a very high price, whereas the correspondent
banker just takes the cream of the crop such as the New York to
Chicago type heavy volume areas, leaving only the remote and small
volume to other people.
One of the basic reasons why the Fed has been in this business is
to provide a basic level of service to all banks and to assure ourselves
a certainty and speed of credit flows in this country.
Mr. MooRHEAD. I unfortunately have to leave and cannot question
Mr. Sprinkel. He supports the amendment which would tie the discount rate to the average yield on Treasury bills.
Do you agree or disagree with that proposal i
Governor CoLDWELL. I disagree with it, Congressman. We have already had some examples of this. Canada did it for some time, but
they decided it did not work. All of us have problems with discount
rate determination, as witness the last month when we had the problem
of raising it again. There are some announcement problems attached to
it; but we think we would be giving up something by the loss of that
announcement ability if we really want to alert the entire community
of a change in monetary policy.
Mr. MooRHEAD. Mr. Hill testified, I think in his oral testimonyI think I have it correct, at least substantially-he said,
I believe that the erosion of membership will hamper the ability of the Fed
to control monetary policy and hence inflation.

Is that the thrust of your testimony today, sir i
Governor COLDWELL. Yes, it would be.
Mr. MooRHEAD. Thank you.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Mr. Moorhead.
Mr. Stanton.
Mr. STANTON. Mr. Chairman, I have several questions, but I understand Governor Coldwell's time problems, and also the other panel is
waiting. I am like Mr. Moorhead. I have a luncheon commitment. I
can only be here a little longer.
I would simply make one statement. That would be to ask that
several questions I do ha,ve for you, Governor Coldwell, I might insert into the record, and if you could answer them, I would appreciate
that.
Second, back to the question of the specific pricing of membership,
Mr. Chairman, I am not sure if that is exactly that big of a problem
as has been emphasized here this fnorning.
I don't know the exact figures, but it seems to me the Fed, when
they sent.us their proposal, had some specific figures-at least I took
them as spe'cific-of a phase-in of the servic;es to be rendered over two
phases.
Phase 1 would bring- in, I think, some $225 million, and phase 2
would bring- in $400 million. I think roughly that was the figure. So,
if we could just do the reverse and have some of the statistics of
which that $400 million was based on, it would provide, I think, the
general atmosphere of what we are talking about, rather than the
specific.
The CHAIBMAN. I agree. Somebody must have picked up $461
million, or whatever it was. Let us see what it was.

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Mr. STANTON. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Pattison?
Mr. PATTISON. In the interest of time, Mr. Chairman, I think I
would withhold at this time.
The CHAIRMAN. All right.
Mr. Grassley?
Mr. GRASSLEY. Mr. Coldwell, on page 10 of your testimony, where
you say,
My concern is that unless the Federal Reserve utilizes similar flexibility it
will not be able to adjust to the realities of the competitive marketplace, and may

be forced to reduce or abandon its role as a provider of basic level of services
nationwide.

Is that really a realistic fear? It seemed to me that maybe you are
throwing out here something that isn't real just to get our attention.
Governor COLDWELL. We don't really know, Congressman. That is
our problem. We have some correspondent data which include specific
charges.
We know our own costs. If you take it just on the face value of those
two figures, I think we are probably 25 to 30 percent lower than some
of the correspondent data we know of.
On the other hand, we know perfectly well that where an individual
entrepreneur wants to make a loss leader, all he has to do is cut his
prices to get into a particular area.
We don't really know what the situation will be after we price. We
don't know whether we are going to have continued handling of the
checks the way they are now, or a much larger or much smaller volume.
It is our intent to try to keep it about where it is until we see the
efl'ects of pricing.
Mr. GRASSLEY. That is the only question I have, Mr. Chairman.
The CHAIRMAN. Thank you.
Mrs. Fenwick?
Mrs. FENWICK. I just have a short question, or two short questions.
One, how many member banks has the Federal Reserve lost?
Governor COLDWELL. I am sorry. I couldn't hear you.
Mrs. FENWICK. I understand that the Federal Reserve has lost
member banks. How many member banks?
Governor COLDWELL. Congresswoman, I am not sure I can precisely cite the number.
Mrs. FENWICK. I see.
Governor CoLDWELL. It has been a steady erosion. I have watched it
for 27 years.
Mrs. FENWICK. From the high to the present, if you could give us
those figures, I would be grateful.
Governor COLDWELL. 430 over the past 8 years, roughly.
Mrs. FENWICK. They have lost 430 members? That is considerable.
I believe you plan to transfer some $575 million from surplus to the
Treasury in order to pay for the interest that will be the carrot to draw
members back.
How did you come' to that fig-ure? As I understand it, on page 5 of the
chart that has been prepared for us, the loss to the U.S. Treasury will
be some $300 million a year. Am I correct in that?
Governor CoLDWELL. I believe that is correct.

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Mrs. FENWICK. How did you happen to pick $575 million?
Governor COLDWELL. It is a cumulative figure.
Mrs. FENWICK. For 2 years?
Governor COLDWELL. Yes. It is cumulative. In other words, you
would lose that amount over 3 years, but it would be offset through the
transfer from the Federal Reserve surplus. A further offset would
occur because of higher personal or commercial bank taxes paid on the
interest earnings from reserves.
Mrs. FENWICK. Well, the price tag for services, that is already figured in. Interest payment to the banks would cost $765 million. The
revenue loss to the Federal Reserve caused by the reduced reserve
requirements would cost some $350 million.
But your pricing for services would reduce that again to a $605
million loss, if I read your figures correctly. But the point I am trying
to get at is, you are going to take this from your surplus. Why do you
ke~p a surplus of that size?
Fifty-six point seven billion dollars has been paid to the U.S. Treasury since you started, but you still have a very considerable surplus on
hand, over $1 billion.
Governor COLDWELL. I was asked the same question by Senator
Proxmire at two separate hearings 1 year apart. My response to him,
as I am afraid it is going to have to be to you, is that we are required
by law to have a surplus; and we are a banking institution, and most
banks have surplus accounts.
Now, that is a very weak excuse.
Mrs. FENWICK. Well, how do you feel about this universal
requirement?
Governor CoLDWELL. I think it is the best way to go, partly because
I think it does broaden the total group of banks and depository institutions for which monetary policy would be directed in the first initial
stage.
At present, as you know, we have only about 40 or 45 percent of the
banks and are having to increase the pressure of our monetary policy
in order to get the secondary effects.
Mrs. FENWICK. I see. Thank you.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Mrs. Fenwick.
Governor Coldwell, we appreciate your staying with us.
Governor COLDWELL. Thank you very much, Mr. Chairman.
The CHAIRMAN. We will now hear from an old friend of this committee, the executive vice president and economist of the Harris Trust
& Savings Bank of Chicago, Beryl W. Sprinkel.
Mr. Sprinkel has some good ideas to share with us.

STATEMENT OF BERYL W. SPRINKEL, EXECUTIVE VICE PRESIDENT AND ECONOMIST, HARRIS TRUST & SAVINGS BANK, CHICAGO, ILL.
Mr. SPRINKEL. Thank you.
Mr. Chairman and other distinguished members of the House Committee on Banking, Finance and Urban Affairs: I appreciate the op-

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portunity to express my opinions concerning the important b1mking
and monetary policy issues now under consideration. Rather than
commenting upon the details of each proposal, I will attempt to address what I believe to be the basic issues underlying all proposals. The
views are my own and not necesarily those of my employer, the
Harris Trust & Savings Bank of Chicago.
Reserve requirements as presently imposed can best be viewed as a
tax on bankin~, whose cost is ultimately paid by the user of banking
services. Reqmred reserves do not represent an important source of
liquidity as once believed. Nor is it necessary for all banks and other
.financial intermediaries to maintain reserves for the purpose of improving the execution of monetary policy. In fact, it can be demonstrated that the Federal Reserve can regulate the money supply with
zero reserve requirements so long as it is able to determine the monetary base. Therefore, I cannot support universal reserve requirements
since the costs would very probably outweigh any resulting benefits.
I support proposed reforms to pay interest on required reserves
while charging banks for services provided by the Federal Reserve.
Central bank services are not a free good, and explicit pricing of these
services will lead to a better allocation of resources. Reduction in required reserves and payment of interest on those reserves will serve
to reduce the tax on banking services. Although the bills under consideration do not remove the prohibition of interest payment on demand de-posits, I believe such a change would be desirable. Permission
for explicit payment of such interest by commercial banks would be
preferable to the various techniques currently used to reward demand
deposit holders. The above reforms would improve "the efficiency and
competitiveness of our .financial system."
In my opinion, the "conduct of monetary policy" would be improved
by adopting uniform reserve requirements for banks rather than the
present system of variable reserve requirements. Shifts of deposit
funds between institutions with different marginal reserve requirements or between different deposit categories in the same bank changes
the money multiplier in an unpredictable way. Shifts in the ratio between the monetary base and deposits makes it difficult, if not impossible, to predict the monetary effect of a given Federal Reserve action.
Adoption of a "progressive scale of reserve requirements" as proposed
in the amendment to R.R. 12706 would exacerbate the monetary control problem while levying a higher tax on success.
From a monetary control point of view, ,all deposits should be subject
to identical reserve requirements. In April this year all deposits subject
to reserve requirements amounted to $586.1 billion. Reserves on deposit
at the Federal Reserve banks amounted to $27.8 billion. If the vault
cash reserves requirement were eliminated and required reserves were
reduced $5 billion as proposed, there would remain $22.8 billion required reserves for $586.1 billion deposits; an average requirement of
3.9 percent. If all commercial bank deposits were made subject to reserV'e requirements, the average required reserve ratio would decline to
2.5 percent. Any move toward a more uniform system of reserve requirements would be an improvement over the present multiple reserve
requirement as reflected in the following table:

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MEMBER BANK RESERVE REQUIREMENTS t
[Percent of deposits]
Requirements in effect
May 31, 1978
Type of deposit, and deposit interval in millions of - - - - - - - - dollars
Percent Effective date
Net demand:•
0 to 2••...•...•••...••••....•••...•.••••...••...
2 to 10••••••••••••••••••••••••••••••••••••••••••
10 to 100••••••••••••••••••••••••••••••••••••••••
100 to 400 ••••...•••.................•....•••...•
Over 400 •.•••.....•.................•.....••....
Time:21
Savings •••••••••••••••••••••••••••••••••••••••••
Other time:
Oto

~b ~\'!j4n3a~~-::-:.........................

180 days to 4 years.......................
4 years or more..........................
Over 5, maturing in30 to 179 days...........................
180 days to 4 years.......................
4 years or more..........................

Dec .30, 1976
7
9½ ••••• do•••••••
11¾ ....• do •••••••
12¾ ..••. do •••••••

16¼ ..... do •••••••
3

Mai. 16, 1967

Previous requirements
Percent Effective date

7½ Feb. 13, 1975

10
12
13
16½

Do.
Do.
Do.
Do.

3½ Mar. 2, 1967
3½ Do.

3 ••••• do.......
• 2½ Jan. 8, 1976
•I
Oct. 30, 1975

3
3

Mar. 16, 1967
Do.

6
Dec. 30, 1974
• 2½ Jan. 8, 1976
•I
Oct. 30, 1975

5
3
3

Oct. 19, 1974
Dec. 12, 1970
Do.

-----------------LegaI limits, Maym3~n,. lm9u7m8,
Legal limits, May 31, 1978,
I I

Net demand:
Reserve city banks •••••••••••••••••••••••••••••••
Other banks •••••••••••••••••••••••••••••••••••••
Time •••••••••••••••••••••••••••••••••••••••••••••••

10
7
3

maximum

14
10

' For changes in reserve requirements beginning 1963, see Board's Annual Statistical Digest, 1971-1975 and for prior
changes see Board's Annual Report for 1976, table 13.
• (a) Requirement schedules are graduated, and each deposit interval a~plies to that part of the deposits of each bank.
Demand deposits subject to reserve requirements are gross demand deposits minus cash items in process of collection and
demand balances due from domestic banks.
(b) The Federal Reserve Act specifies different ranges of requirements for reserve city banks and for other banks.
Reserve cities are designated under a criterion adopted effective Nov. 9, 1972, by which a bank having net demand deposits
of more than $400,000,000 is considered to have the character of business of a reserve city bank. The presence of the head
office of such a bank constitutes designation of that place as reserve city. Cities in which there are F.R. Banks or branches
are also reserve cities. Any banks having net demand deposits of $400,000,000 or less are considered to have the char•
acter of business of banks outside of reserve cities and are permitted to maintain reserves at ratios set for banks not in
reserve cities. For details see the Board's Regulation D.
(c) The Board's Regulation M requires a 4•percent reserve against net balances due from domestic banks to their
foreign branches and to foreign banks abroad. Effective Dec. I, 1977, a !•percent reserve is reguired against deposits that
foreign branches of U.S. banks use for lending to U.S. residents. Loans agsregating $100,000 or less to any U.S. resident are
excluded from computations, as are total loans of a bank to U.S. residents If not exceeding $1,000,000. Regulation D imposes
a similar reservs requirement on borrowings from foreign banks by domestic offices of a member bank.
• Negotiable orders of withdrawal (NOW) accounts and time deposits such as Christmas and vacation club accounts are
subject to the same requirements as savings deposits.
• The average of reserves on savings and other time deposits must be at least 3•percent ,the minimum specified by law
Note: Required reserves must be held in the form of deposits with F.R. banks or vault cash.

I just want to ·read down the varia.tions in marginal reserve requirements. They defy understanding, much less memory: 7 percent, 9½
percent, 11% percent, 12¾, percent, 16¾ percent, 3 percent, again 3
percent, 2½ percent, 1 percent, 6 percent, 2½ percent, and 1 percent.
Even the :proposal ,to exempt th~ first $10 million in deposits from
reserve reqmrements would be an -1mprovement over the present system. However, moves to subsidize smaller banks through lower reserve
requirements still creates problems with respect to the conduct of
monetary policy. If Congress desires to subsidize smaller banks, this
could be accomplished more efficiently by other means.
In addition to supporting more unform reserve requirements, I support three other proposed changes recently made by Chairman Reuss
of the Committee on Banking, which I believe will further improve
the operation of monetary policy.
First, set the agreed-upon reserve requirements by law and remove
the present ,a;bility of the Federal Reserve Board to vary them within

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prescribed limits. The power to raise and lower reserve requirements is
the power to impose hig<her -and lower taxes upon the banking industry.
This power should reside with our elected representatives, that is, the
Congress and the President. Furthermore, variation in reserve requirements is a blunt instrument of monetary policy and results can be
better achieved through incremental adjustments in open market
operations.
Second, tie the discount rate ,to the average yield on Treasury bills
with less than 92-day maturities issued during the previous 2 weeks.
Under present circumstances, the discount rate 1s adjusted infrequently
and there is a tendency for commercial bank borrowing from the Federal Reserve to soar as Federal funds and the Treasuri hill rate rises
relative to the discount rate. Borrowing banks get a subsidized bargain,
but Federal Reserve credit soars, and unless offset by open market
sales, so does the money supply. Automatic adjustment of the discount
rate would lessen this disturbance and frequent adjustment would remove the sometimes disturbing announcement effect of discount rate
changes.
Finally, I support more frequent acquisition of nonmember deposit
data which should enable the Federal Reserve to better measure the
various money supplies. It is difficult to determine appropriate monetary actions when the Federal Open Market Committee does not know
the size of the recent and present money supply. Since the acquisition
of this data is important for public policy and does involve a private
cost, perhaps the Federal Reserve should consider reimbursing financial institutions for this cost.
Two additional institutional changes bearing on monetary policy
execution that are not proposed but that should he considered are:
First, elimina,tion of lagged reserve computations. Presently this
week's required reserves are based on deposits outstanding 2 weeks ago.
The necessary attempt of banks to acquire reserves to meet obligations
determined 2 weeks before is an unnecessary interfe:-ence with Federal
Reserve attempts to regulate monetary growth. Basing this week's
required reserves on this week's deposits would reduce market interference; and second, staggering of reserve settlement days for member banks or expanding the "allowable carry-forward" would reduce
the frequent extreme fluctuations in Federal funds each Wednesday.
Reducing variation in marginal reserve requirements, floating the
discount mte, legislating reserve requirements, acquiring more timely
deposit data, eliminating lagged reserve settlements, and staggering
reserve settlement days would improve monetary policy formulation
and execution. I once believed the Congressional Moneta.ry Resolution,
later enacted into law and adopted hy the Federal Open Market Committee, would similarly facilitate achievement of a stabilizing monetary policy. Indeed, the objective of gradually reducing monetary
growth until it was eventually commensurate with real output was
and is the right objective. But alas, as monetary targets gradually
receded in recent years, monetary growth accelerated. The music was
soothing, but the results have been rising inflation, as money growth
accelerated. I reluctantly conclude that regardless of improved structural adjustments such as those just discussed, there is little hope for
monetary policy becoming a stabilizing influence upon our economy

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until the Federal Reserve changes its operating technique and permits
the market to determine the Fed funds rate while it concentrates its
attention on regulating growth in the monetary base or another closely
related aggregate. Until this necessary reform is adopted by the Federal Open Market Committee, monetary policy will remain a procyclical rather than a stalbilizing influence upon our economy.
Thank you.
The CHAIRMAN. Thank you, Mr. Sprinkel.
Now Frank E. Morris, president of the Federal Reserve Bank of
Boston.
Let me take this opportunity, Mr. Morris, to congratulate you on the
economic deveJlopment work in your Federal Reserve district which
your bank has been conducting for some years through seminars, publications and general leadership. It is a model for the whole country.
I have taken the liberty of plagiarizing some of the things you have
been doing, seeing that they are done in our own Federal Reserve
district.

STATEMENT OF FRANK E. :MORRIS, PRESIDENT, FEDERAL
RESERVE BANK OF BOSTON
Mr. MoRRIS. Thank you, sir. I am very pleased tobeihere.
As you know, the New England area has been the area most impacted by the membership problem in recent years.
I will a.bbreviate my statement, Mr. Chairman.
The CHAIRMAN. Your entire statement will of course be included in
:full in the record.
Mr. MoRRIS. Thank you, sir.
When Congress was drafting the Federal Reserve Act 65 years ago,
I don't believe it contemplated that in 1978 the cost of membership in
the Federal Reserve System would lead to a large erosion of membership in ,the System and impair the very objectives for which the Federal Reserve Act was written.
The erosion of membership impairs our lenders-of-last-resort function because it means fewer and fewer banks have direct and quick
access to the discount window.
For example, in New England now we have 56 banks with deposits
in excess of $100 million. Of these 56 banks, 29 are now not members
of the Federal Reserve, and :they have deposits of $8 billion.
These 29 large banks are going to have to depend upon the correspondent 'banking system in a liquidity crisis booause we will not be
able to deal rapidly with their needs the way we can with member
banks.
Second, I am concerned about the shrinking reserve base. Mr.
Sprinkel argued ithat we don't nood ,a reserve base in order to control
the money supply. He said as long as we have the monetary base, we
can control the supply.
But that confused me a bit because member bank reserves are an
important component of that monetary base.
The question is nOlt whether we can control the money supply at all.
The question is oon we control it with the precision tha.t the Congress
is asking us to control it.

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Member banks reserves are the fulcrum upon which our moneJtary
management ootions take place. We have to try fo estimrute day by day
how many deposits will be generated wirth a given input of reserves.
As that fulcrum gets smaller and smaller relative to the total deposit
base, our estimates ,are going to get more and more inaccurate.
One of the early monetarists, Henry Simons of the University of
Chicago, was sufficiently oonce,rned a:bout this precision ,aspect of
monetary control th:at he argued for a 100-percent Reserve System,
so that the central bank would know if it put in a dollar of reserves
it got a doHar of deposits; no more, no less.
Well, I don't think •anyone ever seriously considered •a 100-percent
Reserve System, but I think it is clear that if the body of reserves
shrinks relative to tlhe body of deposits, that estimating the effect of
our actions on the money supply is going to grow more and more
difficult.
Now, turning to page 2 of my statement, I have some informa,tion
on the decline of membership in New England in the recent past, and
the prospootive decline of membership if nothing is done ,about this
problem.
In 1977, 11 banks in New England and 58 banks in the rest of the
United States wi,thdrew from :the Federal Reserve System. These 11
banks accounted for about 5 percent of the total of member banks in
New England, and had desposits amounting :to more than 10 percent
of total deposits held at all member banks.
By the end of 1977, the proportion of insured commercial bank deposits held by member banks in New England had fallen below 63 percent as compared to 75 percent in the rest of the country.
In the past, the membership problem 'has l,argely been restricted to
small banks. But this is no longer the case. During 1977, 8 of the 11
banks which le:flt the System in New England and 7 of the 58 banks
which withdrew in the rest of the country had deposits of $100 million
or more, and these 15 banks had total deposits of $3.3 billion.
Now, I have been talking in a very open manner to our member
banks in New England, urging them to postpone temporarily any
decision to leave tlhe System since the Fedeml Reserve was going to
seek congressional action to deal with the membership problem.
They have by and large heeded my advice. Thus for in 1978, only
three banks have ·announced target dates for withdrawal. However, ·an
additional 34 banks have indicruted to me that they ,are se,riously considering withd11awal from membership.
Of these 34 banks, 14 banks have deposits of $100 million to $500
million, and 3 'have deposits over $500 million. Together, these 37
banks that may leave the System if nothing is done have deposits of
$5.3 billion and account for almost 28 percent of deposits currently
held by 'all member banks in New England.
These banks currently keep $273 million in reserves with the Federal
Reserve Bank of Boston, upon which we earned and turned over to
the Treasury last year a,bout $18 million.
If no action is taken to deal with the membership problem, I think
it is probable that by the end of 1979, Federal Reserve member banks
will hold less than half of all commercial bank deposits in New
Eng1'and.

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Mr. Hill, I think, pointed out some of the reasons why the rate of
withdrawal of member banks in New England has been greater than
the rest of the country.
We have a very aggressive, competitive environment in New England, probably the most competitive retail banking environment in the
country. We have thrift institutions which unlike their counterparts
in most other sections of the country can offer full seryice banking to
the consumer.
This intensified retail banking competition has resulted in lower
profit margins for New England bankers. In 1977, in Massachusetts
banks, net income before taxes and securities transactions as a percentage of total ·assets was 0.76 percent. The corresponding figure for
commercial banks nationally in 1977 was 1.09 percent, 43 percent
greater than the Massachusetts average.
So, this relatively weaker earnings performance has generated pressure to increase earnings by leaving the Federal Reserve and avoiding
what I call the Federal banking franchise tax.
All of the New England banks that have left the System have done
so very reluctantly. They are particularly reluctant to give up direct
access to the discount window. But the pressure of the bottom line has
just been too great to permit them to remain members of the System.
I would like to elaborate a bit on why I am concerned about the loss
of the lender-of-last-resort function as more and niore banks leave the
System.
I think it is rendering our banking system more vulnerable, and the
ability of the economy to withstand financial shocks is being lessened
by the fact that an increasing proportion of banks will not have access
to the discount window.
In recent years the development of sophisticated techniques of
liability management has lessened the importance of the discount window as a routine source of liquidity. Many banks leaving the System
believe that if need should arise, they will be able to obtain funds from
their large correspondents.
In the normal course of events, there is no doubt that the large banks
will be able to meet the liquidity needs of their smaller correspondents.
But if a general liquidity crisis should occur, the large banks may not
be able or willing to meet the needs of all nonmember banks.
Even if they have the funds available, or are able to obtain them
from the Federal Reserve, the large banks may be reluctant to assume
the substantial credit risks involved in numerous large-scale advances
to their correspondents.
The committee should remember that the original impetus to the
formation of the Federal Reserve was the failure of the correspondent
network to provide adequate liquidity to country banks during the
financial crisis of the early 1900's.
The Federal Reserve 1s the only lender that can unconditionally
guarantee a sufficient supply of the funds in times of crisis. Performance of this guarantee requires a direct relationship between the
Federal Reserve and the borrowing bank.
The decline in membership thus endangers the performance of the
Federal Reserve function which is only of routine importance presently, but whose successful implementation in time of crisis is imperative.

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There are obviously two ways of dealing with this problem. One is
to mandate uniform reserve requirements, placing all financial institutions on an equal footing, a solution which would increase the revenues
of the Treasury.
But if Congress remains unwilling to do this, it should approve the
only alternative solution-to eliminate the excessive burden of membership in the Federal Reserve.
Now, in my judgment the Board's cost estimates of its proposal are
much too high since they make no allowance for the effect of increased
membership.
There is no doubt in my mind that if the Board's program were
adopted, most of the New England banks which left the System would
rejoin promptly, along with many commercial banks and some savings
banks which have never been members.
In the long run, I believe that the cost of the Board's program to the
Treasury will be less than the cost of doing nothing and suffering the
declining revenues produced by a continued decline in membership.
Now I would like to turn to the issue of pricing Federal Reserve
services, for which I have been a long-term advocate. It is an economic
truism that any costly service provided free of charge will be overused. Resources are wasted because the cost of providing the services
will inevitably be higher than its value to the marginal user.
I think it is unfortunate that the Fedeml Reserve is in a position that
it must offer free services to member banks to partially offset the cost
of the nonearning balances they must keep with us as reserves. I think
both the Federal Reserve System and the commercial banking system
would operate more efficiently if they paid depositors a market rate of
interest on their deposits and charged for services on the basis of the
costs incurred in providing those services.
In any industry in which price competition is constrained, competition takes the wasteful form of giving away free services. And the more
competitive the industry, the more waste is generated. We saw this in
the brokerage industry before fixed pricing was abolished. We see it
now in the commercial banking industry, where the more competitive
the market, the more institutions compete by offering free services or
other amenities which cost more than their value to the consumer. The
free checking account is one common example. The proliferation of expensive branches is another.
Now when banks are charged for Federal Reserve services, they
will use these services more sparingly. In some cases they may do more
processing of the checks themselves, or they may set up local clearing
associations in which they simply swap checks among themselves,
avoiding the Federal Reserve System altogether.
To the extent that such services can be performed outside the System
at a lower cost, this private market development would simultaneously
save money for the public and reduce a heavy check burden which the
Federal Reserve now bears. Thus the introduction of pricing would
improve the efficiency of the Nation's payment system.
Pricing of services will also increase efficiency by reducing the use
of checks as a means of payment. It will also hasten the rate at which
substitutes for checks are introduced. At present the public shows no
great enthusiasm for innovations, such as electronic funds transfer

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systems, since the present costly system of paper checks is provided at
low charge. However, if customers were charged the cost of check processing, the relative cost and convenience of electronic funds transfer
would become more attractive. Unfortunately the System cannot introduce pricing for its severance until the burden of membership is
eliminated.
Thus, the membership problem not only creates obstacles of increasing significance for the efficient conduct of monetary policy, but it also
blocks the way toward a more efficient and less costly banking system
for the American public.
Thank you, Mr. Chairman.
[Mr. Morris' prepared statement follows:]

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Statement of
Frank E. Morris
President of the
Federal Reserve Bank of Boston
before the
House Committee on Banking, Finance and Urban Affairs

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I appreciate the opportunity to testify on an issue which
has great long-run consequences for the efficient conduct of monetary
policy and the stability of our banking system.
my remarks to two principal areas:

I propose to limit

(1) the Federal Reserve System's

membership problem, how it has come about, why it is a problem and
what can be done about it, and (2) the issue of charging for Federal
Reserve services--why it will be publicly beneficial once the membership burden has been eliminated.
Membership Burden
While membership in the Federal Reserve System entitles
banks to receive free services provided by the System, member banks
are required to hold reserves against demand and savings and time
deposits either as vault cash or as deposits with Federal Reserve
Banks.

Non-member banks are permitted by state authorities to hold

most of their reserves as earning assets or in the form of balances
which the normal course of business would require.

Historically,

the Federal Reserve has not paid interest on reserves held by member
banks 1 so that membership involves a cost equal to the interest

foregone on the non-earning balances held at the Federal Reserve.
The difference between the value of the services received
and the interest foregone equals th~ net burden of membership.

the member bank gives up more in interest revenue than the value of
services it receives, then it may be to the member bank's advantage
to withdraw from the System and purchase these services from a

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correspondent.

Over the past ten years the net burden of membership

has increased sharply as a consequence of the inflation-connected
rise in open market interest rates.

For all member banks it is esti-

mated that the net burden of membership is about 9 percent of 1977
before-tax income.

For banks in the $100 million to $1 billion

deposit size class, where the most serious erosion of member·ship
has occurred in recent years, the net burden is estimated at 10 to
12 percent of pre-tax earnings.
The net burden associated with membership in the Federal
Reserve System is in effect a Federal franchise tax which member banks
must pay but which non-member banks can avoid.

Since the Federal

Reserve System is the only central bank with voluntary membership,
banks can avoid this Federal franchise tax by relinquishing their
membership.

When Congress passed the Federal Reserve Act it neither

foresaw nor intended that Federal Reserve membership would involve
a substantial financial burden.

The goal of the present legislative

package should be to adjust benefits and costs so that the Federal Rese 1rve
membership decision will not involve either a net burden or a windfall
gain.
Decline in Membership
During 1977 11 banks in New England and 58 banks in the
rest of the U.S. withdrew from the Federal Reserve System.

These

11 banks accounted for about 5 percent of the total number of member
banks in New England and had deposits of more than 10 percent of
total deposits held at all member banks.

By the end of 1977 the

proportion of insured commercial bank deposits held by member

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banks

had

fallen

below

percent

New

En~land

and

75 percent elsewhere, which compares with figures of 77 percent
and 79 percent, respectively, at the end of 1972.
In the past, the membership problem has been largely
restricted to small banks; but this is no longer the case.

During

1977, 8 of the 11 banks which left the System in New England and
7 of the 58 banks which withdrew in the rest of the United States
had deposits of $100 million or more.

Among them, these 15 banks

had total deposits of $3.3 billion.
We have discussed the burden of membership in an open and
frank manner with our members in New England and attempted to impress
upon them that the System intended to seek Congressional action to
alleviate the net burden.

As a result of these discussions many

banks have temporarily postponed their decision pending the outcome
of legislation.

Thus far in 1978, only three New England banks have

announced target dates for withdrawal.

However, an additional 34

banks have indicated that they are seriously considering withdrawal
from membership.

Of these 34 banks, 14 have deposits of $100 million

to $500 million, and three have deposits of over $500 million.
Together the 37 banks have deposits of $5.3 billion and account for
almost 28 percent of deposits held by all member banks in New England.
These banks currently keep $273 million in reserves with the Federal
Reserve Bank of Boston upon which we earned (and turned over to the
Treasury) almost $18 million in 1977.
If no action is taken, it is probable that by the end of
1979 Federal Reserve member banks will hold less than half of all
commercial bank deposits in New England.

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The rate of withdrawal by member banks is substantially
greater in New England than elsewhere, although the trend is accelerating around the country.

The higher rate of withdrawal by member

banks in New England is due to several factors.

First, because of

aggressive competition from well-established thrift institutions,
commercial banks in New England have difficulty in attracting time
and savings deposits and as a result tend to have higher ratios of
demand deposits to total deposits than do banks in the rest of the
country.

Because the impact of reserve requirements falls mainly

on demand deposits, the net burden of membership is relatively
larger for New England banks of a given size than for equivalent
banks elsewhere.
A second factor responsible for the greater exodus in
New England is the impact of NOW accounts and the related fact that
thrift institutions, unlike their counterparts in most other sections
of the country, can offer full service banking to the consumer.
The intensified retail banking competition has resulted
in lower profit margins for New England bankers.

For example, in 1977,

net income before taxes and securities transactions as a percentaee of

total assets was 0.76 percent in Massachusetts.

The corresponding figure

for commercial banks nationally in 1977 was 1.09 percent--more than
43 percent greater.

This relatively weak earnings performance has

generated pressure to increase earnings by leaving the Federal
Reserve and avoiding the Federal banking franchise "tax.''

All of

the New England banks that have left the System have done so

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reluctantly, but the pressure of the "bottom line" has been just
too great.
Why Declining Membership is a Problem
The erosion of membership worries me, because the System's
very reasons for existence are being threatened.
The membership problem impairs the ability of the Federal
Reserve to conduct monetary policy with the precision we are seeking.
Every time a bank leaves the System our information base on deposits
shrinks, the reserve base shrinks relative to the deposit base and
the reserve multiplier (the relationship between a change in reserves
and a change in deposits) will become more unstable.

In an era when

precise control of the money supply is given more importance than
ever before, the membership problem is weakening the ability of the
Federal Reserve to execute monetary policy.
In addition, the banking system is rendered more vulnerable
and the ability of the economy to withstand financial shocks is
lessened by the fact that an increasing proportion of banks do not
have access to the discount window.

In recent years the development

of sophisticated techniques of liability management have lessened
the importance of the discount window as a routine source of liquidity,

and many banks leaving the System believe that if need should arise
they will be able to obtain liquid funds from their large correspondents.

In the normal course of events, there is no doubt that the

large banks will be able to meet the liquidity needs of their smaller

correspondents.

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But if a general liquidity crisis should occur, the

254
large banks may not be able or willing to meet the needs of all
non-member banks.

Even if thev have the funds available or are able

to obtain them from the Federal Reserve, the large banks may be
reluctant to assume the substantial credit risks involved in numerous

large scale advances to their correspondents.
It should be remembered that the original impetus to the
formation of the Federal Reserve was the failure of the correspondent
network to provide adequate liquidity to country banks during the
financial crises of the early 1900s.

The Federal Reserve is the

only lender that can unconditionally guarantee a sufficient supply
of funds in times of crisis, but performance of this guarantee
requires a direct relationship between the Federal Reserve and the
borrowing bank.

The decline in membership thus endangers the

performance of a Federal Reserve function which is only of routine
importance presently but whose successful implementation in time of
crisis is imperative.

Two Solutions
There are fundamentally two ways of dealing with the
problem.

One way is to mandate uniform reserve requirements,

placing all financial institutions on an equal footing.

If the

Congress remains unwilling to do this, then it should approve the

only alternative solution--to eliminate the excessive burden of

membership in the Federal Reserve.
The proposal made by the Board of Governors to reduce
the membership burden by a combination of reserve requirement
reductions and interest payments on reserve balances will solve

the problem at little or no cost to the Treasury in the long run.

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In my judgment the Board's cost estimates are much too
high, since they make no allowance for the effect of increased
membership.

There is no doubt in my mind that if the Board's

program were adopted, most of the New England banks which left
the System would rejoin promptly, along with many commercial banks
and some savings banks which have never been members.

In the long

run, I believe that the cost of the Board's program to the Treasury
will be less than the cost to the Treasury of doing nothing and
suffering the declining revenues produced by a continued decline
in membership.
Service Charges
I would like to turn now to the issue of the pricing of
Federal Reserve services.

It is an economic truism that any costly

service provided free of charge will be overused.

Resources are

wasted because the cost of providing the service will inevitahly
be higher than its value to the margina! user.

It is unfortunate

that the Federal Reserve must offer free services to memher hanks
to partially offset the cost of the non-earning balances they must
keep with us as reserves.

Both the Federal Reserve and the commercial

hanking system would operate more efficiently if they paid depositors
a market rate of interest on their deposits and charged for services
on the basis of the costs incurred in providing those services.

In any industry in which price competition is constrained,
competition takes the wasteful form of giving away free services--

and the more competitive the industry the more waste is generated.

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We saw this in the brokerage industry before fixed pricing was
abolished.

We see it now in the commercial banking industry

where the more competitive the market, the more institutions
compete by offering free services or other amenities which cost
more than their value to the consumer.

The free checking account

is one common example, the proliferation of expensive branches
another.
For example, New England commercial banks have attempted
to compete with one another by increasing the number of banking
offices to offer greater convenience to the customer.

As a result,

total deposits at commercial banks in New England were only about
$13.3 million per office at the end of 1977 compared to $20.6
million per office in the rest of the country.

The effect of these

lower deposits per office is to increase substantially operating
costs per dollar of deposits.

In 1977 the non-interest expense

per dollar of assets at New England commercial banks was almost
26 percent higher than for banks in the rest of the ·country.
Ultimately, these higher costs must be borne by the consumer.
When banks are charged for Federal Reserve services, they
will use those services more sparingly.

In some cases they may do

more processing of the checks themselves or they may set up more
local clearing associations in which they can simply swap checks
among themselves, avoiding the Federal Reserve System altogether.
To the extent that such services can be performed outside the
System at a lower cost, this private market development would
simultaneously save money for the public and reduce the heavy
check burden which the Federal Reserve now bears.

Thus, the

introduction of pricing would improve the efficiency of the nation's
payment system.

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Pricing will also increase efficiency by reducing the
use of checks as a means of payment.

From 1972 to 1977 the number

of private checks processed by the Federal Reserve System increased
from 8.4 billion to 13.3 billion or by 58 percent.

This rapid

growth in the use of checks has imposed substantial costs on both
the commercial banks and the Federal Reserve System.

If depositors

were charged for each check written, future growth in the volume
of checks would be substantially reduced (especially in checks for
very small amounts), with significant savings for both the commercial
banks and the Federal Reserve System.
Pricing will also hasten the rate at which substitutes
for checks are introduced.

At present, the public shows no great

enthusiasm for innovations such as electronic funds transfer systems,

since the present system of paper checks is provided at no charge.
However, if customers were charged the costs of check processing,

the relative costs and convenience of EFTS would become more attractive.
Pricing would also eliminate another deficiency in the
structure of the Federal Reserve System.

As matters now stand

any bank which requires few System services pays the same membership
fee in terms of lost earnings on reserves as does a bank of the
same size which uses many System services,

Thus, a large member

bank with a small correspondent business now carries a much larger

net burden than does a member bank of the same size with a large
correspondent business.

If the System membership package could

be unbundled so that member banks were required to pay for all

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the services they receive, we would create a much more equitable

and logical system.
Unfortunately, the System cannot introduce pricing for
its services until the burden of membership is eliminated.

The

membership problem not only creates obstacles for the efficient
conduct of monetary policy but it is blocking the way toward a
more efficient and less costly banking system for the American
public.

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The CHAIRMAN. Thank you, Mr. Morris.
I am not going, Mr. Sprinkel, to address any specific question to you
because I find your whole testimony very persuasive-where we agree,
I naturally find jt persuasive; where we don't, I am most interested in
what you have to say. I am going to reconsider my thinking.
Mr. Morris, you base your proposition that congressional action
should be taken to halt attrition in the Federal Reserve membership
system largely on two grounds: Ground No. 1, you say that every
time a bank leaves the System, our information base on deposits
shrinks.
My question: Couldn't we solve this monetary control and information problem simply by authorizing the Federal Reserve to collect
whatever information it needs on the deposit liabilities and assets of
nonmember institutions 1 Wouldn't this be a simpler and more effective way than doling out hundreds of millions of dollars in taxpayer's
money in order to induce nonmember institutions to join the Fed i
In this connection, I am very sympathetic to the suggestion made by
Mr. Sprinkel that maybe the paperwork costs that you would put to
depository institutions in making these reports should be borne by
the Government, they should be reimbursed. I think that would be fair.
Putting that to one side, you can achieve monetary control without
a compulsory or semicompulsory or heavily subsidized membership,
can't youi
Mr. MORRIS. Well, it is a question again of the degree of control.
I think information is one of our problems. It is not the only problem.
The Committee, the Federal Open Market Committee, found out in
March, for example, of this year, that the money supply, M1 , grew at
about half of 1 percent faster than we had thought it had grown. I find
this kind of information gap in our system completely inexcusable.
The CHAIRMAN. Mr. Sprinkel had a couple of suggestions, lag
reserves and daily, rather than 1 day a week, reporting, which I think
in the future could help. I was cheered that Chairman Miller the other
day indicated that the day of lag reserves is nearing its end, it will not
be missed, as far as I am concerned.
Mr. MORRIS. I have been an advocate of eliminating the lagged
reserve procedure within the System. I think we ought to move ahead
on that. I haven't seen sufficient study of the proposition to have
various banks end their weeks on different days to know what problems
that might occasion. But on the surface, my initial impression is that
it might not be a bad idea. Until it is studied carefully, r really couldn't
take a position. I think you are overlooking some of the other problems
I raised. I am very much concerned about the g'l"OWing inability of the
Federal Reserve to deal with a large-scale liquidity crisis in this
country.
The CHAIRMAN. That was the second point I was going to come to,
in which you say that, and I am quoting you "an increasing proportion of banks don't have access to the window," and that this may be
all ri~ht on a sunny day. You then go on to say that, if a general
liQuidity crisis should occur, the large banks may not be able to or
willing to meet the needs of all nonmember banks.
Since you have raised it as your second point and came out for it
quite strongly in your testimony, let me ask my question on that.

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Suppose you have this general liquidity crisis, God forbid, but
suppose we do. The Federal Reserve under its present authority could
open its discount window directly to nonmember institutions, it could
exercise that authority.
Wouldn't the affected nonmember banks quite eagerly pay the
penalty rate of interest in order to maintain the liquidity necessary
to their survival~
If so, and I believe that is so, what is the problem~ Why shell out
half a billion dollars a year just to keep up the membership in the
country club~
Mr. MoRRIS. First of all, with respect to your half billion dollars,
Mr. Chairman, I personally feel that the Board's proposals wouldn't
cost the Treasury a nickel because I think in the absence of some
action by the Congress the erosion in membership is going to continue,
and with the erosion in membership will go a decline in revenue to
the Treasury which I think is going to be quite commensurate with
any cost of the System's proposal.
The CnAmMAN. It is interesting to note, though I don't want to
divert, that just the other day Chairman Miller testified that higher
interest rates were a big, big factor in the tendency toward erosion.
That is plausible enough. The higher the interest rate, the more you
Jose by sterile deposits. Then he gave us the good news that interest
rates were going to come down.
Well, if so, you might be getting some members without raising a
finger.
Mr. MoRRIS. w·ell, I would like to think they are going to come
down far enough to deal with the membership problem, but I think
that is highly unlikely in the foreseeable future. On this issue of
lending to nonmembers, the problem, Mr. Chairman, is the speed with
which we can react.
I have the authority to make loans to members quickly without reporting what I am doing to Washington until after the fact. We send
weekly, monthly, and quarterly reports to the Board. If they think we
are doing something wrong, they will let me know about it. I don't
have to come to Washington for authority to lend to a member bank.
w·e can move very rapidly. But under the present law to make a loan
to a nonmember institution, I have to come to Washington and get
five of the seven Board members to approve that loan.
Now we are talking about a very time-consuming proposition. And
there are occasions when I might not even be able to find five of seven
Board members. I am talking about a situation in which it is imperative, for the health of the economy, that the Reserve banks be able to
move quickly in putting money into the places where that money is
needed.
Now another reason I think that would cause delay is that vv;e know
what is going on in our member banks. We keep weekly charts, showing what happened to their loans, investments, Federal funds position,
so on. So if we see a bank with a liquidity problem on the horizon,
we are alerted to it in advance. We know the condition of the bank;
it is not a surprise to us.
On the basis of that knowledge, we can talk to the bank well before
it gets into a critical position. If it is a nonmember institution, we

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probably wouldn't even be advised until it is a:bout to go down the
chute. I don't think I, as a public official, can lend Government money
to an institution about which I know practically nothing just like
that.
The CHAmMAN. Of course, the amendment backed by such of our
members as Mr. Vento, Mr. Lundine, just to name two of them, imposes a rigorous mandate on the Fed to go get that information on
nonbanking institutions. I think you do a good job on hanks, but increasingly, as has been pointed out plenty of times, quasi-banks, known
as mumc1pal savings banks, savings and loans, and credit unions are
creating money. We must have some method. You and the Board of
Governors here need some help, which we intend• to give you.
My time is almost up. I would however ask Mr. Sprinkel if he cares
to comment on either of the points made by Mr. Morris, either what
do you do about the liquidity point or the earlier point.
Mr. SPRINKEL. Well, if I could add one statement, clarifying statement. I don't want to be interpreted as saying that membership in the
Federal Reserve is trivial, and therefore we should do nothing to keep
it. I do not like to see specious arguments used for justifying getting
all the banks into the System.
The point that I made was that we can regulate the money supply
without required reserves. That does not convince me, however, that,
as a practical matter, we should encourage continued attrition in the
membership of the Federal Reserve System. They perform some very
important roles, and one of them I think is probably overriding. I
think it ~s very important politically that we have strength and support behmd a central bank who has some independence from the Congress, from the administration, within Government, and membership
in the Federal Reserve probahly will strengthen that independence. So
I just want to make sure that you didn't understand me to say that Mr.
Morris is worrying about trivial matters. I don't think you were.
The CHAIRMAN. I don't think anybody would have thought that,
but it is very clear now.
Mr. Pattison.
Mr. PATTISON. I am not a banking expert, so you will pardon my
ignorance in some of my questions.
But isn't the major reason for reserve requirements, whether they
be deposited in sterile accounts or whether they be required to be maintained and set aside, that is simply a matter of safety for the depositor; is that not correct?
•
Mr. MoRRis. I think that was some of the thinking in the original
act. But actually since we require all banks to keep those reserves with
us, week in and week out, it is not really a liquidity reserve for the
banks. It is a fulcrum for monetary policy, but it is not liquidity for
the bank.
Mr. PATTISON. Isn't the problem one that if you don't have some reserves, whether you keep them in a shoe box or keep them in the Federal Reserve, that you can find yourself with a liquidity crisis quite
rapidly and that that is the main reason for the reserves?
Mr. SPRINKEL. Unfortunately, the most illiquid asset on the balance
sheet is required reserve with the Fed. The only way to get those reserves is to go out of business.

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Mr. PATTISON. But if under the State banking system you are just
simply required to have a certain amount of assets in treasuries, or
whatever else they require you to have them in, that isn't illiquid, you
can realize that very quickly.
Mr. SPRINKEL. Yes.
Mr. PATTISON. That would solve the safety problem if we simply
required all financiial institutions, banks, thrifts, savings and loans,
anything else, to maintain a certain amount of reserves in their own
way, regulated perhaps but invested themselves, as opposed to being
put in the Reserve System.
Mr. SPRINKEL. Self-survival will insure that. They must have adequate resources to meet drains, to meet transfers of funds. You may
want to require it, too. But required reserves does not perform that
function.
Mr. PATTISON. Required reserves in the-Mr. SPRINKEL. In the form of deposits with the Fed.
Mr. PATTISON. But required reserves otherwise would-Mr. Sprinkel, would -you require reserves to be held by ~11 institutions, not in the Fed, but just simply some set-aside safety factors to
be held by all institutions?
Mr. SPRINKEL. With the Fed?
Mr. PATTISON. No, no.
Mr. SPRINKEL. They all have requirements of one kind or another,
either State requirements-Mr. PATI'ISON. Isn't one of the problems really that the dual banking
system says the States regulate certain kinds of institutions or certain
institutions, and the Federal Government regul ates other institutions?
There is an imbalance sometimes because you hold sterile reserves in
the Federal Reserve System and not sterile reserves in the State system.
So you have a competition between the two systems.
Mr. SPRINKEL. That is correct. Those banks that must set aside
assets on which they get zero return bea,r a tax that the other institu1tions do not, and that tax gets passed on to you and me who use the
banking services.
·
I might add, incidentally, that one of the advantages, relating back
to Mr. Annunzio's initial question of reducing reserve requirements,
that I believe that most of those temporary benefits or profits that appear initially will get competed a.way. That is why I am in :liavor of
paying demand deposit interest. It is the public who will benefit from
this move, not the hanking industry.
Mr. PATTISON. How does that occur in the light of the dual banking
system, or can it? How would we require that?
Mr. SPRINKEL. You mean if you continue to have some bank members of the Fed and others that are not members?
Mr. PATI'ISON. Suppose we took out of the Fed membership the requirement that you hold reserves in the Fed but required just reserves
to be held, as manv of the State institutions do, in separate instruments.
Mr. SPRINKEL. That would reduce the differential tax, it would eliminate it. The Federal Reserve might well argue they couldn't control
the money supply with zero reserve reQuirements.
Mr. PATTISON. That is the next question.
Mr. SPRINKEL. But I don't agree with that.

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Mr. PATTISON. At that point the Fed has two problems, one it has
no money that it can use to---Mr. SPRINKEL. Federal Reserve's ability to acquire assets is not a
function of how many deposits we have with them, even though many
bankers believe that is true. It really isn't true. They have unlimited
authority to expand money.
Mr. PATTISON. By open market, buying Treasuries and selling
Treasuries~
Mr. SPRINKEL. Yes, that is correct.
Mr. PATTISON. All right. So your point is that they don't need those
sterile reserves to be held at the Fed.
Then that would give them a problem, would it not, with the discount window~ From where would they get the money to lend in a
discount window~
Mr. SPRINKEL. Same place they get the other money, create it.
Mr. PATTISON. That is what I thought. Therefore the point that
Mr. Morris makes is that because there is a lot of people who are not
able to get to the discount window because they have gotten out of the
Fed, could be. resolved by simply making the Fed discount window
available to them. Obviously the point he further makes is he doesn't
want it to be available to them unless he knows son1ething about them.
Couldn't that be solved in the same way that you solve your requirements with the Fed members now 1
Mr. Moruus. Y e.s. But to the extent we make the discount window
available to nonmembers as well as members then you have created
another reason for members to leave the System. That is a very important reason why banks do not leave the System.
Mr. PATTISON. Except it is possible you could pay, as suggested
by the chairman, you could require nonmember banks to pay a premium and that would be a disincentive to get out of the Fed.
Mr. MoRRIS. Yes. But that premium would look pretty small, no
matter how big it was. It would be pretty small against the cost of
maintaining noninterest bearing reserves with us.
Mr. PATTISON. Then I suppose you could say that everybody has
to have the ,availabilitv of the dist'onnt window and everybody pays
a certain amount for that privilege, whether you are a member of the
Fed or not, that would accomplish the same thing, would it not?
Mr. MORRIS. I think something could be structured along those
lines, yes.
Mr. PATI'ISON. I might point out, Mr. Morris, that Chairman Miller
doesn't take the same position that you do about the increase of membership to the l!'ed. He says that these proposals are not intended to
attract new members and he says "I don't think the proposals would
attract members." And then Mr. Campbell, who te.stified before you,
agrees with that also, and he says that the proposals, since they provide the heaviest burden-since the heaviest burden of membership
falls on the small banks, the payment of interest on reserves would
TI:dound primarily to the large banks. He says explicit pricing would
d 1 scourage small banks from becoming members because they get a
better deal with correspondent banks. And the discount window, the
only unique service provided by the Fed isn't sufficient inducement to
get people to go in. So he would differ with you also on whether or
not the proposals would attract new members to the Fed.

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Mr. MoRRis. Yes. I certainly differ with him in that respect. On the
basis of my exit interviews, I think every one of the banks we lost last
year would be willing to come back into the System if this package
that the Board has proposed were to take legislative form. In fact
several of them told me explicitly that they feel that sooner or later
the Congress will have to do something about this membership
problem, and that when Congress does, they will 1be back in, but in the
meantime they will have increased their earnings for several years.
Mr. PATI'ISON. Thank you.
My time has expired.
The CHAIRMAN. Mr. Vento, could I ask you to be kind enough to
act as chairman for the remainder of the session~
Permit me to thank Mr. Sprinkel and Mr. Morris for very
constructive testimony.
Mr. VENTO. Thank you, Mr. Chairman. I think I can function from
here. I am the last one to ask questions and I too have to make the
recorded vote. I will try to be as brief as I can.
I looked over both of the testimonies.
Mr. Sprinkel, I think that Representative Pattison was looking at
a significant factor here in terms of talking about the other types of
reserves that might be required by States or by the FDIC or whatever the regulatory mechanism is for the financial institutions.
Has anyone looked at that in a comprehensive manner that you can
report to us; or for that matter, Mr. Morris, has anyone looked at
these particular reserves to determine how sterile they are, what the
earnings are~
What I am suggesting is that one of the purposes of these hearings
is to look at the eroding membership of the Fed.
What is the competition doing which is causing the competition
to take place; how sterile~ What 1s the rate for the required reserves,
of all the reserves, or however they are held~
Mr. MoRRis. Well, there are some differences among the States.
Mr. VENTO. I understand that. But I realize this has to be a general
answer, but someone must have looked at that.
Mr. MoRRis. Yes, we have.
By and large, I think it is true that the State reserve requirements
impose no net burden to the State-chartered nonmember hanks, because they permit the reserves to be satisfied by either income-ea.ming
assets or non-income-earning assets that the bank would have to hold
in the normal course of events. That is, a bank has to hold some cash.
A bank does have at any one point in time claims on other banks
through the check claim process. These can be counted as reserves in
most States.
So that I think the short answer to your question, sir, is that there
is, by and large, no burden of reserve requirements for nonmember
banks.
Mr. VENTO. I see nodding approval. I assume that is agreement.
Mr. SPRINKEL. Yes.
Mr. VENTO. On page 4 of your statement, Mr. Sprinkel, you point
out that you disagree with apparently the lowering of reserve requirements, not the lowering but the complete removal from smaller banks,
and you suggest that if it is our desire to help smaller banks, that there
are other means that would be more efficient.

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What, for instance~
Mr. SPRINKEL. The reason I argued that is that if they have zero
reserve requirements and other banks have higher reserve requirements, the movement of deposits from one categ<!,ry to another creates
more noise in the System and makes it more difficult for the Federal
Reserve to predict what the effect of a given action will be on the money
supply.
I don't know, you can do it with taxes, you can have lower marginal
tax requirements on smaller banks. There must be a multitude of ways
that do not monkey with the money multiplier. Because the real purpose of the Fed, the major purpose, is to conduct a stabilizing monetary policy. Things that get in the way of it, I would like to find ways
around them.
Mr. VENTO. The other point on page 2, you recognize demand
deposit problems.
What is your attitude with regard to the different reserve requirements the Fed proposes for transaction accounts as opposed to demand
deposits~
Mr. SPRINKEL. Well, I have the same argument, that is, we have a
large multitude of varied reserve requirements now. And if you add
to that an additional one, it will make the matter of predictions that
much more difficult.
Now the Fed obviously doesn't believe that is important, because we
have had a tendency in recent years toward greater differentiation
in various kinds of marginal reserves. I think it makes it more difficult
to regulate and predict the money supply.
Mr. VENTO. Putting on two different requirements, you think, is a
mistake in terms of reserve requirements for transactions versus demand deposits~
Mr. SPRINKEL. Yes, sir.
Mr. VENTO. Mr. Morris, we had quite a discussion. Representative
Oakar ·asked a question regarding whaJt. the cost of the Federal Reserve's plan was. You raised the same question today in a very forceful manner.
The basis for the •argument thrut the Fed put forward is the plan will
attnwt new members and actually not cost anything. As you have observed, the plan provides banks with $5 million or less in deposits will
have no reserves held by the Fed. These new members will hold required reserves that they did not hold before. These required reserves
are viewed as a tax on commercial banks, both of you say, a tax equal
the income they would have earned if they were to invest this money
in income-earning securities such as Treasury bills.
Without going through the argument any further, let me say why
I think it is a wrong argument which obscures the fac't ithaJt. the Fed
is ,asking for authority to increase expenditures by hundreds of millions of dollars in perpetuity.
A bank joins the Federal Reserve and gives up its nonmember status,
agreeing to hold costly, sterile reserves only because its dter!Jax income will rise under tJhe Federal Reserve plan to pay interest on
reserves. The banks simply must earn more on its required reserves
than it was able to earn on these funds when it was a nonmember
bank or it will not change to membership status. The subsidy must be

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bigger than the :t,a,x, and this is true of every bank that enters the Fed
and of all the banks entering the Fed taken together. It must cost the
Fed more than it takes back in taxes for the Treasury or the banks
won't change to membership status.
Economists tell us that if you transfer real resources to member
banks, someone must pay.
Is it t'he Treasury which receives lower taxes i
I would like Mr. Morris to fully explain why he thinks the Fed proposals would be costless if enough new mem:bers join the Fed.
I would say that if you lose fax revenues on the net subsidy required
to aitt:mct one member, you don't increase total tax revenues with
higher volume.
Please begin, Mr. Morris, by telling me how a nonmember bank with
less than $5 million deposits, which would be exempt from reserve requirements under the Fed plan, would increase the Treasury's fax
revenues by changing the membership stia.tus i
I would also like Mr. Sprinkel to comment on this.
Mr. MORRIS. Obviously, that par'ticu1'ar bank would not, but the
problem that we have had with membership, particu1arly in New
England lately, and the thing tha.t disturbs me most is tlhe Fact that
we have had very large banks, banks from $100 million to $500 million
deposits, leaving the System.
I think under our proposal those large banks, particularly around
the $1 !billion mark, would still have some net burden of membership.
And there would be this half of 1 percent differential between ,tJhe
interest we paid out and the interest we have earned. So there would
be a nett g,ain financially to the Treasury.
In addition to that, if we don't do something, the Board has estimated that 4 years out our Treasury revenues will be from $80 million
to $200 million less than they are today, because of additional departures of memberships from the Fede,rial Reserve.
This business of lost membership is just getting started. Bankers
are very conser¥ative people. They like to do what they are expected
to do. They lrike to do what is in good form. In the past it has· been
considered good form for a bank of any size to be a member of the
Federal Reserve System. That concept is breaking down in New England where it is now considered perfectly good form for ia $500 million
bank to leave ithe System, and I th:ink that new mores among bankers
is going to spread around the country.
When this happens, the loss to the Treasury from nonmembership
is going to accelerate.
Mr. VENTO. Mr. Sprinkel i
Mr. SPRINKEL. Well, this is an empirical issue which I think we
really won't know until we try it. However, the direction of change
is in the correct one.
We know when a member bank drops out of the System, the reserves
in the System in the first instance remain the same but required reserves go down, which means there are excess reserves in the System,
and the Federal Reserve then has to liquidate some of its assets if it
wants to hold the same degree of monetary stringency.
Conversely, when they come in the opposite occurs. So that we know
at the beginning of this particular system there will be reduced earn-

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ings for the Treasury. There is no doubt about it. The question is will
other banks either not drop out that would have, or new ones that are
out come back in.
I suspect that I think Mr. Morris is right when he says that some
banks will stay in the System even if it does cost them net. There is a
certain prestige to being a member of the Federal Reserve System.
So, I don't think you have to get it down to zero cost to get a lot of
them to stay. As they come back in, this, of course, will add to the
holding of the Government securities by the Federal Reserve, and
their earnings will go up.
Whether the initial deficit will eventually be offset by some gain
later, I don't know.
Mr. VENTO. I am almost out of time. I have to run over to vote. I
don't want to hold you here beyond that. I have a number of other
questions I will submit in writing.
On this point, I am going to have to adjourn the meeting, and I will
submit additional questions in writing.
The chairman asked me to announce we are adjourning until 9 a.m.
Friday, August 4, and will continue the hearings on this topic.
The committee stands adjourned.
[Whereupon, at 1 :05 p.m. the committee adjourned, to reconvene at
9 a.m., Friday, August 4, 1978.J

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MONETARY CONTROL AND THE MEMBERSHIP
PROBLEM
FRIDAY, AUGUST~4, 1978

HousE OF REl'ru:SENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN .AFFAIRS,
W(l,8hington, D.O.
The committee met, pursuant to notice, at 9 a.m., in room 2128,
Rayburn House Office Building, Hon. Henry S. Reuss (chairman of
the committee) presiding.
Present: ReJ?resentatives Reuss, Moorhead, Gonzalez, Hanley,
Mitchell, AuCom, Derrick, Cavanaugh, Vento, Watkins, Stanton, McKinney, Hansen, Hyde, Kelly, Grassley, Fenwick, Leach, and Green.
Mr. MITCHELL. Today we continue our hearings on the efficiency of
monetary control and Federal Reserve membership.
We have before us three bills and an amendment to one of these
bills: H.R. 13476 and H.R. 13477, the Federal Reserve proposals
submitted by request; H.R. 12706, the Stanton bill, and an amendment to the Stanton bill.
Our witnesses today will be: the Honorable George LeMaistre,
Chairman of the Federal Deposit Insurance Corporation; Parke W.
Wicks, president and chief executive officer, First Trust & Deposit
Co. of Syracuse, N.Y.; Harry E. Leonard, bank commissioner, State
of Okl,ahoma, representing the Conference of State Supervisors and
accompanied by Dr. Lawrence E. Kreider, executive vice presidenteconomist of the conference; and John Perkins, president, Continental National Bank and president-elect of the American Bankers Association, accompanied by Lei£ Olsen, chief of the economic policy
committee of Citibank, New York, N.Y.
I have seveml brief announcements to make. The House is now in
session. The Congress does work. We started at 9 a.m. this morning. However we have obtained permission to continue the hearings
during the time the House is in session. We hope to finish up the
other 50-some amendments on the foreign aid hill today.
I yield briefly to my distinguished colleague, Mr. Hanley, for a
statement at this time.
Mr. HANLEY. Thank you very much, Mr. Chairman. We are delighted to have this distinguished panel before us. I am confident the
testimony they offer this morning is going to be of immeasurable
assistance to this committee as we deliberate this rather important
subject matter.
I would be less than candid i£ I didn't say I am especially delighted
to note at the table my dear friend and constituent, one who has long
heen associated with the commercial banking industry and one who

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many regard as a national expert on the subject matter, Parke W.
Wicks.
Mr. Wicks, it is ,g-oorl to see you here this morning. I am delighted
that you saw fit to respond to the invitation of the committee to appear. Having good knowledge of your background, I am confident
that what you say is going to be very meaningful. I am sure that will
apply to all of the other members of the panel also.
Just one final note. I am sorry to be ad vised that this will be Chairman LeMaistre's swan song. I extend to you my personal appreciation
for your many courtesies and certainly throughout your tenure your
contribution has been invaluable. The best to you as you proceed
through the future.
Thank you, Mr. Chairman.
Mr. MITCHELL. Mr. Hyde, you are the ranking minority member.
Do you have an opening statement i
Mr. HYDE. I have none. I associate myself with the remarks of yourself, Mr. Chairman, and with Mr. Hanley and I welcome the distinguished panel, particularly Mr. Perkins from my hometown.
Mr. MITCHELL. I thought we would proceed by ca.lling on Chairman
LeMaistre.
Chairman LEMA.ISTRE. I will summarize mv statement. I will ask
the entire statement be included in the record:
Mr. MITCHELL. Without objection.
STATEMENT OF HON. GEORGE A. LeMAISTRE, CHAIRMAN,
FEDERAL DEPOSIT INSURANCE CORPORATION
Chairman LEMAISTRE, I appreciate the opportunity to testify before
this committee and to present the FDIC's views on the Federal Reserve Membership Act of 1978 introduced by Mr. Stanton and the
amendment to this bill that has been proposed by Chairman Reuss.
During the course of this statement, I shall also discuss the FDIC's
views on the Federal Reserve Requirements Act of 1978 and the Interest on Reserves Act of 1978, both introduced at the request of the
Federal Reserve System, and the Monetary Policy Data Improvement
Act of 1978.
I should point out at the outset the Comptroller of the Currency,
John Heimann, a member of the FDIC Board, has not had an opportunity to review this statement. The other two members of the Board
have agreed on it, but Mr. Heimann has really not seen it.
For the most part, the proposals contained in these bills seem to
grow out of the Federal Reserve's concern with declining membership.
There has been a slow but steady erosion of Federal Reserve membership over the last 10 or 12 years and banks continue to choose to leave
the System.
Recently this gradual decline has acceleralted.
Let me begin by stating our view tha't the legal requirement that
the Federal Reserve member banks maintain sterile reserves is inequitable to them and inequitable to their customers.
In many States it places member banks 'a.t a competitive disadvantage, vis-a-vis nonmember banks, ·and the several bills which ra,re under
discussion propose two solutions. The first is to establish universal

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reserve requirements for all banks or depository inst1tutions ·and the
second is to pay interest on r~rves to reduce reserve requirements and
to charge banks for Federal Reserve services which are now provided
free to member banks.
We •strongly oppose the establishment of universal reserve requirements. The alternate proposal is attvacitive on its face and we think
deserves thoughtful and sympathetic consideration, but its implementation is not going rto be eiasy because a redressing of the imbalance
between member and nonmember banks does raise many difficult issues.
These include noitabJy rthe issue of changes in the Federal regulwtory
structure, particularly whether the Federal Reserve should continue
to exercise supervisory authority and the issue of regulatory reform,
pavticu1'arly whether interest rate ceilings and the prohibition of interest on demand deposits ought to be ·abolished.
I will attempt to explain how we reached these conclusions by discussing how these two proposals for dealing with the ,attrition of
Federal Reserve membership bear on seve11al important J;?Ublic policy
considerations: First, the capability of the Federal Reserve System to
conduct monetary policy effeotively i second, the bal·ance between State
and national banking systems; third, the efficiency and innovative
capacity of the banking system; •and fourth, the viability of t'he bankin,r system under liquidity pressures.
As to monetary policy effectiveness, according to the Federal Reserve System, the Federal Reserve Requirements Act, of 1978, H.R.
13476, is intended to provide the basis for more effective mone1bary control. Furthermore, the Fedeml Reserve has stated its belief that the
decline in. the proportion of deposits held by member banks caused by
membership attrition adversely affects the precision with which monetary policy can be conducted.
There have been a number of studies of the monetary oontrol issue
by economists outside the Federal Reserve and •all of those that I am
famili,ar with have concluded that increased Federal Reserve membership •and legal reserve requirements are not imporllant to the effectiveness of monetary policy.
The studies are cited in t!he prepared statement that I am filing, and
in the interest of time I won~ discuss those studies exoopt to say :tlhat
the evidence ·and the opiinions on this i·ssue are dist'inctly one-sided.
Knowing the tendency for eoonomists to disagree, I think unanimity
in this oose is impressive.
We might oonclude that legal reserve requirements ,and 'increased
membership are not necessa.ry to the conduct of monet:ary policy.
What the Federal Reserve does need to conduct monetary policy
effectively is information about monetary aggregates. We support the
proposals that make available to the Federal Reserve summary statistics on assets and liabilities of all depository institutions and reports
of deposits and required reserves. We do not believe, however, that
the adoption of the Monetary Policy Data Improvement Act of 1978
is really necessary. This proposal would require the FDIC to collect
data on deposit and cash items each week from a sample of 1,000 nonmember banks, including all those having deposits over $100 million,
and to transmit that information to the Federal Reserve.
Several years ago, the Federal Reserve became concerned about the

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adequacy of its data on the money supply and established a committee which recommended better and more frequent data on nonmember bank deposits.
Following that report, the FDIC instituted a special schedule in
the quarterly call report for all nonmember banks to provide the
Federal Reserve with better information on the money supply. This
collection was initiated with the spring 1976 call for report of
condition.
Also beginning the first week of July 1977, a sample of 580 nonmember banks has been reporting deposit and cash items on a regular
weekly basis, the same items as all nonmember banks report four
times a year.
The Federal Reserve has indicated that it expects the data from
these two surveys to enable significant improvement in their estimates
of the nonmember bank component of the Nation's money supply.
In summary, we believe the need of legal reserve requirements for
monetary control purposes is not supported by the weight of available evictence. The evidence to date suggests that monetary policy
effectiveness depends on adequate data, proper estimation procedures
and appropriate open market operations decisions, and not on reserve
requirement jurisdiction.
A second broad consideration is the potential impact of these proposals on the dual banking system.
We believe the dual system of State and national banks has been a
positive element in the American system of government and has contributed to a more innovative and responsive financial system.
Accordingly, maintaining a balance between the State and national
banking systems is a desirable public policy. Nonetheless, we should
not maintain a "balance" for the sake of balance. It is clear that Federal Reserve reserve requirements bear heavily on member banks and
result generally in such banks earrying more cash than they otherwisA
would. In direct competition with the nonmember bank, a member
bank might be disadvantaged.
One solution to the problem of equity that we believe should be
resisted is the proposal to improve universal reserve requirements on
the transactions balances of nonmember depository institutions.
If nonmember banks have to maintain reserves at the Federal Reserve just as member banks must do, but have no access or have limited
access to the discount window and other system benefits, why not
become members¥
The assumption is that obligatory universal reserves would not only
make nonmembership unattractive, but many institutions would also
be inclined to convert to a national charter. Indeed, even the payment
of interest on reserves and lowering of requirements might result in a
massive influx into the State member and national systems.
If this occurred, many State systems would lose their viability, and
the Federal Reserve's and the Comptroller's supervisory authority
would have grown substantially without the benefit of congressional
consideration.
·
My point is that the issue of Federal regulatory structure cannot be
isolated from this issue of balance. The better of the two proposalsthe payment of interest on reserves and lowering of reserve require-

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ments-avoids some serious shortcomings of the universal reserve requirement proposal, but it too may affect the State/Federal balance.
The Congress should not allow that issue to be resolved without conscious consideration.
The efficiency of the banking system is a third consideration.
Market pricmg encourages competition to improve the quality of
goods and services and to lower their cost. Presently pricing is absent
m at least three areas that bear directly or indirectly upon the legislation under consideration: First, the absence of interest payments on
the required reserves of member banks; second, the provision of services by the Federal Reserve to member banks; and third, the prohibition of interest payments on demand deposit balances and deposit
interest rate ceilings.
As a matter of principle, whether to pay interest on reserves should
not be an issue.
Presently failure to pay interest is tantamount to the imposition of
a tax without calling it that. However, structuring a procedure for
paying interest on reserves has raised difficult questions about the
appropriate interest rate, concerns about possible windfall gains to
large banks, and controversy over what percentage of the Federal
Reserve System's revenues should be available for mterest payments.
A much simpler approach would be to permit member banks to
invest their reserves in interest-bearing securities.
The Federal Reserve could determine what kinds of securities should
be eligible for this purpose based on considerations such as risk. This
approach would permit each bank to make its own choice and obviate
the necessity of having the Federal Reserve establish a rate. Presently
36 States allow State nonmember banks to hold at least part of their required reserves in the form of U.S. Government securities.
Explicitly, pricing Federal Reserve services should increase the
efficiency of our financial system by allowing various financial institutions to purchase the services they desire from the Federal Reserve or
private alternatives.
The Federal Reserve has stated its opposition to the Stanton bill
which it says would require the System to price each service on the
basis of costs and a return on capital.
This loss of flexibility would place the System at a significant competitive disadvantage. We are sympathetic to its concern about constraints on its flexibility in setting prices, but are not sure that the
Stanton bill would require full cost pricing of each service.
We would recommend that the matter of pricing guidelines receive
careful study prior to the enactment of legislation on the issue of
pricing to make sure that the Federal Reserve has pricing flexibility
without unfair adva.ntage.
Payment of interest on reserves of member banks potentially could
nlace nonmember banks at a disadvantage because the 40-year-old prohibition against the payment of interest on demand deposits does not
permit member banks to pay interest on correspondent ·balances.
These balances often serve as reserves for nonmember banks and
serve as well for check-clearing operations and compensation for other
correspondent services.
If the principle of explicit pricing is adopted for member banks

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then parallel treatment would dictate that banks should have the
choice of paying interest on correspondent balances and levying explicit charges for correspondent services.
However, if the interest prohibition is lifted for correspondent
deposits, it should be lifted for all demand deposits. I have long supported elimination of the prohibition of interest payments on all
transactions balances as well as removal of interest rate ceilings on
other kinds of deposits.
Finally, I would like to discuss some discount window issues.
The Federal Reserve believes that the ability of the financial system to handle liquidity "crunches" will weaken if membership attrition continues unabated. It should be understood that the decline in
Federal Reserve membership does not impair the ability of the System to cope with the kind of generalized liquidity crisis most of us
are concerned about, in which the public demands more cash than the
banking system holds. Aggressive open market operations and discount window accommodation to members can provide cash sufficient
to meet the public's demand.
The decline in membership does impair the ability of the System to
minister to a localized liquidity squeeze involving one or 'a few
institutions.
In the past the Federal Reserve has sometimes resorted to conduit
loans in such circumstances; that is, loans to a member bank which in
turn provides credit to a nonmember institution. We think that the
Federal Reserve should accommodate directly a solvent nonmember
bank in such special circumstances.
Indeed, we are concerned that membership attrition has contributed
to a narrow interpretation of its authority to lend to nonmember institutions in another regard. We believe that emergency borrowings
from the Federal Reserve discount window should be available to
member and nonmember banks alike upon certification by the FDIC
that they are in danger of failing and that such assistance is necessary
for a temporary period until a merger, a receivership sale or some
other orderly resolution of the bank's problems is arranged. The
FDIC, in turn, should be authorized to guamntee the repayment of
such borrowings out of the resources of the deposit insurance fund.
The legislative proposals "before the committee which address the
issue of attrition of Federal Reserve membership raise many of the
other difficult issues we have been facing for the past decade-Federal
supervisory structure and regulatory reform. The persistent surfacing of these issues is -a measure of the need to address them and resolve them. The job of the Congress in this respect is not easy. I hope
that my comments will prove to be help:£ul. Thank you.
[Chairman LeMaistre's prepared statement, on behalf of the Federal Deposit Insurance Corporation, follows:]

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Statement on

Federal Reserve Membership Act of 1978 (H. R. 12706),
and Related Legislative Matters

Presented to
COJIDllittee on Banking, Finance, and Urban Affairs
U.S. House of Representatives

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George A. LeMaistre, Chairman
Federal Deposit Insurance Corporation

276
Mr. Chairman, I appreciate the opportunity to testify before
this Committee and present the FDIC's views on the Federal Reserve
Membership Act of 1978 (B. R. 12706) introduced by Mr. atanton and
the amendment to this bill that has been proposed by Chairman Reuss.
During the course of this statement, I shall also discuss the FDIC's
views on the Federal Reserve Requirements Act of 1978 (H. R. 13476)
and the Interest on Reserves Act of 1978 (B. R. 13477), both introduced at the request of the Federal Reserve System, and the Monetary
Policy Data Improvement_Act of 1978 (H. R. 13549).
For the most part, the proposals contained in these bills grow
out of the Federal Reserve's concern with declining membership.
There has been a slow but steady erosion of Federal Reserve membership over the last decade as banks have chosen to leave the System.
Recently, this gradual decline accelerated.

Since the beginning of

1977, 108 banks have withdrawn from membership.

The percentage of

total deposits of commercial banks held by Federal Reserve members
has decreased from 83 percent in 1965 to nearly 73 percent at the
present time.
The Federal Reserve System has become increasingly concerned
about the attrition of membership and the declining proportion of
deposits held by member banks.
membership as a solution.

For many years it proposed mandatory

The proposal never received a serious

hearing in the Congress for various reasons, but primarily because
of the concern expressed by the States about the impact of mandatory
membership on the viability of State banking systems.

More recently,

the Federal Reserve modified its proposal to provide for mandatory
reserves and membership privileges for nonmembers.

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Last year, as the problem of membership attrition became more

acute, the System proposed payment of interest on required reserves
and reductions in the minimum statutory reserve requirement limitations.

Those proposals were coupled with the Consumer Financial

Services Act (S. 2055) which would have authorized depository institutions to offer NCW accounts.

In my testimony before Mr. St Germain's

Subcommittee on Financial Institutions Supervision, Regulation, and
Insurance last year, I stated that payment of interest on required
reserves and reduction of reserve requirements as proposed ins. 2055
would have important implications for the competitive balance between
member and nonmember banks, and for the structure of the banking
system.

I indicated that in my judgment these issues are quite

complex and are not related to permitting interest bearing NCW
accounts on a national basis.

Therefore, I recommended that these

issues be dealt with separately and be subjected to careful and
reasoned study.

These'hearings and those scheduled before the

Senate Banking Committee provide the opportunity for the thorough
consideration I think is essential.
Let me begin by stating our view that the legal requirement that
Federal Reserve member banks maintain sterile reserves is inequitable
to them and inequitable to their customers.

In many States, it also

places member banks at a competitive disadvantage vis-a-vis nonmember
banks.

The several bills under discussion propose two solutions:

the first is to
,~ establish universal reserve requirements for all banks
or depository institutions, the second is to pay interest on reserves,
to reduce reserve requirements, and to charge banks for Federal Reserve
services now provided free to member banks.

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✓

For reasons I shall discuss, we strongly oppose the establishment of universal reserve requirements,

The alternate proposal,

however, is attractive on its face and deserves thoughtful and
sympathetic consideration.

However, its implementation will not be

easy because a redressing of the imbalance between member and nonmember banks raises many of the difficult issues with which the
Congress has been wrestling, without resolution, for a number of
years.

These include, notably, the issue of changes in the Federal

regulatory structure, particularly whether the Federal Reserve
should continue to exercise supervisory authority1 and the issue of
regulatory reform, particularly whather interest rate ceilings and
the prohibition of interest on demand deposits should be abolished.
In the remainder of this statement I shall explain how we
reached these conclusions by discussing how these two proposals
for dealing with the attrition of Federal Reserve membership bear
on several important public policy considerations:

(1) the capability

of the Federal Reserve System to conduct monetary policy effectively,
(2) the balance between the State and national banking systems, (3)
the efficiency and innovative capacity of the banking system, and
(4) the viability of the banking system under liquidity pressures.

.Monetary Policy Effectiveness

According to the Federal Reserve System, the Federal Reserve
Requirements Act of 1978 (H. R. 13476) is intended to provide the
basis for more effective monetary control.

Furthermore, the Federal

Reserve has stated its belief that the decline in the proportion of
deposits held by member banks caused by membership attrition adversely
affects the precision with which monetary policy can be conducted.
The point is that as a larger portion of deposits becomes subject to

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diverse State reserve requirements the linkage between bank
reserves and the money supply becomes less predictable.
Of course, estimating the impact on the monetary aggregates of a
particular change in reserves becomes more difficult when different
banks are subject to different reserve requirements.

But this problem

would exist even if all banks were subject to universal reserve requirements or if all banks were member banks.

Under the present reserve

structure of the Federal Reserve, time deposits are subject to different
requirements than demand deposits and different size classes of member
banks are subject to varying reserve requirements.

Hence, a shift of

funds among member banks has precisely the same effect of blurring the
precision of monetary policy that disturbs the Federal Reserve when
nonmember banks are involved.

It should be noted that H. R. 13476

would not alter this appreciably, nor would the Reuss amendment which
would maintain the present system of varying the percentage of
deposits set aside as reserves based on bank size but which would also
remove the Federal Reserve's power to change reserve requirements.
There have been several studies of the monetary control issue
by economists outside the Federal Reserve.

All of those that I am

familiar with have concluded that increased Federal Reserve membership is not important to the effectiveness of monetary policy.
There have been two major statistical studies which attempted
to ascertain the impact of uniform reserve requirements for nonmember
banks on the implementation o:,_ monetary policy.

The first was

conducted by Clark warburton for the Commission on Money and Credit.
Warburton concluded that nonmember banks are affected by Federal
Reserve monetary policy actions in approximately the same way that
member banks are.

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Another investigation was reported by Dennis

280
,Starleaf of Iowa State University.
M

In Starleaf's study the actual

money multiplier for the period 1962-1972 was compared with a

money multiplier series simulated under the assumption that all
banks were subject to the reserve requirements of·the Federal
Reserve.

The simulation indicated that had nonmember banks been

subject to such reserve requirements there would have been even
greater variations in the money stock.

Starleaf thus rejected

the argument that uniform Federal Reserve reserve requirements
are necessary for the implementation of monetary policy.
There have also been a number of articles that attempted to
analyze the logical arguments and the statistical data that exist
·on this issue.

The Hunt Commission concluded that "reserve require-

ments are unnecessary for open market operations to control the
monetary base effectively.•

Carter Golembe, after discussing the

difficulties in conducting monetary policy with precision, concluded
that,
••• so many factors contribute to the lack of
precision and certainty that simply changing
the proportion of deposits subject to Federal
Reserve requirements from almost 80 percent
to nearly 100 percent would be of relatively
minor importance.
In a 1974 study, Professors Ross Robertson and Almarin Phillips
investigated the argument that nonmember banks behave in a differ-

ent manner from member banks and that such behavior thwarts implementation of Federal Reserve monetary policy.

They concluded that

these arguments have no validity:
This contention deluded those who are innocent
of money matters and even a few who should know
better. As has been observed, open market
operations are for all practical purposes the
instrument of monetary control. Like the rain
from heaven that falls on us all, regardless of

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our merits, open market operations affect member
and nonmember banks alike. There is not one
shred of evidence to the contrary.
A study conducted by Gary Gilbert and Manferd Peterson at the FDIC
found results similar to those of Robertson and Phillips.

They

concluded that,
••• the behavior of nonmember banks under varying
degrees of monetary ease or restraint is relatively
similar to that of country member banks. To the
extent that systematic behavior of the demand
deposits components is important for the effective
control of the money supply, there is no indication from available evidence that the nonmember
banking segment has hampered monetary policy.
Some economists have stressed the caveat that the Federal Reserve
could control monetary aggregates without member banks or without
reserve requirements.

For example, in a 1973 article Henry and Mable

*allich stated that,
Since intermediation [the function of gathering
funds from various entities and lending them to
others] is a constructive activity, there ,eems
to be no reason why Congress should place burdens
upon it beyond those that the tax system imposes
on any other form of business. The bulk of commercial banking has been exposed to a special
tax, in the form of reserve requirements. It
makes no essential difference that the revenues
from the tax reach the Treasury via the Federal
Reserve. There is no particular reason for this
tax, since the Federal Reserve can quite well
conduct monetary policy operations without
required reserves. The requirement could, then,
be phased out to give full effect to the benefits
of intermediation.
Most economists regard reserve requirements as secondary to open market
operations in conducting monetary policy.

~he Federal Reserve has made

minimal use of changes in reserve requirements in recent years, in
part owing to its fear of aggravating the membership attrition
problem.

Nonetheless, the limited use of this monetary tool has not

32•972 0 • 78 • 19

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had a noticeable impact on the ability of the Federal Reserve to
conduct monetary policy.
Furthermore, several studies have shown that open market
operations have a timely impact on all commercial bank reserves.
These studies indicate that the total impact is felt by banks in
some regions within the first 2 weeks following open market
operations.

In most cases, the impact of open market operations

on reserves is transmitted within 6 weeks.

Moreover, the length

of time for the impact of open market operations to be transmitted is not related to the region's distance from money market
centers.
What the Federal Reserve does need to conduct monetary policy
effectively is information about monetary aggregates.

The Reuss

amendment to H. R. 12706 would authorize the Federal Reserve, as
it deems necessary for the conduct of monetary policy, to obtain
from the appropriate Federal agency summary statistics on assets
and liabilities of all depository institutions.

H. R. 13476 would

require depository institutions to report their deposit liabilities
and required reserves directly to the Federal Reserve.

We support

making such information available to the Federal Reserve and have
no objection to the adoption of either proposal.

We do not believe,

however, that adoption of the Monetary Policy Data Improvement Act
·of 1978 (H. R. 13549) is necessary.

This proposal would require

the FDIC to collect data on deposit and cash items each week from
a sample of 1,000 nonmember banks, including all those having
deposits exceeding $100 million, and transmit that information to
the Federal Reserve.

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Several years ago, the Federal Reserve became concerned about
the adequacy of its data on the money supply and established a
committee chaired by Professor George L. Bach of Stanford University
to recommend changes in money supply statistics.

One of the maj~r

recommendations of the Bach Committee was that better and more frequent
data on nonmember bank deposits were desirable. Following that report,
~f«c.:,ol ,._,.~,.le:~ tt..t ..•~"•', ea// ••J'••,f 4,,. ,ol/
the FDIC instituted a .weeltl ¥ SJJnrev gf a sampl a M nonmember banks to
~

provide the Federal Reserve with better information on the money supply.
.,.&,. .. :.. ,., ".,._,..,.,c,.. • .,..,f,.J I- c.•-,,._lc. A .,_,.,._., ......... c. e+.tA.,,-.,,·"./a ..... f-1tc.
1 .,,, ~ <:r'ri'\'s'7co'it.c'tlo,f'w~s•tn•t~1iated with the spring 1976 Call for Report of

i"ac. lt.lt#M./(

Condition.
A second step, also recommended by the Bach Committee, went into
effect in the first week of July 1977.

A sample of 580 nonmember

banks is reporting deposit and cash items on a regular weekly basis,
the same items as all nonmember banks report four times a year.

The

Federal Reserve has indicated that it expects the data from these two
surveys to enable significant improvements in their estimates of the
nonmember bank component of the Nation's money supply.

The FDIC and

the Federal Reserve have agreed to review this program in mid-1979
to determine whether nonmember bank data are necessary for monetary
policy purposes and, if they are, whether the sample of nonmember
banks is adequate.

In the interest of improving the timeliness of

the survey data to the Federal Reserve, the FDIC intends to request
the 580 banks participating in the program to submit the data
directly to the Federal Reserve rather than through the FDIC regional
offices, which is the present procedure.
In summary, we believe the need of legal reserve requirements
for monetary control purposes is not supported by the weight of
available evidence.

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Federal Reserve Bank of St. Louis

The evidence to date suggests that monetary

284
policy effectiveness depends on adequate data, proper estimation
procedures and appropriate open market operations decisions, and
not on reserve requirement jurisdiction.
Bank Supervision and the Exercise of Monetary Policy
Representatives of the Federal Reserve System have also argued
that significant supervisory and regulatory responsibilities are
required for the effective conduct of monetary policy.

Chairman

Miller reiterated in his testimony before this Committee the Federal
Reserve's belief that its activities in the bank supervisory and
regulatory area "cannot be readily separated from its job of
conducting monetary policy.•

In the past, representatives of the

Federal Reserve have argued as well that an understanding of the
nuances of monetary policy and of developments in the economy·
facilitate bank supervision.
Three major arguments have been advanced by those who believe
bank supervision and regulation and the conduct of monetary policy
should be separated.

First, it has been argued that the Federal

Reserve's responsibility for bank supervision diverts attention
from monetary policy formation and that this diversion may reduce
its effectiveness in implementing monetary policy.

Former Federal

Reserve Governor James Robertson voiced this concern in stating:
As a practical matter, I believe it would be
seriously detrimental to place in the Board
the important additional responsibilities
that would accompany unification. There are
limits to a man's ability effectively to
perform his assigned duties. In our complex
society, merely keeping informed of what is
going on in the national economy is becoming
more and more difficult. Developing and
implementing appropriate monetary policy at
a given time require consideration and
evaluation of the significance of an enormous

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285
volume of available data and their interrelationships. The responsibilities are of such
magnitude that the Board should not be also
burdened with the performance of bank supervisory functions. Supervision is too
important a function in itself to be the
Federal Reserve's part-time job.
This argument has assumed greater importance today than when first
made by Governor Robertson because of the Federal Reserve's mushrooming responsibilities under the civil rights and consumer protection laws and because of the ever increasing burdens of holding
company supervision and regulation.
second, some observers find the existing concentration of power
within the Federal Reserve System disturbing, given the System's
insulation from the political process.

They would favor separation

of the supervisory and monetary policy functions.
Third, it is argued that when the implementation of monetary
policy goals and bank supervision are combined, the former will
inevitably take precedence leading to inconsistent and inequitable
bank supervision.

For example, it is argued that the monetary

authority would be loath to restrain the aggressive policies of a
group of overextended money center institutions when monetary
policy goals are aimed at credit expansion.

Conversely, it is

argued that the Federal Reserve might move to check bank holding
company expansion on safety and soundness grounds when its actual
reason ls to effect a restrictive monetary policy.

Events during

the period 1971-1975 are cited to support this proposition.

Many,

including former FDIC Chairman Frank Wille, believe this combination of supervision and the implementation of monetary policy goals
to be inappropriate, arguing that bank supervision and regulation
should be based upon an independent appraisal of the condition of

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286
the bank and not upon the monetary goals of the moment.

Former

FDIC Chairman Wille concisely stated the case as follows:
The basic problem, of course, is that where the
implementation of monetary policy goals is
combined with bank regulation and supervision,
the former will always be viewed as more
important than the latter and the temptation or
threat is ever present to use the powers of
regulation and supervision to reward banks for
their cooperation or to penalize banks for their
lack of cooperation with the Board's most recent
view of its monetary policy goals. Since those
goals change with some frequency, the likelihood
of a consistent, evenhanded approach to matters
of bank regulation and supervision over any
length of time is very much in doubt. Whereas
prior to 1970, this ·was a special concern only of
large State member banks which the Federal Reserve
System actually examined or of member banks forced
to the discount window, it is now the concern of
every bank in a holding company system.
We believe that the first and third of these arguments have
merit.

Yet, we think that the merits of the Federal Reserve's

contention that it is necessary for it to have supervisory and
regulatory responsibilities to conduct monetary policy effectively
deserve consideration.
The Federal Reserve has stated two reasons.

First, the Board

of Governors has contended that information gained directly from
examination and supervision of banks provides a useful input in
the formulation of monetary policy.

This argument implies that

supervisory responsibilities provide the Board with a tangible feel
for events in the banking system.

Former Governor Bolland argued in

testimony before this Committee that "examiner asset evaluations
supply firsthand knowledge of the changing quality of credit ••••
This provides valuable supplements to the meaning of the quantitative
statistics on monetary and credit aggregates.•

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~e do not disagree that information derived from bank examinations and supervision might be helpful to the Federal Reserve.
However, the Federal Reserve does not need to be engaged actively in
supervision to obtain such information.

It could be attained easily

through conversations with supervisory agencies or through participation on their boards.

Alternatively, the Board could be given

authority to collect information reflecting credit quality by means
that do not involve the full panoply of supervisory responsibilities.
Second, even if monetary policy benefits from information provided
firsthand through direct supervision, which cannot be obtained in
other ways, one still must consider whether the value of such
information outweighs the very substantial costs in terms of time and
resources that are consumed by supervisory and regulatory responsibilities.

Finally, many analysts question whether such information can

possibly be relevant given the lags between changes in credit quality
and the examination and between events in the economy and changes in
credit quality.
The second reason given for the Federal Reserve's retention of
supervisory and regulatory responsibilities is, in effect, that
supervisory and regulatory responsibilities and the conduct of
monetary policy are mutually reenforcing.

Again, testifying before

this Committee, then Governor Holland asserted:
Now more than ever, the Federal Reserve's
role as monetary policymaker and as lender
of last resort interacts with the effects
of prevailing bank supervisory and regulatory policies. Each of these policies
increasingly influences the effectiveness
of the other. To divorce them is to weaken
both.

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Governor Holland argued by way of example that if the bank supervisor
alters bank capital or liquidity standards •at an inopportune moment,
he can dilute or frustrate for a time the thrust of monetary policy.•
The difficulty with this position is obvious and it·is pointed
up in former Chairman Wille's arguments.

Sometimes objective super-

visory standards will and should run counter to the thrust of monetary
policy and will, therefore, dilute or tend to frustrate it.

This will

be the case whether or not supervisio~ is within or outside of the
Federal Reserve System.!!!!.!!!! the Federal Reserve is really arguing
that supervision and regulation ought to be used to facilitate the
implementation of monetary policy.

This, of course, would be objected

to by those who believe in consistent and equitable supervision and
regulation and by monetarists who would argue that the attempt to use
such a tool is wholly inappropriate and ultimately an ineffective way
to conduct monetary policy,
Thus far, we are not persuaded by the case put forward by the
Federal Reserve for the importance of bank supervision and regulation
to the effective conduct of mone~ary policy,

Furthermore, we believe

some benefits will be gained from the functional separation of supervision and monetary policy.

Therefore, it is our opinion that the

attrition of members from the Federal Reserve System and, hence, a
lessening of its supervisory and regulatory presence has not interfered with the effective conduct of monetary policy.
In summary, based on the available evidence and experience,
we tentatively conclude that neither control of reserve requirements in nonmember depository institutions nor supervisory jurisdiction is critical to the conduct of monetary policy.

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In fact,

289 ,
membership might not even be necessary for the Federal Reserve to
conduct monetary policy effectively,
11,

Dual Banking System

Historically, our Nation's banking system has developed within
the unique Federal character of our State and national governments.
Today this is manifested in the ability of both the States and the
Federal Government to charter banks and other kinds of depository
institutions.

The vitality of this dualism is maintained by permit-

ting banks to convert from one chartering authority to another.
~hile some may disagree, we believe the dual system of State
and national banks has been a positive element in the American
system of government and has contributed to a more innovative and
responsive financial system.

Accordingly, maintaining a balance

between the State and national banking systems is a desirable public
policy.

The attrition in Federal Reserve membership gives some pause

that this balance is more precarious now than it has been in the past.
However, despite the decline of Federal Reserve membership, member

banks still hold about three-quarters of domestic deposits.

Moreover,

the largest banks which depend on Federal Reserve clearing and money
transfer services represent a hard core of membership and deposits
not likely to leave the system.
Nonetheless, we should not maintain a "balance" for the sake of
balance.

It is clear that Federal Reserve reserve requirements bear

heavily on member banks and result generally in such banks carrying
more cash than they otherwise would.

In direct competition with the

nonmember bank, a member bank might be disadvantaged.

For example,

how can a member bank offer the same rate for a $100 time deposit as

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290
a competing nonmember if the member is able to invest less than
its competitor because the law requires it to hold more in cash?
Its deposit customers will tend to be offered lower rates, its
loan customers will tend to be charged higher rates, or its
shareholders will receive lower returns.
One solution to the problem of equity that we believe should be
resisted is the proposal in H. R. 13476 to impose universal reserve
requirements on the transactions balances of nonmember depository
institutions.

As we explained above, extension of universal reserve

requirements to nonmember institutions is not essential to conduct
monetary policy effectively.

While reserve requirements are primarily

responsible for the inequity of Federal Reserve membership, we believe
that equity can be achieved in other ways-~such as paying interest on
reserves, permitting reserves to be held in the form of marketable
securities, or reducing reserve requirements--without the necessity of
resorting to universal reserves for all institutions.
Universal reserve requirements are perceived as a threat to the
integrity of State banking systems.

If nonmember banks have to main-

tain reserves at the Federal Reserve just as member banks must do,
but have no access or have limited access to the discount window
and other System benefits, why not become members?

The assumption

is that obligatory universal reserves would not only make nonmembership unattractive, but many institutions would also be inclined to
convert to a national charter.

The result would be an imbalance in

the dual system in favor of membership and the national banking
system.
There is little evidence to substantiate the accuracy of such
a scenario.

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The fear may well be a false one.

However, the impact

291
of redressing the reserves imbalance on the dual banking system
cannot be predicted accurately.

It is conceivable that there

would be a massive influx into the State member and national systems.
If this occurred, many State systems would lose their viability, and
the Federal Reserve's and the Comptroller's supervisory authority
would have grown substantially without the benefit of Congressional
consideration.

My point is that the issue of Federal regulatory

structure cannot be isolated from this issue of balance.

The better

of the two proposals--the payment of interest on reserves and lowering of reserve requirements--avoids some serious shortcomings of the
universal reserve requirements proposal, but it holds the potential
of an inadvertant resolution of an issue which the Congress has
conscientiously debated for many years and which deserves conscious
choice for its resolution.
III.

Banking System Efficiency and Innovativeness

Market pricing of goods and services is vital to the efficient
allocation and use of those goods and services.

In the words of

Milton Friedman, pricing is highly desirable " ••• to prevent the
waste that arises from the absence of specific charges for them."
Generally, market pricing encourages competition to improve the
quality of goods and services and to lower their cost.

Presently,

pricing is absent in at least three areas that bear directly or
indirectly upon the legislation under consideration:

(l) the absence

of interest payment on the required reserves of member banks, (2) the
provision of services by the Federal Reserve to member banks, and
(3) the prohibition of interest payments on demand deposit balances
and deposit interest rate ceilings.

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I will address each in turn.

292
Interest on Reserves
As a matter of principle, whether to pay interest on reserves
should not be an issue.

Presently, failure to pay interest is

tantamount to the imposition of a tax without calling it that.

substantial amount of the revenue foregone by member banks is
passed on to the Treasury Department by the Federal Reserve.

Some

of the revenue is used by the System to offset the cost of providing
"free• services to member banks.

If it were the national policy to

tax banks, it would be preferable to levy the tax directly on all
banks and other depository institutions as well.

Then all would be

treated equally.
Concern has been raised about the adverse impact payment of
interest on reserves would have on Treasury revenues.

This concern

has lead to attempts to structure a procedure for paying interest
while minimizing the loss in Treasury revenues.

However, structur-

ing a procedure for paying interest bogs down in questions about the
appropriate interest rate, concerns about possible windfall gains to
to large banks, and controversy over what percentage of the ~ederal
Reserve System's revenues should be available for interest payments.
We submit that none of this is really necessary.

It imposes the

subjective judgment of men in dealing with the cost of membership
when the market system could probably do better.

Why not permit

member banks to invest their reserves in interest bearing securities?
The Federal Reserve could determine what kinds of securities should
be eligible for this purpose based on considerations such as risk.
This approach would permit each bank to make its own choice and
obviate the necessity of having the Federal Reserve establish a rate.
Presently, 36 States allow State nonmember banks to hold at least

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293
part of their required reserves in the form of U.S. Government
securities.

To our knowledge, such a change would not have any

significant impact on the effective conduct of monetary policy.
If either the loss of Treasury revenues or subsidization of small
banks were felt to be important problems, we would recommend that
the Congress address these problems directly through national tax
policy.
To the extent that our faith in the efficacy of the market
system might be misplaced, we are willing to endorse the provision
in Section 3 of B. R. 12706 (Stanton bill) that would require the
Board of Governors to prepare a study on permitting member banks to
invest their reserves in securities.
Pricing of Services
Explicitly pricing Federal Reserve services should increase the
efficiency of our financial system by allowing various financial
institutions to purchase the services they desire from the Federal
Reserve or private alternatives,
major services are:

Among the Federal Reserve System's

operation of the payments system, including check

processing and transportation and automated clearinghouse servicesi
pickup and delivery of coin and currencyi wire transfers, purchase,
sale, safekeeping and clearing securitiesi and operation of the
discount window.
The Federal Reserve has proposed pricing most of these services
except the discount window in a two-phase process.

In the first

phase, pricing of services would be limited to those connected with

the payments mechanism and access would be limited to member banks.
This would permit the Federal Reserve time to develop appropriate

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294
prices before bringing in all deposit·ory institutions.

Services

would be priced according to geographic region and whether the
activity in question is processed through a city bank, country bank,
regional check processing center, or interdistrict transfer.

Non-

member institutions would be permitted to deposit intraregional
checks and drafts through regional check processing centers.

In the

second phase, nonmembers could purchase virtually all services the
Federal Reserve has to offer, but would continue to clear checks and
drafts through reserve accounts of member banks.

Charges for services

would not be determined on the basis of membership.
The Stanton bill would require the Federal Reserve to price
each service explicitly, based on all the costs of providing the
service including overhead plus a return on capital.

The Federal

Reserve would be required to offer each service to every depository
institution at the same fee.
If interest were paid on member bank reserves, by whatever means,
pricing of Federal Reserve services would be essential to prevent discriminatory treatment of nonmember depository institutions.

Pricing of

services also is sound policy because it would enhance the efficiency
of the financial system.

This would provide a better opportunity for

the correspondent banking system to compete with the Federal Reserve.
Such competition, in turn, should encourage the Federal Reserve to
eliminate waste, to improve services and to offer new ones.
The Federal Reserve has stated its opposition to the Stanton
bill which would require the System to price each service on the
basis of costs and a return on capital.

Governor Coldwell pointed

out that private competitors would not be required to price services
separately as the Stanton bill would require of the System.

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This loss

295
of flexibility would place the System at a significant competitive
disadvantage.

It should be noted, however, that if the Federal

Reserve is not subject to pricing guidelines of some sort, it could
achieve the same advantage that the Stanton bill would provide to
private competitors.

Assuming that it. is good public policy to

maintain a significant presence for the Federal Reserve in the payments mechanism, we are sympathetic to its concern about constraints
on its flexibility in setting prices.

Therefore, we would recommend

that the matter of pricing guidelines receive careful study prior to
the enactment of legislation on the issue of pricing.

Some of the

reason~ for favoring such an intermediate approach and some of the
matters that need to be considered are discussed below.
The costs of producing the same service for a variety of
customers may differ in various areas of the country because labor
and capital costs are not equal.

Thus, it may be more efficient to

allow the Federal Reserve to charge different prices according to the
costs of providing services to different customers.

The cost of

providing a certain service to nonmember banks and nonbank depository
institutions could be below the cost of providing-the same service
only to member banks.
service were utilized.

This could result from the way in which a
For example, a credit union may not require

daily pickup and delivery of coins or currency, or a savings and
loan association might not complete security transactions as often
as a commercial bank.
To allow the Federal Reserve some flexibility in developing and
implementing a pricing system, the Federal Reserve could be permitted
to price services explicitly by broad service classes.

One price

schedule might be developed for payments services, another for

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296
securities services, and another for transportation.

Perhaps a cost-

plus pricing system could be developed for the services now provided
by the Federal Reserve, and the markup over the cost of providing the
service might be limited to a fixed percentage.
There seem to be economies of scale associated with at least some
services that the Federal Reserve now provides.

If these economies are

pervasive, the Federal Reserve will be able to offer the relevant service at a lower price than any private competitor.

There is nothing

undesirable about this, but the result should be determined by experience, not fiat.

It is not unlikely that the Federal Reserve has a

natural monopoly on some services because private competitors could not
attract sufficient volume to offer the same services at as low a price.
According to materials that former Federal Reserve Chairman Burns
submitted to Senator Proxmire on October 4, 1977, in recent years the
per unit costs of conventional ch~ck processing, return items, transfer
of funds, and automated clearinghouse activities have declined as
volumes increased.

If these trends continue, the private sec~or might

not be able to offer competing services at costs that are as low as
those incurred by the Federal Reserve.

On the other hand, the cash

services offered by the Federal Reserve do not seem to show declining
costs with increasing volumes.

In an electronic banking environment,

it is not clear that several payments systems can compete efficiently.
However, in this regard the private bank wire continues to compete
with the Federal Reserve wire, and networks of correspondent banks
provide payment services that are preferred by some member banks over
Federal Reserve payment services.

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Interest on Demand Deposits
Payment of interest on reserves of member banks potentially
could place nonmember banks at a disadvantage because the 40-year
old prohibition against the payment of interest on demand deposits
does not permit member banks to pay interest on correspondent
balances.

These balances often serve as reserves for nonmember banks

and serve as well for check clearing operations and compensation for
other correspondent services.

If the principle of explicit pricing

is adopted for member banks, then parallel treatment would dictate
that banks should have the choice of paying interest on correspondent
balances and levying explicit charges for correspondent services.
There can be little doubt that this would increase the efficiency
of the financial system.
As a matter of principle, if the interest prohibition is lifted
for correspondent deposits, it should be lifted for all demand deposits.
I have long supported elimination of the prohibition of interest payments on all transactions balances as well as removal of interest rate
ceilings on other kinds of deposits.

Economists have demonstrated

that there is no merit to the contention that competition for demand
deposits through the payment of interest led to bank failures during
the Depression as some contend.

They have also demonstrated, at least

to our satisfaction, that competition for deposits through the pricing
mechanism would result in a more efficient allocation of resources than
competition through indirect means involving the implicit payment of

interest by building more branches, keeping open longer hours, providing
free checking services, offering premiums and free travelers' checks, as

well as a variety of other services.

Such competition would lead to

substantial benefits for both financial institutions and bank customers.

32-972 0 • 78 • 20

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Under the present system of implicit interest payments on
checking accounts, depositors are denied the opportunity to
determine for themselves how they wish to spend their portion of
the income the bank earns on their deposits.

If interest were paid,

a depositor might choose to consume the same services that banks
now offer in the course of competing with other institutions for
accounts or a depositor might choose to forego such services and spend
interest income on different goods and services.

This is an important

benefit--consumers would decide how to spend their interest income,
not the banks.
Free- or below-actual-cost checking encourages inefficient use of
resources because depositors have little or no incentive to economize
on check writing, even though check clearance costs are substantial.
Direct charges for checks are likely to prompt depositors to write
fewer checks.
checks.

Such fees should cover a substantial cost of clearing

Management's adoption of pricing policies more nearly in

line with the costs of providing services to customers will enhance
a financial institution's capability of paying a c9mpetitive interest
rate on deposit balances without impairing earnings.
Payment of competitive interest rates will lower some operating
costs by reducing the need for customers to transfer funds from noninterest bearing checking accounts to savings accounts.

Thus depositors

will no longer find it necessary to maintain separate checking and
savings accounts.

Customers will not need to spend as much time and

effort in managing deposit balances, particularly when interest rates
are high.

Also, existing inequities, whereby some depositors pay less

than the cost of servicing their accounts will be eliminated.

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IV.

Banking System Viability and Liquidity Pressures

One of the important functions of the Federal Reserve System
is to serve as the Nation's lender of last resort.

Through the

vehicle of the discount window, the Federal Reserve is able to
provide liquidity when it is needed.

The discount window acts as

a safety valve by permitting the Federal Reserve to cushion the
impact of a tight monetary policy on individual institutions.
It can also assist member banks in meeting routine but unexpected
loan demand or deposit withdrawals, seasonal liquidity requirements,
and emergency liquidity needs.
expected to be to the market.

A member bank's first recourse is
If sufficient funds are not available

in the market, the Reserve Bank might provide accommodation, but it is
understood that it is temporary.

Each member bank must eliminate its

discount window borrowings within a reasonable period.

Reserve

Banks also require member banks to pledge collateral, typically of

high quality.
The Federal Reserve Act authorizes entities other than member
banks to use the discount window only under •unusual and exigent"
circumstances.

As a result, the Federal Reserve indicates, for

example, that no nonmember bank has borrowed from the discount
window since 1966.
While nonmember banks also face unexpected needs for liquidity,
they ordinarily cope with them with little difficulty by borrowing
from correspondent banks in much the same way that members do from
the Federal Reserve.

Indeed, even when· nonmember banks are in

trouble, it is generally possible for them to borrow from correspondents if they have sufficient and acceptable collateral.

To be

sure, the lending bank may also impose special conditions on the

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borrowing bank.

But in that regard, the Federal Reserve also behaves

like a careful creditor in accommodating a floundering bank.

It makes

sure such loans are well collaterized, that its interest in the collateral is perfected, and that the borrowing bank is solvent.

Thus, the

fact that nonmembers do not have window accommodation is not seriously
disadvantageous in most circumstances.
The Federal Reserve believes that the ability of the financial
system to handle liquidity •crunches• will weaken if membership
attrition continues unabated.

It should be understood that the

decline in Federal Reserve membership does not impair the ability of
the System to cope with the kind of generalized liquidity crisis most
of us are concerned about, in which the public demands more cash than
the ba.nking system holds.

Aggressive open market operations and

discount window accommodation to members can provide cash sufficient
to meet the public's demand.

The decline in membership does impair

the ability of the system to minister to a localized liquidity squeeze
involving one or a few institutions.

In the past, the Federal Reserve

has sometimes resorted to conduit loans in such circumstances--that is,
loans to a member bank which in turn provide credit to a nonmember
institution.

We think that the Federal Reserve should accommodate a

nonmember bank directly in such special circumstances.
Indeed, we are concerned that membership attrition has contributed
to a narrow interpretation of the words •unusual and exigent• by the
Federal Reserve.

If experience is a guide, these words appear to be

interpreted by the Board of Governors as requiring a national emergency
before a Reserve Bank would be authorized to lend to a nonmember institution.

The interpretation could be less restrictive, but at the

present time it does not appear that the Board of Governors is willing

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to interpret •unusual and Exigent• circumstance as extending to
situations that are unique to an inidividual nonmember institution.
The unwillingness of the Federal Reserve· to open the discount window
·to American Bank and Trust of Orangeburg, South Carolina, in
September 1974 led the FDIC to take the unusual step of providing
short-term liquidity directly to the bank under Section 13(c) of
the FDI Act.

This was the only time the FDIC ever took such action

for temporary liquidity purposes.*
Former FDIC Chairman Frank Wille in a letter to Mr. St Germain
in January 1975 stated:
I believe that the statutory provisions,
regulations and policies surrounding direct
Federal Reserve loans to nonmember banks
need to be reviewed and a procedure adopted
whereby the failure of a nonmember bank will
not be precipitated by a sudden and purely
temporary need for liquidity.
We share Chairman Willa's concern.

We believe that emergency

borrowings from the Federal Reserve discount window should be available to member and nonmember banks alike upon certification by the
PDIC that they are in danger of failing and that such assistance is
necessary for a temporary period until a merger, a receivership sale
or some other orderly resolution of the bank's problems is arranged.
The FDIC, in turn, should be authorized to guarantee the repayment
of such borrowingeoout of the resources of the deposit insurance
fund.

In connection with this authority, the FDIC should be required

by law to keep the Federal Reserve fully informed with up-to-date
information as to the financial condition of all banks certified to
borrow from the discount window under this provision.

*Two weeks later the bank was closed.

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Mr. MITCHELL. Thank you very much.
I think it would be best if we heard from the rest of the witnesses
so that we can question them all at the same time.
Thank you very much for your testimony.
Mr. Wicks.
STATEMENT OF PARKE W. WICKS, PRESIDENT AND CHIEF EXECUTIVE OFFICER, FIRST TRUST & DEPOSIT CO., SYRACUSE, N.Y.
Mr. WICKS. I appreciate the fine introduction I received from my
good friend, Congressman Hanley.
I am Parke W. Wicks, president and chief executive officer of First
Trust & Deposit Co. of Syracuse, N.Y. We welcome the opportunity
to meet with you and to share our views on the Federal Reserve
membership issue.
By way of background, First Trust & Deposit Co. is a $500-millionasset commercial bank serving a five-county central New York marketing area of approximately 1 million people. We operate a network
of 43 branch locations and 50 point-of-sale electronic fund transfer
terminals.
We are a subsidiary of First Commercial Banks, Inc., an upstate
New York holding company comprised of six commercial banks covering 23 counties, and with assets of $1.9 billion. I am pleased to be
serving, as well, as a director of this organization.
First Trust's local roots go back well over a century. Today we are
a strong community bank with more than 56 percent of our business
mix going into the consumer segment. Of our $80 million mortgage
portfolio, 99 percent goes to work right in New York State. This is
despite the fact that New York is the only State in the Union which
limits its return to 8.5 percent on residential mortgages.
This past January the board of directors of our bank voted to withdraw from the Federal Reserve System. This action was taken concurrently with two of our affiliate banks, Kingston Trust Co. and
Oystermen's Bank & Trust Co.
On Wednesday, August 2, we effected withdrawal. This was not an
easy decision. Our relationship with the Fed goes back to December 24,
1913, when we applied to join the newly formed Federal Reserve
System as a charter member. Over the years a most pleasant and
professional working relationship developed mutually.
But, during this 65-year period the overall banking climate has
changed. In recognition of these changes, we undertook a complete review of the potential benefits of withdrawal in 1973. While identifying the possible monetary advantages, we concluded that congressional action to correct the developing inequities of Fed membership
was imminent. Consequently, we decided to withhold action.
Here we are 5 years later and what has happened i
Continued inflation and high money rates make the opportunity
cost of Fed membership greater than ever.
There are other factors: The NOW experiment in New England;
third party payment powers by thrift institutions in New York and
other States; automatic transfer powers with resultant interest on
transaction accounts; the continuing question of interest parity and

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its impact on our market base; and the prospect of interest on Treasury
tax and loan deposits.
These all serve to deplete our profit markings at a time when bank
capital ratios are at their lowest levels since the depression.
In my capacity as a director of a bank holding company, capital
formation in today's marketplace has to be our prime concern. In
executing our responsibility to our shareholders and our depositors,
we must look not only to ways to increase the profits of the bank and
therefore improve our rate of internal capital generation, but also
to make our stock more attractive to the investor. In this way we can
continue to be innovative in our products and to meet the needs of the
communities we serve.
Withdrawal from the Fed offers us the opportunity to do just this.
As an illustration, I will use our 1977 average balance sheet figures.
During the year we had an average of $396 million in deposits.
Against this total we were required to maintain $23 million in sterile
reserve assets which includes cash on hand and balances with Fed. This
is approximately 6 percent of our deposits.
Because of the difference in reserve requirements, and by definition
those assets which qualify as reserve for a State nonmember bank, we
are able to free-up for our use approximately $11 million. This is in
line with a study published by the Federal Reserve Bank of St. Louis
in March 1978, entitled "Federal Reserve Requirements and Their Enforcement: A Comparison Across States."
In reference to the services hitherto performed by the Fed, we are
able to obtain these services from our correspondent banks for approximately $1.5 million compensating balances, which perform double duty
as part of our reserve base. This includes substantial lines of credit to
replace lost Fed window borrowing privileges. At current money market rates, we are estimating the net after-tax impact upon First Trust
at $380,000 on an annual basis. This equates to a 10-percent increase in
our return on assets.

In your deliberations, I request you give serious consideration to the
cost to member banks of the sterile balances maintained at the Fed,
and its detrimental effect on both the Fed membership question and
banking practices in general.
I believe Congress should also consider the issue of reserve inequities,
especially as they exist between the commercial banks and thrift institutions which have the advantages of third party payment accounts
combined with the interest differential. I am convinced that unless
these inequities are resolved, the attention in Fed membership will continue at an accelerated rate.
IDtimately any solution must incorporate, in my opinion, a reasonable rate of return on reserves based on prevailing market conditions,
an equitable distribution of reserve requirements and a competitive fee
structure for services performed. I firmly believe that, to be effective,
any legislation must look beyond the short-term impact on the
Treasury.
Mr. MI'1.1cHELL. We thank you for your presentation and for accommodating the committee by being here this morning.
Mr. Leonard?

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STATEMENT OF HARRY E. LEONARD, BANK COMMISSIONER, STATE
OF OKLAHOMA, PRESIDENT-ELECT, CONFERENCE OF STATE BANK
SUPERVISORS, ON BEHALF OF THE CONFERENCE; ACCOMPANIED
BY DR. LAWRENCE E. KREIDER, EXECUTIVE VICE PRESIDENTECONOMIST, CONFERENCE OF STATE BANK SUPERVISORS

Mr. LEoNARD. Mr. Chairman, my name is Harry E. Leonard. I am
bank commissioner for the State of Oklahoma and president-elect of
the Conference of State Bank Supervisors-CSBS-on whose behalf
I am testifying today.
With me is Dr. Lawrence E. Kreider, executive vice presidenteconomist of the conference.
CSBS is the nationwide organization of State officials who constitute the primary chartering, examination and regulatory source of
10,550 State-chartered commercial plus mutual savings banks with
total assets of $670 billion.
CSBS is particularly appreciative of the opportunity to testify on
H.R. 12706, the "Federal Reserve Membership Act of 1978" and
related proposals.
1 The House Committee on Banking, Finance and Urban Affairs is
to be commended for its approach to the request for these hearings.
Your insights, Mr. Chairman, on the tools the Fed needs-and doesn't
need-to discharge its monetary policy responsibilities are most
rncouraging to observe. The conference agrees with a number of comments expressed by the chairman and reported in the Congressional
Record of Friday, July 14, 1978, particularly with reference to the
Fed· not needing universal reserve-setting authority for its monetary
policy role.
The conference wishes to emphasize that our comments today are
intended to be supportive of what appears to be the committee's basic
goals in these hearings. We do, however, wish to offer for your consideration some concepts which might be developed as alternative approaches toward objectives we share in common.
Our emphasis will be on H.R. 12706, as amended, since the chairman
has recommended that it be the primary legislative vehicle at these
hearings and since it has a more meritorious foundation than related
proposals under consideration.
First, however, it should be recognized by all-as the chairman of
this committee implied in statements on the floor of the House-that
the so-called "Federal Reserve membership problem" is of a somewhat
different nature than some have claimed.
To our knowledge, for example, it has not been demonstrated that
the decline in Fed membership was a significant causal factor in faulty
monetary policies during much of the period from 1965 to 1975.
Indeed, there is a widely held contrary belief by monetary observers
from outside the Federal Reserve System and by some from within.
Declining Federal Reserve membership, if it is a problem, is primarily of a practical political constituency nature. It goes to the question of how much unbridled power an independent public agency
should have.
Further, to the extent it reflects ineQuitable treatment of some
member banks, the Fed unilaterally or with readily acceptable statu
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tory changes could have largely or entirely solved the problem long
ago.
.
.
.
On the other side of the issue, it has been observed that withdrawals
to date from the Fed have strengthened the ability of the priy~te
correspondent banking system to serve the thousands of commumties
of our Nation.
Second, if it is feared that further withdrawals might at some future
date create monetary problems-even though such fears are not justified by available evidence-it must be recognized that there is a floor
below which membership will not fall. That floor is established by
the fact that the majority of member bank assets are now in banks
that enjoy net benefits from membership. As you know, membership
normally is one requisite to a dynamic correspondent banking operation by individual banks.
A summary of related data illustrates this point. At the beginning
of this year, 74 percent of all insured commercial bank deposits were
in member banks. Approximately two-thirds of these deposits were in
banks with $5 million or more of correspondent "due to" balances, and
a large proportion of the banks holding significant amounts of correspondent deposit liabilities will remain as a Fed membership base.
There is a strong relationship between Fed membership and correspondent banking services as evidenced by the fact that 95 percent
of the aggregate deposits of correspondent-type banks are in members
banks as compared with the figure of 74 percent noted earlier for all
insured commercial banks, including noncorrespondent types.
Further, observations of banks which have withdrawn from the
Fed reveal that very few of them are heavily involved in correspondent
banking. Those that are heavily involved tend to stay in the System.
In addition to this strong correspondent bank Fed membership
base, numerous other banks will remain as members for a variety of
reasons. The chairman of this committee appropriately recognized
this strong base of continuing membership when he referred on the
floor of the House on July 14 to "the many banks which have no intention of leaving the Federal Reserve System."
Further, each withdrawal makes it more attractive for remaining
member banks to stay with the Fed because each withdrawal tends to
transfer balances from the Fed to private correspondent banks. This
increases the total "pie" of correspondent balances for which correspondent bankers who are members of the Fed can then compete.
Thus, if some level of membership is significant from monetary
policy or public interest standpoints, and we doubt that it is, there is
a floor which will assure that a majority of commP-rcial hank deposits
remain in "Fed constituent" banks.
Third, inequities which may now exist between member/nonmember
bank groups and between members could largely be eliminated by
r~latively moderate adjustments in Fed reserve requirements. A reduction of 1 percentage point, for example, in reserve requirements for
certain member banks would largely solve the equitable treatment
problem. I will comment in more detail on that noint later.
In view of the facts that declining Fed membership has not contributed significantly to monetary policy imperfections, a floor limiting

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withdrawals exists, and any inequities between banks that may be attributable to Fed reserve requirements largely could be eliminated by
relatively moderate adjustments in reserve requirements, the conference believes that the much publicized Fed membership problem is of a
different nature and less serious from the monetary policy and public
interest standpoints than claimed by some Fed officials.
I£, however, the committee is of the judgment that action must be
taken for Fed "constituency" or whatever reasons, to limit withdrawals
from the Fed, the conference respectfully suggests a congressional program which would have the following benefits: Minimize the net impact on the Federal budget; encourage most member hanks to remain
in the Fed; reduce the reserve burden on all member banks; permit
the private correspondent banking system to compete more effectively
for correspondent business; cause a minimum of disruption of desirable interbank relationships and bank services; achieve more equitable
treatment between correspondent and noncorrespondent types of
banks; and be relatively simple to implement and be effective.
These goals can be accomplished by one or more of the following
alternatives:
First, consistent with a basic concept introduced in H.R. 12706 as
amended, set reserves on the first $10 million of the total amount of
demand deposits and transaction accounts of any member bank at a
:reduced level of 4 percent. All member banks would get some relief.
Smaller member banks, however, would get proportionately more relief from reserve burdens than would larger banks.
This alternative would impose a smaller net burden on the Federal
budget than H.R. 12706, as amended, and far less than the burden
which would be imposed by Fed proposals, yet it would achieve goals
sought by H.R. 12706, as amended.
Further, this proposal would reduce the possibility of a "reserve
war" between the States and the Fed which might ensue if reserves
were removed completely on the first $10 million of member bank
deposits.
Second, reduce reserve requirements by 1 or 2 percentage points
below present schedules for member banks not heavily involved in
correspondent banking. The criterion for "heavily involved" could be
set using a ratio of correspondent balance liabilities to total deposits.
A ratio of 0.02 to 0.03 would be a reasonable division between "heavily
involved" and "not heavily involved."
As a specific example, a member bank with net demand deposits of
$8 million, time deposits of $8 million, total deposits of $16 million,
and correspondent demand balance liabilities less than $320,000,
would have reserves reduced by 1 percentage point on each of its deposit categories or by 2 percentage points on demand deposits. A
gradual reserve requirement transition between the two ratios of 0.02
to 0.03 could be established.
This proposal would free less reserves than the first alternative
above, H.R. 12706, as amended, and Fed proposals; would therefore
minimize the drain on the Federal budget and wonld reduce the reserve burden most selectively and accurately for those member banks
which may presently be tempted to withdraw from the Fed. This
proposal most closely represents a "rifleshot'' solution to the prob-

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lem. It suffers, however, from the fact that it would inject into the
reserve determination process a criterion other than deposits and
would also add arithmetic complications to the reserve schedule.
Third, set reserves on all member bank net demand deposits at 1
percentage point below the present schedule. This would free approximately $1.8 billion of reserves. It would, however, reduce reserves
for banks not likely to withdraw just as it would those seriously considering withdrawal.
From an ideal conceptual standpoint, the second alternative above
is advantageous. It would go sharply to the problem. From a practical
standpoint, however, the first alternative may be preferred since it
would be less complicated, yet would largely achieve goals stated by
the chairman of this committee, and achieve benefits listed above.
The third alternative has the advantage of simplicity. It has serious
disadvantages, however, in that it would be more oostly to the Federal
budget and would tend to create inequita:ble treatment between classes
of member banks and between member and nonmember banks.
The conference would like to recommend that the committtee give
serious consideration to alternative No. 1 above, which is a modification of H.R. 12706 as amended.
These proposals do not include compulsory affiliation of nonmember
banks or other depository institutions with the Fed for reserve purposes. The conference wishes to support the Chairman's statements on
the floor of the House on July 14 to the effect that universal reserve
requirements are not necessary for improved monetary control, would
unnecessarily impose burdens on certain banks ,and would extend the
regulatory jurisdiction of the Fed beyond present limits thus upsetting
the long-established regulatory jurisdictions of State banking departments and others.
CSBS has testified on previous occasions in support of continued
optional affiliation with the Fed for reserve purposes, has documented
this support with an in-depth study entitled "Optional Affiliation
with the Federal Reserve System for Reserve Purposes Is Consistent
With Effective Monetary Policies," and knows of no showing by the
Fed to document its contention that compulsory affiliation is necessary
for effective monetary policy.
The proposal for compulsory affiliation for reserve purposes is with~
out redeeming merit from a national interest standpoint. Congress very
wisely has consistently rejected such a proposal, and it should forever
be discarded.
Further, the proposals outlined above by CSBS do not explicitly
include the collection of additional data which may be needed for the
conduct of monetary policy. CSBS, however, favors the ready availability to the Fed of statistical or other data for monetary policy purposes whenever there is a demonstrated need, and it has cooperated
with the Fed and others whenever a need has been shown to exist.
E-ach request for data. however. should stand the test of cost/
benefit analysis. The Fed should not have the unrestrained right to any
and all data it might reauest, or in the form it might request it. Experience suggests that such authority could likely violate cost/benefit
nrinciples. CSBS agrees with the Chafrman's reported view that such
data should be collected through established sources, including the

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FDIC and State banking departments for State-chartered nonmember
banks.
CSBS at this time is not prepared to comment officially on the issue
of pegging the discount rate to a money market rate; nor on the complex question of payment of interest on reserves up to an aggregate
amount received by the Fed from explicit charges for services; or on
the question of who should set reserve requirements.
These are certainly valid questions for this committee to raise. As
the specifics of these proposals and their impact on CSBS goals of
strong State banking departments and effective State/Federal checks
and balances become more clear, we would ask if we might be permitted to submit a supplementary statement to the committee.
Mr. Chairman, thank you for the opportunity to testify on important issues which are being pursued in depth by your committee.
Mr. MITCHELL. We thank you for your very provocative testimony.
Certainly we would welcome the submission of a supplementary
statement.
Mr. LEONARD. Thank you.
Mr. MITCHELL. Mr. Perkins i
STATEMENT OF JOHN H. PERKINS, PRESIDENT, CONTINENTAL
' ILLINOIS NATIONAL BANK & TRUST CO., CHICAGO, ILL., PRESIDENT-ELECT, AMERICAN BANKERS ASSOCIATION, ON BEHALF
OF THE ASSOCIATION; ACCOMPANIED BY LEIF OLSEN, CHIEF,
ECONOMIC POLICY COMMITTEE OF CITIBANK, NEW YORK, N.Y.,
AND CHAIRMAN, ECONOMIC ADVISORY COMMITTEE, AMERICAN
BANKERS ASSOCIATION

Mr. PERKINS. Mr. Chairman and members of the committee, I am
John H. Perkins, president of the Continental Illinois National Bank
~ Trust Co. of Chicago, Ill.
I would like to ask that my prepared statement be incorporated in
the record at this time and I will summarize it.
Mr. MITCHELL. Without objection, that will be done.
Mr. PERKINS. I am also president-elect of the American Bankers
Association, a trade association whose membership includes more than
92 percent of the Nation's 14,383 full-service banks.
Accompanying me is Leif Olsen, chairman of the economic policy
committee, Citibank, New York, N. Y., and chairman of the economic
advisory committee of our association.
We are delighted to be here today to testify on the important proposals before your committee. There are few absolute certainties in any
of the arguments pro and con to the proposals for change. All of us
are having to speculate about living in a Federal Reserve operating
environment none have experienced.
The first question for consideration should not be, how do we maintain a relatively high level of membership in the Federal Reserve
System i Rather, more fundamental objectives should be clearly stated.
Our association believes these objectives are paramount: to assure the
continued independence and effectiveness of our central bank in its
mana.gement of monetary policy; to enhance the efficiency of the payments system; and to eliminate arbitrary forms of discrimination

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against particular types of financial institutions which inhibit the
delivery of banking services at least possible cost.
The proposals before you, H.R. 13476, the Reserve Requirements Act
of 1978, and H.R. 13477, the Interest on Reserves Act of 1978, and
H.R. 12706, the Federal Reserve Membership Act of 1978, are constructive attempts to deal with the first two concerns, although we
do· have some specific disagreements with them. Our third concern is
barely addressed in the proposals. There appears, in fact, to be an
attempt to justify discrimination against medium-sized and larger
banks on the grounds that they are not leaving the Federal Reserve as
frequently as smaller banks and hence do not deserve the same level of
relief from the excessive burdens of membership. There also appears to
be a belief that such discrimination will mitigate Treasury revenue
losses. The first notion is simply unfair and, as we shall discuss below,
the second is probably incorrect.
In discussing legislative and regulatory proposals, the p<>licymaking
bodies of the American Bankers Association attempt to discipline their
thinking by asking four questions: How do bank customers benefit
from the proposal~ Will the proposal enhance the broad competitive
environment~ Is the proposal consistent with national economic and
social priorities~ Does the proposal achieve or maintain equal com~
petitive ground rules among various types of competing financial insti:.
tutions, and does it provide opportunity for competitive financial insti7
··
tutions to maintain viability and profitability regardless of size i
An attachment to ,this testimony analyzes the proposals before you in
terms of these criteria.
We have been involved in research and discussion of the issues raised
in these legislative proposals for some time. Attached to our testimony
are other documents which might prove useful to the committee and we
request that they be made a part of the record of these hearings.
First : ABA testimony before the Subcommittee on Financial Insti~
tutions of the Senate Committee on Banking, Housing and Urban
Affairs, on .June 21, 1977. This testimony discusses NOW accounts, the
Federal Reserve's membership problem, and S. 1668, our association's
legislative proposal to deal with these issues.
Second: ABA testimony before the Senate Committee on Banking,
Housing and Urban Affairs, on October 11, 1977, on the role of the
Federal Reserve in providing payments services.
Third: A letter from ABA to Senator Richard Lugar dated Novem•
her 4, 1977, discussing the extent to which required reserves might be
reduced for Federal Reserve member banks without impairing the
effectiveness of monetary policy.
Fourth: An outline of a research project the ABA will undertake to
determine the impact of pricing of Federal Reserve services and relief
of the Federal Reserve's membership problem on the structure of the
banking industry. This outline was part of a request for proposals that
was sent to various consulting firms. We are currently in the process of
evaluating their proposals and hope to begin the project soon.
THE CENTRAL BANK AND ITS MANAGEMENT OF MONETARY POLICY

The need for mandatory universal reserve requirements oil transaction accounts held by all depository institutions in order to assure an

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effective monetary policy has not been demonstrated. We oppose this
proposal as unjustified and likely to harm our Nation's innovative system of dual banking.
The Fed has sponsored this proposal as a means of increasing the
effectiveness of its monetary management. Nevertheless, it should be
noted that the Federal Reserve does not have universal support for its
view that reserve requirements are a necessary tool for monetary policy. It is our view that reserve requirements for existing Fed member
banks could be significantly lowered, and the membership burden concomitantly relieved, without any significant diminution of the Fed's
ability to conduct monetary policy. To achieve this within a framework
in which the Fed retains maximum flexibility to use reserve requirements for monetary policy purposes, we propose that existing statutory
minimum reserve requirements be eliminated. Our views on this point
are amplified in the attached letter to Senator Lugar.
It is true that the percentage of transaction accounts subject to reserve requirements of the Federal Reserve is declining. The decline o:f
Federal Reserve membership is only one factor accounting for this.
Another is the increasing proportion of transaction accounts that are
held outside the banking industry. Differing levels of reserve requirements among member and nonmember institutions can cause additional
instability in the money supply as deposit shares of these different categories of institutions change and money flows among them. But economists in the banking industry believe that a much greater source o:f
insta;bility is the graduated levels of reserve requirements among banks
who are already members of the Fed. Elimination of these differences
would be a significantly greater contribution to monetary stabilityand an act of simple fairness to the institutions involved.
We disagree with the proposal that would legislate inflexible reserve requirements because this would tie the hands of the Fed in
its ability to use changes in reserve requirements as a tool of monetary
policy. We believe, however, that existing reserve requirements levels
can be reduced, and favor giving the Fed the ability to do so to the
extent that it prudently can. An appropriate move for the Congress
would be to set the minimum of the statutory ranges at zero, rather
than setting the exact levels by legislative action.
As already stated, we believe that probably the reduction in reserve
requirements should be the preferred method used to alleviate the
current membership burden. However, if it is administered fairly,
we do support proposals calling for the payment of interest on rei::erves. Indeed, the two methods can be considered complementary to
each other.
Limiting the payment of interest on reserves to revenues received
from the pricing of services as specified in the proposed amendment
to H.R. 12706, would. however, aggravate rather than alleviate, the
Fed's membership problem. This would occur because H.R. 12706 also
provides for equal access for all institutions to Fed services. As Chairman Miller has already testified in these hearings, the revenue received
from the pricing of .services would be insufficient to effectively eliminate the membership burden. Hence, since access is available to everyone, the membership drain would be accelerated. The Fed could try
to combat this by raising its prices in hopes of increasing the revenue

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it has available to pay interest. But if its customers were price sensitive and looked for other providers of payments services, this probably
would not work.
The gathering of additional ·information from nonmember institutions provided the data are needed for monetary policy purposes and
the data gathering is done in a way that minimizes the reporting
burden placed on those institutions has our support.
We do not support tying the level of the discount rate to the Treasury bill rate because this would also tie the hands of the- Federal
Reserve in the use of this tool for monetary policy purposes. Changes
in the discount rate are widely understood in financial markets both
at home and abroad. They can be used to lead market interest rates
down at the start of •a recession. The use of a signal by raising the
rate during a recent period of disorderly foreign exchange markets
was a key in limiting serious market problems. We understand the
concern supporters of this provision have over "arbitrage profits."
Indeed, it is quite natural for bankers to pay attention to interest mte
spreads between the funds they receive and the funds they lend. This
is the heart of their business. Nevertheless, in addition to power to
set the discount rate, the Fed has administrative controls on the use
of the discount window which we believe are sufficient and appropriate. Also, the total earnings of the Federal Reserve from the use of the
discount window are only $40 million. We believe the bulk of this
represents earnings on legitimate loans. The earnings of the banking
industry are approximately $8.9 billion and those of the Federal Reserve .System are approaching $6 billion. Surely any unnecessary
'~arbitrage" profits are very small relative to the earnings of the banks
ing industry and the Fed. It seems more prudent to let the Fed retain
flexibility in the use of this tool.
While we do not agree with all of the specifics of the various proposals to solve the Fed's membership problem, we continue to believe
that, for the foreseeable future, a strong membership base will be
very important to the conduct of monetary policy. The problem is
urgent and attention should be paid to it as soon 1as possible. We are
acutely aware that the cost of Federal Reserve membership is an important item on the current agenda of bank board meetings all across
the country. As Chairman Miller pointed out in testimony before this
committee in these hearings, and as Secretary Blumenthal pointed
out in hearings last year on S. 1664 and S. 1668 which dealt with the
membership problem, the longer the problem continues, the more
banks will withdraw from the System and Treasury revenues from
th3;t source will decline anyway. Limiting the options available to
relieve the membership burden because of concern over current Treasury revenues could be penny-wise and pound-foolish. By the Fedeml
Reserve's own estimate, withdrawals from the Fed since 1970 reduced
Federal Reserve payments to the Treasury in 1977 by nearly $200 million from what they otherwise would have been. The problem is long
run. It is structural. It is continuing, and it should be solved.
1

ENHANCEMENT OF THE EFFICIENCY OF THE PAYMENTS SYSTEM

We believe the efficiency of the payments system would be greatly
enhanced if the Federal Reserve charged for its services. However,

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we must note that we foresee several difficulties in pricing of existing
Federal Reserve services and the provision of new ones. The problem
of determining proper cost allocations is difficult enough for private
firms. If the Fed decides to take into account its own costs in setting
its prices, as it most certainly should, the situation is substantially
more difficult. How does one allocate overhead costs among such diverse activities as the administration of monetary policy through open
market operations, the provision of services as fiscal agent for the
Federal Government, the supervision of State-chartered member
banks, the regulation of bank holding company activities, and the
provision of payments services which also can be provided by private
banks~ Even if ,all the relevant data were known, we can think of no
way to do this on a rational basis. Indeed, as new payments systems
evolve, it becomes more and more difficult to even know the relevant
data.
The provision of payments services is the main banking area in
which the Fed competes directly with the private banking system.
Yet with 12 regional banks, each having several branches which serve
primarily as operations centers, the Fed already has a nationwide system of operations centers in place. There is no way a single bank can
match this capability under the current banking structure. This makes
accuriate comparisons of the public and private clearing systems more
tenuous.
The proposal to limit payment of interest on reserves to revenue
received from pricing would diminish rather than enhance the efficiency of the payments system. We have already discussed why it
:would accelerate the membership drain. This accelerated loss of membership might cause the Fed to become more aggressive in providing
hew services in an attempt to raise pricing revenue so as to be able to
alleviate more of the membership burden. If it believed its customers
were price-elastic it could, to the extent Congress and its auditors
permit it, undercut the private sector in an attempt to raise its revenues
~n order to pay more interest on reserves and achieve a greater alleviation of its membershif burden. Neither of these responses would enhance the efficiency o the payments system, and it is not clear that
either of them could ever enable the Fed to achieve an effective elimination of its membership burden.
We are somewhat dismayed by the Federal Reserve's comment that
if universal reserve requirements were enacted the Board would have
to reevaluate tts :progra~ to reduce ~he cost burden of required reserves and price its services. We believe the Fed should reduce the
cost burden of reserves and price its services regardless of the structure of reserve requirements among depository institutions. Such a
program, if properly constructed, would greatly enhance the efficiency
of the payments system without significantly diminishing its ability
to conduct monetary policy.
It is our strong belief that an efficient payments system will be maintained only if tliere is a strong, healthy, private-sector alternative to
payments services provided by the Fed. To insure this, we would propose two rules to which the Federal Reserve should be bound in setting
its prices: First, Fed prices should not be less than fully allocated
costs, including allowances for overhead, cost of capital and taxes.

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The cost of float is an important part of these costs; and second, Fed
prices should not be less than what the private sector would charge for
similar services.
Although these standards would be difficult to enforce, they are not
mutually exclusive, and both should be used in the evaluatio~ of Fed
prices. If this is done in a fair and impartial manner, the efficiency o:C
the payments system will be greatly enhanced. Our testimon_y before
the Senate Banking Committee on October 11, 1977, which follows my
prepared statement, elaborates on this view. The private sector alternative gives market discipline and allows for maximum innovation.
Because of the Fed's role as a Government agency with privileges
accorded to no private institution, and the conceptual and practical
difficulties in setting a price for its services, attention should also be
paid to what services should be provided by the Fed as well as the
price that should be paid for them. Only when this is clearly agreed
upon and understood by the Fed, the Congress, and the private sector, can a fair and sensible balance be achieved between the Federal
Reserve and the private sector as providers of payments services.
ARBITRARY DISCRIMINATION AMONG FINANCIAL INSTITUTIONS

Chairman Miller has recognized the competitive inequity in the
reserve requirements structure of member and nonmember institutions.
However, inequities which are just as harmful exist in the reserve
requirements structure for existmg member banks. In his testimony
before this committee, Chairman Miller stated that his proposal for
universal reserve requirements would not increase regulatory burdens
on nonmember banks. This statement neglects an important part of
the picture. Many banks elect to have a State charter and to be a non-'
member purely to avoid the excessive burdens of the Fed's reserve
requirements-not because they dislike the regulatory administration
of the Comptroller of the Currency or the Fed.
1Should universal reserve requirements be enacted, the ultimate value
of many State bank charters would be substantially diminished and
many banks would over time opt to join the Fed as a national bank;
Rather than substantially change the relative value of State and
national bank charters, a more sensible approach is to extend reserve
requirements on transaction accounts to all federally chartered deposi
tory institutions, and to those State-chartered institutions that elect
to join the Federal Reserve or the Federal Home Loan Bank Board.
This proposal was made by our association in S. 1668 and is discussed
in the attached testimony on that bill. This alternative preserves the
relative value of State and national bank charters and extends the
dual banking concept, as it is known in the banking industry today,
to thrift institutions as they come into the payments business.
Limitation on total interest that may be paid on reserves unnecessarily restricts the Fed's options. We caution the committee to be sure
that any such limitation is realistic, and does not excessively hamper
the Fed in its attempt to effectively relieve its membership burden.
Setting a lower interest ceiling on required reserves over $25 million
is discriminatory and we oppose it.
These proposals seem to be inspired by the view that interest on
required reserves would be a "raid on the Treasury" and would, unless

32•972 0 • 78 • :u
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controlled, constitute an unnecessary subsidy to larger banks. We disagree with both points.
In the first place, reserve requirements are a tool of monetary policy.
If they are to be considered a part of the Internal Revenue tax collection system, they should be discussed in that perspective.
Second, from a theoretical standpoint, there 1s no reason to assume
that a reduction of required reserves will reduce Treasury receipts.
The key determinant is the volume of reserves in the System which
can be handled by Federal Reserve open market operations. Any reduction in reserve requirements can be easily offset by the Fed, and
Treasury receipts are the same.
Table 1 at the end of our testimony compares Federal Reserve payments to the Federal Treasury with total Federal budget receipts in
selected years. Between 1957 and 1976 the percentage of Federal budget
receipts accounted for by Federal payments to the Treasury rose over
240 percent. The contribution of sterile member banks reserves tq the
Federal Reserve earnings constitutes a significant proportion of the
total earnings.
The proportion may have declined somewhat because of the lowering of reserve requirements since 1957. But it has not declined sigp.i:ficantly, and it seems safe to say that the contribution of sterile
member bank reserves to Federal budget receipts has more than
doubled since 1957.
Proponents of the thesis that interest on reserves would be a "raid
on the Treasury" have, on occasion, pointed to the low effective tax
rate paid by banks. This emphasis is misplaced. Those banks that pay
effective tax rates substantially below the statutory rate of 48 percent
do so because they take advantage of specific tax incentives designed
to influence the allocation of their funds. The most important example
of this is the tax exemption on municipal bonds-an exemption that
has, for a long time, been basic to our system of State/Federal relations. In responding to the objectives of this exemption, banks forgo
substantially higher income they might earn on taxable securities and
other alternative investments. In the process, however, these banks
make a significant contribution to financing the needs of State and
local governments.
Another example is the investment tax credit, an incentive specifically enacted into law by the Congress for the purpose of job creation
and capital formation. Through their leasing operations, banks make
a significant contribution in this area. Banks are proud of their record
as taxpayers and deliverers of financial services. There is no justification for discrimination against any size class of banks, or against
banks as an institution vis-a-vis their competitors.
Also, declines in Federal Reserve payments to the Treasury because
of reduced reserve requirements could easily be mitigated by a gradual phase-in of ·the program to relieve the membership burden. Of
course, this would mean that it might take longer to achieve a significant alleviation of the membership burden. Nevertheless, knowledge that positive steps were being taken to relieve this burden would
probably stem the membership attrition in a substantially shorter
period of time.
The Federal Home Loan Bank Board is frequently viewed by thrift

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315
institutions, who are major competitors of most banks, as its "central
bank" which performs many of the functions for its members that
the Federal Reserve performs for its members. Members of both
systems supply funds to the "central bank" and in turn receive a
return on funds supplied.
Table 2 provides estimates of this return. For banks in the Federal
Reserve System, the return is 2 percent-mainly an imputed return
from the cost of Federal Reserve services. For thrift institutions in the
Federal Home Loan Bank System, the return is 4.3 percent.
Finally, we would like to note that, although we have no objections
to payments from the Fed's surplus to the Treasury, the "surplus"
does not represent idle cash or current earnings, but merely an accounting entry that arises because past earnings from the use of required reserves or the provision of coin and currency have been
retained arid invested in other assets.
In summary, we believe the current discriminatory aspects of the
reserve requirements structure are unfair and unnecessary. We oppose
the compounding of this problem by additional discrimination in the
interest rate paid on reserves. The emphasis being put on the relationship between Treasury revenues and the membership burden is misplaced and, in the long run, will he detrimental to both the Fed and
the Treasury. The efficiency of the payments system would be greatly
enhanced by explicit pricing of Federal Reserve services in a manner
that recognizes the constructive and innovative role played by the
private sector in the provision of payments services.
Such explicit pricing must be accompanied by an effective allevia~
tion of the Federal Reserve's membership problem. The most promis:,,
ing way to do this is to reduce reserve requirements. We also support
fair and impartial methods of allowing hanks to earn interest on their
reserves. Thank you.
[Text resumes on page 393.]
[The prepared statement of Mr. Perkins, on behalf of the American
Bankers Association, along with the supporting material referred to
in his oral presentation, follows:]

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Statement of
the
American Bankers Association
before the
Committee on Banking, Finance, and Urban Affairs

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Federal Reserve Bank of St. Louis

U.S. House of Representatives

August 4, 1978

H.R.13476, the Reserve Requirements Act of 1978
H.R.13477, the Interest on Reserves Act of 1978
H.R.12706, the Federal Reserve Membership Act of 1978

317
Congressman Mitchell, Congressman St Germain,.and members of the
Committee, I am John R. Perkins, President of the Continental Illinois National
Bank and Trust Company of Chicago, and President-Elect of the American
Bankers Association, a trade association whose membership includes more
than 92 per cent of the nation's 14,383 full-service banks.

Accompanying me

is Leif Olsen, Chairman of the Economic Policy Committee of Citibank, New York,
N.Y. and Chairman of the Economic Advisory Committee of our association.
We are delighted to be here today to testify on the important proposals
before your committee.

There are few absolute certainties in any of the

arguments pro and con to the proposals for change.

All of us are having to

speculate about living in a Federal Reserve operating environment none have
experienced.

The first question for consideration should not be:

How do

we maintain a relatively high level of membership in the Federal Reserve
System?

Rather, more fundamental objectives should be clearly stated.

Our

association believes these objectives are paramount:
--To assure the continued effectiveness of our central bank
in its management of monetary policy.
--To enhance the efficiency of the payments system, and
--To eliminate arbitrary forms of discrimination against
particular types of financial institutions which inhibit
the delivery of banking services at least possible cost.
The proposals before you, R.R. 13476, the Reserve Requirements Act of 1978,
and R.R. 13477, the Interest on Reserves Act of 1978, and R.R. 12706, the Federal
Reserve Membership Act of 1978, are constructive attempts to deal with the
first two concerns, although we do have some specific disagreements with them.
Our third concern is barely addressed in the proposals.

There appears,in fact

to be an attempt to justify discrimination against larger banks on the grounds

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318
that they are not leaving the Federal Reserve as frequently as smaller banks
and hence, do not deserve the same level of relief from the excessive burdens
of membership,

There also appears to be a belief that such discrimination

will mitigate Treasury revenue losses.

The first notion is simply unfair

and, as we shall discuss below, the second is probably incorrect.
In discussing legislative and regulatory proposals, the policymaking
bodies of the American Bankers Association attempt to discipline their thinking
by asking four questions:
--How do bank customers benefit from the proposal?
--Will the proposal enhance the broad competitive environment?
--Is the proposal consistent with national economic and
social priorities?
--Does the proposal achieve or maintain equal competitive
ground rules among various types of competing financial
institutions, and does it provide opportunity for competitive
financial institutions to maintain viability and profitability
regardless of size?
An attachment to this testimony analyzes the proposals before you in
terms of these criteria,
We have been involved in research and discussion of the issues raised
in these legislative proposals for some time.

Attached to our testimony are

other documents which might prove useful to the Committee and we request that
they be made a part of the record of these hearings,
1) ABA testimony before the Subcommittee on Financial Institutions of
the Senate Committee on Banking, Housing, and Urban Affairs, on June 21, 1977.
This testimony discusses NOW Accounts, the Federal Reserve's membership problem,
and S. 1668, our Association's legislative proposal to deal with these issues.
2) ABA testimony before the Senate Committee on Banking, Housing, and
Urban Affairs, on October 11, 1977, on the role of the Federal Reserve in
providing payments services.

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3) A letter from ABA to Senator Richard Lugar dated November 4, 1977,
discussing the extent to which required reserves might be reduced for Federal
Reserve member banks without impairing the effectiveness of monetary policy.
4) An outline of a research project the ABA will undertake to determine
the impact of pricing of Federal Reserve services and relief of the Federal
Reserve's membership problem on the structure of the banking industry.

This

outline was part of a request for proposals that was sent to various consulting
firms.

We are currently in the process of evaluating their proposals and hope

to begin the project soon.
The Central Bank and its Management of Monetary Policy
The need for mandatory universal reserve requirements on transaction
accounts held by all depository institutions in order to assure an effective
monetary policy has not been demonstrated.

We opposed this proposal as

unjustified and likely to harm our nation's innovative system of dual banking.
The Fed has sponsored this proposal as a means of increasing the effectiveness of its monetary management.

Nevertheless it should be noted that the

Federal Reserve does not have universal support for its view that reserve
requirements are a necessary tool for monetary policy.

It is our view that

reserve requirements for existing Fed member banks could be significantly
lowered, and the membership burden concomitantly relieved, without any significant
diminution of the Fed's ability to conduct monetary policy.

To achieve this

within a framework in which the Fed retains maximum flexibility to use reserve
requirements for monetary policy purposes, we propose that existing statutory
minimum reserve requirements be eliminated.

Our views on this point are

amplified in the attached letter to Senator Lugar.
It is true that the percentage of transaction accounts subject to reserve
requirements of the Federal Reserve is declining.

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The decline of Federal

320
Reserve membership is only one factor accounting for this.

Another is the

increasing proportion of transaction accounts that are held outside the banking
industry.

Differing levels of reserve requirements among member and non-member

institutions can cause additional instability in the money supply as deposit
shares of these different categories of institutions change and money flows
among them.

But economists in the banking industry believe that a much

greater source of instability is the graduated levels of reserve requirements
among banks who are already members of the Fed.

Elimination of these differences

would be a significantly greater contribution to monetary stability -- and an
act of simple fairness to the institutions involved.
We disagree with the proposal that would legislate inflexible reserve
requirements because this would tie the hands of the Fed in its ability to
use changes in reserve requirements as a tool of monetary policy.

We believe,

however, that existing reserve requirements levels can be reduced, and favor
giving the Fed the ability to do so to the extent that it prudently can.

appropriate move for the Congress would be to set the minimum of the statutory
ranges at zero, rather than setting the exact levels by legislative action.
As already stated, we believe reduction in reserve requirements should
be the principal method used to alleviate the current membership burden.
However, if it is administered fairly, we do support proposals calling for the
payment of interest on reserves.

Indeed, the two methods can be considered

complementary to each other.
Limiting the payment of interest on reserves to revenues received from
the pricing of services as specified in the proposed amendment to H.R. 12706,
would, however, aggravate, rather than alleviate, the Fed's membership problem.
This would occur because H.R. 12706 also provides for equal access for all
institutions to Fed services.

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Aa Chairman Miller has already testified in these

321
hearings, the revenue received from the pricing of services would be insufficient
to effectively eliminate the membership burden.

Hence, since access is available

to everyone, the membership drain would be accelerated.

The Fed could try to

combat this by raising its prices in hopes of increasing the revenue it has
available to pay interest.

But if its customers were price sensitive and

looked for other providers of payments services, this probably would not work.
The gathering of additional information from non-member institutions
provided the data are needed for monetary policy purposes and the data gathering
is done in a way that minimizes the reporting burden placed on those institutions
has our support.
We do not support tying

the level of the discount rate to the Treasury

bill rate because this would also tie the hands of the Federal Reserve in the
use of this tool for monetary policy purposes.

We understand the concern

supporters of this provision have over "arbitrage profits."

Indeed it is

quite natural for bankers to pay attention to interest rate spreads between
the funds they receive and the funds they lend.
business.

This is the guts of their

Nevertheless, in addition to power to set the discount rate, the

Fed has administrative controls on the use of the discount window which we
believe are sufficient and appropriate.

Also, the total earnings of the

Federal Reserve from the use of the discount window are only $40 million.
We believe the bulk of this represents .earnings on legitimate loans.

The

earnings of the banking industry are approximately $8.9 billion and those
of the Federal Reserve System are approaching $6 billion.

Surely any

unnecessary "arbitrage" profits are very small relative to the earnings of the
banking industry and the Fed.

It seems more prudent to let the Fed retain

flexibility in the use of this tool.
While we do not agree with all of the specifics of the various proposals
to solve the Fed's membership problem, we continue to believe that, for the

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foreseeable future, a strong membership base will be very important to the
conduct of monetary policy.

The problem is urgent and attention should be paid

to it as soon as possible.

We are acutely aware that the cost of Federal Reserve

membership is an important item on the current agenda of bank board meetings
all across the country.

As Chairman Miller pointed out in testimony before

this Committee in these hearings, and as Secretary Blumenthal pointed out in
hearings last year on S. 1664 and S. 1668 which dealt with the membership
problem, the longer the problem continues, the more banks will withdraw from
the system and Treasury revenues from that source will decline anyway.

Limiting

the options available to relieve the membership burden because of concern over
current Treasury revenues could be penny-wise and pound-foolish.

By the Federal

Reserve's own estimate, withdrawals from the Fed since 1970 reduced Federal
Reserve payments to the Treasury in 1977 by nearly $200 million from what they
otherwise would have been.
continuing.

The problem is long run.

It is structural.

It is

And it should be solved.
Enhancement of the Efficiency of the Payments System

We believe the efficiency of the payments system would be greatly enhanced
if the Federal Reserve charged for its services.

However, we must note that we

foresee several difficulties in pricing of existing Federal Reserve services·and
the provision of new ones.

The problem of determining proper cost allocations is

difficult enough for private firms.

If the Fed decides to take into account

its own costs in setting its prices, as it most certainly should, the situation
is substantially more difficult.

How does one allocate overhead costs among

such diverse activities as the administration of monetary policy through open
market operations, the provision of services as fiscal agent for the Federal
Government, the supervision of state-chartered member banks, the regulation of
bank holding company activities, and the provision of payments services which also
can be provided by private banks?

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Federal Reserve Bank of St. Louis

Even if all the relevant data were known, we can

323
think of no way to do this on a rational basis.

Indeed, as new payments

systems evolve, it becomes more and more difficult to even know the relevant
data.
The provision of payments services is the main banking area in which the
Fed competes directly with the private banking system.

Yet with 12 regional

banks, each having several branches which serve primarily as operations centers,
the Fed already has a nationwide system of operations centers in place.

There

is no way a single bank can match this capability under the current banking
structure.

This makes accurate comparisons of the public and private clearing

systems more tenuous.

The proposal to limit payment of interest on reserves to revenue received
from pricing would diminish rather than enhance the efficiency of the payments
system.

We have already discussed why it would accelerate the membership drain.

This accelerated loss of membership might cause the Fed to become more aggressive
in providing new services in an attempt to raise pricing revenue so as to
be able to alleviate more of the membership burden.

If it believed its customers

were price-elastic it could, to the extent Congress and its auditors permit it,
undercut the private sector in an attempt to raise its revenues in order to pay
more interest on reserves and achieve a greater alleviation of its membership
burden.

Neither of these responses would enhance the efficiency of the payments

system, and it is not clear that either of them could ever enable the Fed to
achieve an effective elimination of its membership burden.
We· are somewhat dismayed by the Federal Reserve's comment that if universal
reserve requirements were enacted the Board would have to reevaluate its program
to reduce the cost burden of required reserves, and price its services.

believe the Fed should reduce.the cost burden of reserves and price its services
regardless of the structure of reserve requirements among depository institutions.

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324
Such a program, if properly constructed, would greatly enhance the efficiency
of the payments system without significantly diminishing its ability to
conduct monetary policy.

It is our strong belief that an efficient payments system will be maintained
only if there is a strong, healthy, private-sector alternative to payments
services provided by the Fed.

To insure this, we would propose two rules to

which the Federal Reserve should be bound in setting its prices:
1.

Fed prices should not be less than fully allocated costs,
including allowances for overhead, cost of capital, and taxes.

Fed prices should not be less than what the private sector
would charge for similar services.

Although these standards would be difficult to enforce, they are not
mutually exclusive, and both should be used in the evaluation of Fed prices.
If this is done in a fair and impartial manner, the efficiency of the payments
system will be greatly enhanced.

Our testimony before the Senate Banking

Committee on October 11, 1977 (copy attached) elaborates on this view.
Because of the Fed's role as a government agency with privileges accorded
to no private institution, and the conceptual and practical difficulties in
setting a price for its services, attention should also be paid to what services
should be provided by the Fed as well as the price that should be paid for them.
Only when this is clearly agreed upon and understood by the Fed, the Congress,
and the private sector, can a fair and sensible balance be achieved between
the Federal Reserve and the private sector as a provider of payments services.
Arbitrary Discrimination Among Financial Institutions

Chairman Miller has recognized the competitive inequity in the reserve
requirements structure of member and non-member institutions.

However,

inequities which are just as harmful exist in the reserve requirements structure
for existing member banks.

In his testimony before this Committee Chairman Miller

stated that his proposal for universal reserve requirements would not increase

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325
regulatory burdens on non-member banks.
part of the picture.

This statement neglects an important

Many banks elect to have a state charter and to be a

non-member purely to avoid the excessive burdens of the Fed's reserve
requirements -- not because they dislike the regulatory administration of
the Comptroller of the Currency or the Fed.

Should universal reserve requirements

be enacted, the ultimate value of many state bank charters would be substantially
diminished and many banks would over time opt to join the Fed as a national
bank.

Rather than substantially change the relative value of state and national

bank charters, a more sensible approach is to extend reserve requirements on
transaction accounts to all federally chartered depository institutions, and
to those state chartered institutions that elect to join the Federal Reserve,
or the Federal Home Loan Bank Board.

This proposal was made by our Association

in S. 1668 and is discussed in the attached testimony on that bill.

This

alternative preserves the relative value of state and national bank charters
and extends the dual banking concept, as it is known in the bank industry today,
to thrift institutions as they come into the payments business.
Limitation on total interest that may be paid on reserves unnecessarily
restricts the Fed's options.

We caution the committee to be sure that any

such limitation is realistic, and does not excessively hamper the Fed in its
attempt to effectively relieve its membership burden.

Getting a lower interest

ceiling on required reserves over $25 million is discriminatory and we oppose it.
These proposals seem to be inspired by the view that interest on required
reserves would be a "raid on the Treasury" and would, unless controlled,
constitute an unnecessary subsidy to larger banks.

We disagree with both points.

Table 1 at the end of our testimony compares Federal Reserve payments to
the Federal Treasury with total Federal Budget receipts in selected years.
Between 1957 and 1976 the percentage of Federal budget receipts accounted for

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326
by Federal payments to the Treasury rose over two hundred and forty per cent.
The contribution of sterile member banks reserves to the Federal Reserve
earnings constitutes a significant proportion of the total earnings.

The

proportion may have declined somewhat because of the lowering of reserve
requirements since 1967.

But it has not declined significantly, and it

seems safe to say that the contribution of sterile member bank reserves to
federal budget receipts has more than doubled since 1957.
Proponents of the thesis that interest on reserves would be a "raid on
the Treasury" have, on occasion, pointed to the low effective tax rate paid
by banks.

This emphasis is misplaced.

Those banks that pay effective tax

rates substantially below the statutory rate of forty-eight per cent do so
because they take advantage of specific tax incentives designed to influence
the allocation of their funds.

The most important example of this is the

tax exemption on municipal bonds--an exemption that has, for a long time, been
basic to our system of state-Federal relations.

In responding to the objectives

of this exemption, banks forego substantially higher income they might earn
on taxable securities, and other alternative investments.

In the process,

however, these make a significant contribution to financing the needs of
state and local governments.

Another example is the investment tax credit,

an incentive specifically enacted into law by the Congress for the purpose
of job creation and capital fonnation.

Through their leasing operations,

banks make a significant contribution in this area.

Banks are proud of their

record as taxpayers and deliverers of financial services.

There is no

justification for discrimination against any size class of banks, or against
banks as an institution vis-a-vis their competitors.
Also, declines in Federal Reserve payments to the Treasury because of reduced
reserve requirements could easily be mitigated by a gradual phase-in of the
program to relieve the membership burden.

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Of course, this would mean that it

327
might take longer to achieve a significant alleviation of the membership burden.
Nevertheless, knowledge that positive steps were being taken to relieve this
burden would probably stem the membership attrition in a substantially shorter
period of time.
The Federal Home Loan Bank Board is frequently viewed by thrift institutions
who are major competitors of most banks, as its "central bank" which performs
many of the function for its members that the Federal Reserve performs for
its members.

Members of both systems supply funds to the "central bank" and in

turn receive a return on funds supplied.
return.

Table 2 provides estimates of this

For banks in the Federal Reserve system the return is 2.3 per cent --

mainly an imputed return from the cost of Federal Reserve services.

For thrift

institutions in the Federal Home Loan Bank System the return is 4.0%.
Finally, we would like to note that, although we have no objections to
payments from the Fed 1 s. surplus to the Treasury, the "surplus" does not represent
idle cash or current earnings but merely an accounting entry that arises because
past earnings from the use of required reserves or the provision of coin and
currency have been retained and invested in other assets.
In summary, we believe the current discriminatory aspects of the reserve
requirements structure are unfair and unnecessary.

We oppose the compounding

of ·this problem by additional discrimination in the interest rate paid on reserves.
The emphasis being put on the relationship burden is to be misplaced and, in the
long run, will be detrimental to both the Fed and the Treasury.

The efficiency

of the payments system would be greatly enhanced by explicit pricing of Federal
Reserve services in a manner that recognizes the constructive and innovative
role played by the private sector in the provision of payments services.

Such

explicit pr.icing must be accompanied by an effective alleviation of the Federal
Reserve's membership problem.
reserve requirements.

The most promising way to do this is to reduce

We also support fair and impartial methods of allowing

banks to earn interest on their reserves.

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Table 1
Federal Rese:ive Payments to the Treasury
as a Per Cent of Federal Budget Receipts
(1)
First Year

(2)

(3)

Payments to Treasury
b):'. Federal Rese:ive

Federal Budget
Recei11ts

1957

543*

79,990

(4)
Federal Rese:ive Payments
to Treasury as a Per cent
of Federal Budget ReceiEtS

.67%

1962

718

99,676

.72

1967

1,805

149,552

1.21

1972

3,252

208,649

1.56

1977

5,908

356,861

1.66

Source:

Treasury Bulletin

*Calendar Year 1957

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Table 2
Return on Funds Supplied by Member
Institutions to the Federal Home Loan Banks
and the Federal Reserve Banks

Ftmds Supplied by
Member Institutions
Capital Stock (millions)
Reserves
Deposits
(less float)
Rerun, en Ftmds

Federal Reserve
System
(Millions)
24,088

7,438

1,029
26,709
0
3,650
490

Dividends
Interest on Deposits
Services (at cost)
Precentage Return on
Total Ftmds Supplied

Federal Home Loan
Bank System
(Millions)

3,295
0
4,143
321

60
0
430•
2.0%

146
175
0

4.3%

*Federal Reserve' s estimate of the cost of providing check clearing (including AO!)
and coin and currency services.
Source: Board of Governors of the Federal Reserve System, 64th Annual Report,
Federal Home Loan Bank System, Savings and Home Financing Source Sook,
Fede::-al Home Loan Bank Board of Journal, April, 1978.

32-972 0 • 78 • 32
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ANALYSIS OF THE PROPOSALS BEFORE THE COMMITTEE
H.R.13476, the Reserve Requirements Act of 1978
The extension of reserve requirements to non-member banks would hurt
those banks and diminish their ability to serve their customers.
on the competitive environment is unclear.

Its effect

Although some competitive inequities

would be eliminated, the substantial inequities in the existing reserve requirements structure would be maintained.

In addition, the value of many state

bank charters would be substantially diminished thereby putting those banks
at a competitive disadvantage.

Although the proposal does address the Fed's

membership problem in a rather oblique way, we believe there are substantially
better ways of doing this.

The proposal might enhance the ability of the

Federal Reserve to conduct monetary policy, but we would believe this effect
is small.

The ability of small institutions to compete would be diminished

by burdening them with excessive reserve requirements.

The bill recognizes

this by exempting the first $5 million of transaction accounts from reserve
requirements.

But there is still no reason to impose additional burden on

larger non-member banks,

The problems addressed by H.R.13476 can be handled be

better in other ways.
We oppose H.R.13476.
H.R.13477, The Interest on Reserves Act of 1978
In terms of our criteria, bank customers of banks that achieved significant
relief from membership burden would benefit.

Others would not.

The proposal

would make the competitive environment more equitable for some institutions
(those that achieved significant membership burden relief,) and less equitable
for others (those that were discriminated against in the payments of interest.)
Current Treasury revenue losses would be limited, but in the long run they might increase if the.membership problem is not solved.

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The proposal provides specifi-

331
cally for one type of discrimination against larger banks--the two per cent
interest limitation--and gives an incentive for providing another--the limitation on total amount of interest paid.

For these reasons, we cannot support it.

H.R.12706, the Federal Reserve Membership Act of 1978
H.R.12706 offers potential for substantially improving the efficiency of
our payments system and achieving a significant reduction in the burden of
Federal Reserve membership.

Customers of all banks would benefit from the

first achievement and customers of the Federal

Reserve member banks would

benefit from the second, as the reduced level of Federal Reserve membership
costs was passed on to them.

The broad competitive environment would be enhanced

by achieving a greater equality between member and non-member institutions in
the cost of carrying reserves, and a greater equality between the Fed and the
private sector as providers of payments services.

National priorities would

be served by allowing the Fed to retain an adequate membership base for monetary
policy purposes within the framework of an efficient payments-system.

There

would be some initial decline in Treasury revenues due to the payment of
interest on reserves which can be offset by phasing in the program, and the
decline in Treasury revenues due to the erosion of Federal Reserve membership
would be stopped.

The ability of financial institutions to compete regardless

of size would be retained.
We support H.R.12706,

The alleviation of the burden of Federal Reserve

membership which the proposal seeks could also be achieved by a significant
reduction in reserve requirements.

We recommend this approach as a preferable

method, and one that could be used in conjunction with H.R.12706.

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Proposed Amendment to H.R.12706
This amendment has fiye provisions:
1)

Interest paid on reserves would be limited to the sum of receipts
from the pricing of services and earnings on discounts and advances.

Specific statutory reserve requirement levels would replace the
current statutory ranges within which the levels may be set by
the Fed.

The discount rate would be set equal to the average yield on
treasury bills with less than 92-day maturities during the
previous two weeks.

The Federal Reserve would be authorized, as it deems necessary
for the conduct of monetary policy, to obtain summary statistics
on assets and liabilities of all depository institutions.

The Federal Reserve would be directed to pay to the Treasury
$575 million from its surplus within 24 months of enactment
with $300 million to be paid in the first year.

Bank customers would not benefit from the first three provisions of this
amendment.

The efficiency of payments system would be reduced.

The Federal

Reserve's membership problem would not be alleviated, and the effectiveness
of the monetary authority would probably be diminished.

The competitive environ-

ment would not be enhanced and national priorities would not be served.

Since

the membership problem would not be alleviated, equality of competitive ground
rules among competing institutions would not be achieved.
We support the fourth provision, if it is deemed necessary for monetary
policy purposes, and the additional regulatory burden placed on banks is minimized.
For reasons explained in the text, the fifth provision has little real
significance, although we have no objection to it.

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Statement of

Liddon McPeters

on Beha 1f of the American Bankers Association
before the
Subconm1ttee on Financial Institutions
of the
Senate C011111i ttee on Banking, Housing
and Urban Affairs
June 21 , 1977

334
Mr. Chainnan and members of the Subcommittee, I am W. Liddon McPeters,
President of the Security Bank of Corinth, Mississippi, and President of the
American Bankers Association, a trade association whose membership includes
approximately 92% of the nation's 14,000 banks.
We are here today to discuss legislation introduced as a response to a
variety of economic and technological changes that have taken place in our society,
and some more specific responses to these changes by legislators and financial
regulators. The two primary bills we will discuss have been put forward by the Administration (S. 1664) and the American Bankers Association (S. 1668).
comparison of these two bills is given in Appendix I.

We wish to express our

thanks to you, Senator McIntyre, for introducing our bill and allowing us to give
legislative expression to our views.
with

1668.

We have three goals we are trying to achieve

We want to remove competitive inequities which discriminate _against

bank customers.

We want to make consumers savings accounts more useful.

And

we want to alleviate some of the factors which have made Federal Reserve membership
unattractive to an increasing number of banks.
The most important competitive inequity for banks and bank customers is the
differential between the maximum interest rates on time and saving deposits allowed
at thrift institutions and banks.

This differential i_s currently mandated by law.

We wish to see the administration of interest rate ceilings returned to the
regulators.

We also believe that those thrift institutions which gain the advantage

of "one-stop retail banking" through the use of third payment powers will, in
effect, become banks. As such,they should be limited to the same interest rate
ceilings on all classes of deposits as banks, which are their direct competitors.
We wish to make savings accounts more useful by expanding the range of options
open to consumers in making third-party payments.
Also, we believe some of the conditions that ha~e made Federal Reserve membership less attractive to an increasing number of banks in recent years should

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335
be alleviated.
We believe these goals serve the public interest, and that we are proposing
a fair and equitable way of achieving them.

The specific elements of our proposal

are embodied in S. 1668. They are:
{1)

interest is to be allowed on savings accounts used to pay third parties
(by check or any other means) subject to restrictions specified below;

(2)

holders of these interest bearing transaction accounts must be
individuals;

(3)

interest payments must not exceed specified rate ceilings;

(4) any institution offering third party payment accounts must be subject
to the same rate ceilings on all accounts they offer which are
subject to-rate ceilings;
(5)

a uniform rate ceiling on third party payment accounts offered by
all depository institutions is to be set by the Federal Reserve;

(6)

consultation on rate ceilings for all depository institutions should
include the National Credit Union Administration;

(7)

rate cei 1ings on other accounts at insured credit unions should be
set by the National Credit Union Administration subject to items
(4) and (6) above;

(8)

Federa 1 Reserve member banks, members of the Federa 1 Home Loan
Bank System, and Federal credit unions must maintain reserves against
third party payment accounts as set by the Federal Reserve.
Other institutions should be subject to reserve requirements set
by states;

(9)

all reserves required by the Federal Reserve should be held as vault
cash or at a Federal Reserve bank, except that Federal Home Loan
Bank System members may hold reserves at a Federal Home Loan Bank
if it, in turn, holds these reserves balances as vault cash or at
Federa 1 Reserve banks ;

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336
(10)

Statutory reserve ranges on all classes of deposi·ts at Federal
Reserve member banks should be revised downward.

(11)

Federal Reserve banks should be allowed to pay interest on reserves,
and ff they do so, the rate should be unffonn on all reserves
held;

(12)

the Interest Rate Control Act should be extended to December 15,
1980, but the statutory interest rate differential should be

removed.

(13) S. 1668 would take effect 60 days after enactment in New England,
and after. one year in other states.
We believe that S. 1668 is a progressive response to a series of economic
technological, legal, and regulatory changes that have been taking place in our
financial sytem for some time.

Before elaborating in detail on the reasons for

our specific proposa 1s, it may be usefu 1 to review some of the these changes, and
the legislative and regulatory responses that have brought us to this point.
First, we live in an era of.high interest rates.

Present rates are substan-

tially higher than those that existed in 1933 when the prohibition of interest
payments on demand _deposits was first enacted.

High interest rates have caused

cons1111ers, businesses, and bankers to attempt to get more value for the balances
they hold.

Consumers have sought, and received, implicit interest in the fonn of

lower service charges, and other fonns of bank services.

Businesses have been

even more sophisticated in seeking such services as payroll and data processing
assistance, financial advice, and better lines of credit at more favorable
interest rates.

Federal reserve member banks have become increasingly dissatis-

fied with the large amounts of sterile balances held at Federal Reserve banks,
and many have left or are contemplating leaving the Federal Reserve System.
Low services charges on checking accounts, rapid economic growth, and the
increasing sophistication of our financial system have prompted what many perceive to be an excessive use of paper checks. This has aggravated cost pressures

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337
on

banks and prompted a variety of 1ega 1 and techno 1ogi ca1 responses. The

burgeoning use of paper checks has also been perceived as a misallocation of
economic resources which should be corrected by a lifting of restrictions on the
pricing of checking accounts.
The leadership of the banking industry is pursuing a constructive response

to these events. We believe the pressures described above wfll continue to
force a rapid pace of change, and are seeking Federal legislation .because the
public interest wfll be served best by imposing a rational order on the process
of change for all financial institutions.
We are seeking the imposition of a rational order to end what can best be
described as "piecemealing". At first glance, piecemealing may seem to have some
advantages.

It obviates the need for a more comprehensive legislative design with-

out the certain knowledge of where market pressures are leading us.

It allows

for different responses by different states, regulators, and institutions,
depending on their interpretation of the problem. These varying responses
may in turn, facilitate innovation and enable all parties to see more clearly

where the fi nanci a1 system is headed.
However, pi ecemea 1i ng a1so has many disadvantages. As the process has
evolved, competitive inequities have arisen which discriminate against the customers
of different types of financial institutions.

Equally important are the problems

caused by uncertainty over the character and direction of change and the myriad of'
approaches for dealing with it. These problems have made planning by financinal
institutions extremely difficult.
A Federal solution is needed.

Problems of discrimination against bank

customers can be addressed in a unifom manner throughout the nation.

Issues

that are uniquely national in nature, such as. the Federal Reserve's membership

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338
problem, can be considered as part of this package.
We realize that a Federal solution also has inherent dangers. A consensus
may be much more difficult to achieve.

If the end result is bad, competitive

inequities may be perpetuated throughout the nation.

Innovation may be stifled.

Such legislation, occurring at the Federal level, may be difficult to change.
This is the kind of result weforesaw in the Financial Reform Act of 1976 that
was considered in the House of Representatives, and that is why we opposed that
legislation after four years of continually advocating constructive and equitable
change.
Having considered all of these factors, our membership has decided that only
through a Federal solution, can the rational order we seek be imposed on the
process of change. With such a solution, financial institutions will be able
to understand better the rationale of the regulators that govern them. They
will be able to plan better to serve their customers.

Consumers w111 be able

to make more rational choices among a wider range of financial services.

general, the public interest w111 be served better. We believe a constructive
and equitable version of such a solution is contained in S. 1668. The Admfnistration has proposed S. 1664 which is also constructive and forward-looking.
We support its general thrust, although we have some specific disagreements

with it.

I would now like to turn to a more detafled discussion of S. 1668, the

problems that led us to propose it, and to comment on the Administration's
proposal, S. 1664.

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Interest on Consumer Transactions Balances
A central element in the bills we are discussing is the proposal to
allow consumers to earn interest on transactions balances.

Savings accounts

would be made more useful by liberalizations of the law which would let depository institutions offer consumers savings accounts with many of the attributes they traditionally look for in checking accounts.

Measures to make savings

accounts more useful are part of a trend that has been going on for some time.
The NOW account, a savings account on which negotiable orders of withdrawal may
be written, is only one example.

Others include, telephone tranfers from savings

to checking accounts, the payment of bills from a savings account through preauthorized withdrawal by the depositors'

instruction, the payment of bills from

a savings account through telephone authorization of withdrawal by the depository
institution, use of manned remote service units which initiate an electronic transfer of funds, automated teller machines to withdraw savings account money to
pay bills or obtain funds, and finally, share drafts at credit unions.

Appendix II

shows the growth of many of these powers at banks, thrift institutions, and credit
unions.

It illustrates the response of state legislators, state and Federal regu-

lators, and to some extent, the Congress to the pressures which have been moving
our financial system toward interest-bearing transaction accounts.
In the same vein, the Amerfcan Bankers Association for several years has
sought from Federal regulators the power to allow bank customers to make preauthorized transfers from savings accounts to checking accounts, in
the event that their checking account balance fell below a pre-specified level.
We still believe regulators should allow such transfers.

If they did some con-

sumers would probably prefer this method over the NOW account.

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Federal Reserve Bank of St. Louis

Others would not.

340
S.1664 uses the term "NOW ac:c:ount," and "share draft," and then goes
on to say that any ac:c:ount which is used to "provide funds directly or
fndfrec:tly for the purpose of making payments or transfers to third parties,"
may be defined as

a NOW account, or share draft account by the Federal Reserve.

Such an account would then be subject to the same regulations as NOW accounts
and share draft accounts.

S, 1668 has similar language, but ft does not attach

a specific term--e.g., "NOW" -- to the account.

We believe that financial fnstf-

tutfons should have the opportunity to name these accounts fn any manner they
see fit.
The important point is that all savings accounts from which third party
transfers are made should have the same interest rate ceilings wl!,ether they

are called "NOW accounts,""share draft accounts," "Savings ac:c:ounts," or
anything else.
S.1668 restricts interest-bearing transaction ac:c:ounts to natural persons
who are making payments for personal purposes.
also be held by non-profit organizations.
a part of the legislation.

S.1664 says these ac:c:ounts may

This fs unnecessary and should not be

In terms of their payments needs, and the services

they obtain from banks, non-profit organizations are more similar to businesses
than individuals and should likewise be excluded.
The i11111ediate impact of interest on transactions balances would be a cost
increase to fnstftutfons that hold the balances. This in turn would spur
attempts to offset this impact.

Institutions might attempt to achieve greater

operating efficiencies, charge higher loan rates, change their asset mix to
ac:hfeve higher yields, or adjust charges for consumer services.
c:an be found, the result will be reduction in bank earnings.

If no offset

In the long run,

this latter result is not healthy for the banking system and could be inimical
to its attempts to serve the public: needs.

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This nation has

341
about 14,000 banks which compete very strongly for consumer deposits with
each other, and also compete with approximately 5,000 savings and loan associations, 500 mutual savings banks, and 23,000 credit unions.

It is highly unlike-

ly that, in the long run, any of these institutions could suffer a significant
decline in earnings without seriously impairing their ability to grow and serve
the needs of the public.

Thus, the manner in which financial institutions adjust

to their changed environment will be determined by the necessity to recover all
costs associated with interest on transaction balances,
Many observers have been watching the New England experience with NOW
accounts very closely.

They see both good and bad aspects of this experience.

The rapid growth of NOW accounts in New England indicates that consumers are
accepting them, and like them.

However, the advent of the NOW account did bring

a drastic change to the way financial institutions do business with consumers.

The adjustment has been, in many instances, difficult and painful,

The competf-

t1ve situation was particularly difficult· in Massachusetts and New Hampshire
in the early years of the NOW account experiment.

Unfamiliarity with the new

type of account prompted many thrift institutions to offer them free of charge
in an attempt to draw deposits from c011111ercial banks.

In the other New England

states pricing has been somewhat more realistic and the impact of NOW accounts
has not been as severe.
Our Association recently contracted with the Management Analysis Center
of Cambridge Massachusetts to study the impact of NOW accounts, particularly
as they.interact with the interest rate differential enjoyed by thrift institutions over banks.

As yet, we only have a preliminary summary report.

some significant findings,

It indicates

The initial cost impact of NOW accounts is greater on

banks than on thrift institutions.

Their results indicate that in Massachusetts

and New Hampshire banks suffered a decline in profitability relative to banks in

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342
the res~ of New Englandi and in the United States as a whole.

They also

suffered a more severe decline in profitability than thrift institutions in
the same states.
On January 31, 1977, the Federal Reserve Board submitted to your C011111ittee
a paper entitled "Impact of the Payment of Interest on Demand Deposits." This
study represented a major contribution to the consideration of this subject.

Because

of some reservations we had about the study, the American Bankers Association
contracted with Golembe Associates of Washingtin, D.C., to do a critical review
of it, and some further research in some of the areas about which we had reservations.

This Golembe study agrees with us that the Federal Reserve study is very

well done and is an excellent contribution to your Committee's deliberations.

How-

ever, it also states that the Fed study seriously underestimates the probable magnitude of earnings pressures on banks and fails

to devote attention to the differ-

ences in probable impacts among individual institutions.
We do not think any of this research indicates that NOW accounts should

be declared illegal, or even prevented from spreading nationwide.

However, it

does illustrate the need for a good monitoring system by regulators and a removal
of the competitive inequities which would aggravate· the pressures on banks, if
NOW accounts were allowed nationwide.
Knowledge of the experience of New England bankers has caused bankers nationwide to view the current spate of proposals for financial reform with mixed feel-

ings.

These banks are concerned about the earnings of their institutions, and

we believe this concern serves the public interest. Our country is just emerging from a bout with double digit inflation and the worst recession since the
193Os.

Despite some individual mistakes, ihe banking industry served

the public very well during this difficult and trying period, Many individuals

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343
and businesses were severely hurt by this economic instability and managed
to weather the stonn only through the forbearance of their bankers.
for many banks, was a decline in earnings and capital positions.

The result,

In addition,

as Governor Henry Wallich of the Federal Reserve has recently pointed out, the
double digit inflation drastically overstated the true value of banks' earnings.
Earnings are a particularly crucial_ element in the programs of many banks to
rebuild their capital positions.

The key role that banks play in our economy

necessitates that the proposals being considered be structured to enable the banking industry to

continue to grow and prosper.

The monitoring problem is particularly important in the case of credit
unions.

There are more credit unions in our country then any other type of

depository institution.

A credit unfon is the easiest kind of depository insti-

tution to create, and since their beginning, Federally chartered credit unions have
experienced considerably higher rates of failure and liquidation than banks.

Cred-

it union regulators have not had substantial experience in examining institutions
that are in the payments business.

We urge the Comnittee to accord careful atten-

tion to this area.
Efficiency of the payments system is one of the goals long put forth by
proponents of the payment of interest on checking accounts.
we heartily endorse.

Efficiency is a goal

Although the precise effect of the proposed leqislation on the

efficiency of the payments system is not completely known, the direction seems
clear.

Interest on consumer transactions balances will probably prompt higher

service charges and encourage people to cut down on the use of checks·.

This in

turn will spur a more r;ipid development of electronic funds transfer systems,
which many consider to be more efficient.

It should be remembered, however, that

consumers are familiar with our system of paper check-writing, and like it.

Some

might reject a trade-off that involved higher service charges in exchange for explicit interest.

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Federal Reserve Bank of St. Louis

In some areas of New England a p~ttern has developed whereby

344
service charges and balance requirements on NOW accounts are substantially
higher than those on checking accounts.
checks written remains to be seen.

How this will affect total numbers of

It is our view, however, that the lifting

of restrictions as proposed in S.1664 and S.1668 will, in the long run, enhance
the efficiency of our payments system.

How 111.1ch, and in what fonn, is not yet

known.
An area of the proposed legislation we have considered very carefully is
its impact on depositors.

It seems clear that initially, smaller depositors

would not be helped by the advent of NOW accounts,

Almost all bankers tell us

that the ratio of the number of checks written to the average account balance
declines as the average balance increases.

This means smaller account holders

would have the least to gain, and probably even lose somewhat, from a system
which pays interest and increases the charge per check.

Of course, it is not

clear that higher service charges will be imposed in exactly this manner. Moreover, such a system would probably spur the development of electronic funds transfer systems which could become a great boon to small depositors,

Also, the prob-

lem of small depositors may be alleviated if service charges are structured so that
depositors who write large numbers of checks have an incentive to keep their balances
in low-service charge, non-interest bearing accounts.
We suspect some consumers will choose an explicitly priced checking account,
such as a NOW accoµnt, even thought they might suffer a monetary loss in the
trade off between interest rates and service charges.

To some people, more_ exact

knowledge of the value of the benefits they receive from checking account services
would be useful.
account.

Others, we suspect, will continue to choose an implicitly priced

The important point is that the lifting of restrictions, as proposed

in S.1664 and S.1668, will enable banks to offer both types of accounts to cons1111ers, who will then be able to make a choice.

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Federal Reserve Bank of St. Louis

345

Competitive Equality - Interest Rate Ceilings
Recent legislative and regulatory action at the Federal and State levels
has given thrift institutions many of the same asset and liability powers as
commercial banks without requiring parity with respect to interest rate ceilings,
reserve requirements , and treatment of reserves.

In some parts of the country,

thrift institutions already have third party payment powers similar to the interestbearing transaction account being proposed in both S.1664 and S.1668.

However,

these institutions still retain the interest differential on time and savings
accounts
We believe the granting of third party payment powers to thrift institutions

blurs the remaining differences
. between financial insitutions to such an extent
that the advantage of the interest rate differential should be removed fl'OIII all
classes of time and savings accounts at any institution which elects to offer
third party payment accounts.

S.1668 prescribes that any thrift institution which

decides not to offer third party payment accounts would retain the advantage of
the differential, despite our continued objection to this form of discrimination
against bank customers.
S.1668 prescribes that, on the effective date of the bill, credit unions
offering share drafts would be subject to the same interest rate ceilings on all
accounts. This is the same treatment prescribed for any other institution offering
third party payment accounts.

There is no reason to "grandfather" the interest

rate ceilings on credit union accounts as is done in S.1664.
Bill paying services, transfers from remote terminals, and other ways of
transferring money from savings to checking accounts are already increasing the
convenience of keeping transactions balances in thrift institution savings accounts.
And even ff third party payment accounts had the same interest rate ceiling at all

32•972 0 • 78 • 23
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Federal Reserve Bank of St. Louis

346
institutions, thrifts would have the advantages of both one-stop banking and
higher interest rates on tfme and savings accounts if they retained their differential on these accounts.
The decline fn conmercial banking's share of the time deposit market, excluding regular savings and bank time deposits over $100,000, as shown fn Table 1,
reflects the interest sensitfvfty of these deposits.

In contrast, regular savings

deposits are less sensftfve to the interest rate dffferentfal sfnce they are often
mafntafned for use fn emergencies and must be easily transferable to transaction
accounts.

For many poep 1e, the addf tf ona 1 i nconvenf ence of transferrf ng these

funds from thrift fnstftutions without third-party payment powers to a bank wfth
third-party payment powers outweighs

the higher yfeld available at the thrifts.

However, ff thrifts gain general third-party payment powers, the differential wfll
become more important in competftfon for regular savings accounts.

Without the

elfmfnatfon of the differential at thrift fnstftutions that gafn general thfrdparty .payment powers, we will see a decline fn the bank market share of regular
savings accounts similar to that whfch has already occurred in the market for
consumer certificates of deposit.
The market for Individual Retirement Accounts (IRAs) is another example of
how the interest rate differential has placed banks at a competitive disadvantage.
In announcing its decision to allow member banks to pay the same deposit interest
rate as thrift fnstitutfons for IRAs, effective July 6, 1977, the Federal Reserve
Board cited data from December 1976 showing comnercfal banks wfth only about 35
percent of the IRA deposit market whfle accounting for 47 percent of the total
household time and savings deposits.

When you consider that savings and loan

associations have less than 25 percent of the total savings locations, the importance of the 1/4 percent interest rate advantage on IRAs as well as all household
time and .savings deposits becomes even clearer.

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Federal Reserve Bank of St. Louis

347
Although the regulated differential introduced in the Interest Rate
Control Act of 1966 was established to help maintain the flow of funds to the
housing market, the differential may hurt thrifts more than other institutions
during periods of disintermediation.

Since a greater proportion of interest

sensitive funds is at thrifts because of the di fferenti 11 , a greater percentage
of thrift deposits may flow into unregulated money market instruments when interest
rates are rising.
Individuals who have an opportunity to save at a thrift institution. but choose
instead to save at a commercial bank by opening a savings account or buying a certificate of deposit, are being discriminated against.
Bank customers have benefited or will benefit from the elimination of the
differential on:
1) Time deposits of governmental units (1974)
2) NOW accounts 1n Massachusetts and New Hampshire (1974)
3) Long-term retirement accounts ( 1977)
4)

Interest-bearing transaction accounts as proposed in both
S.1664 and S.1668

Bankers are well aware of the justification given in many quarters for the
interest-rate differential--namely, that thrift institutions specialize in housing
more than banks do.

In addition to our feelings about discriminatia, against bank

customers, we have two objections to this rationale for the differential.
First, as mentioned above, the interest rate differential has made
thrift institutions particularly prone to outflows of funds during periods

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Federal Reserve Bank of St. Louis

348
of rising market interest rates.

This instability in the thrift institu-

tion deposit base has been a disruptive force in the mortgage market.
Second, the implication of many of the arguments in favor of the differential
1s that banking is not making a significant contribution to housing finance.

This 1s not true.

As shown in Table 2, banks held $83.7 billion in mortgages

at the end of the first quarter of 1976, more than any other class of institutions,
except savings and loan associations. In addition, banks make a substantial contribution to housing finance through such means as home improvement loans, the purchase of Federal housing agency obligations, and similar investments.

S01111! of

these investments are shown in Table 3, as of the first quarter of 1976.
Over the longer run, as Table 5 shows, the percentage of total assets that
thrift institutions have been holding in the form of mortgages has been trending
downward, while that of banks has been going up.

Indeed, between 1965 and 1976,

the percentage of total assets of mutual savings banks in the form of mortgages
declined from 76.3 to 60.6.

Also, as indicated in Table 4, in both 1975 and

1976 a substantial portion of the increase in deposits at thrift institutions was
not put into housing.

For mutual savings banks, deposits grew at more than twice

the rate of mortgage investments in both years.
We are proud of the record of our industry in housing finance.

From the

standpoint of housing finance there is no justification for the discrimination
against bank customers inherent 1n the interest rate differential.

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Federal Reserve Bank of St. Louis

349
Competitive Equality • Reserve Requirements and Treatment of Reserves
While parity on reserve requirements and treatment of reserves is also
important to the competitive balance between financial institutions, we believe
each State should continue to have the authority to set reserve requirements
for state-chartered depository institutions that are not members· of the Federal
Reserve System, or the Federal Hane Loan Bank System.
The Federal Reserve has pointed to the decline in the percentage of deposits
in member banks (which are therefore subject to reserve requirements) as evidence
that its control of the money supply is eroding.

In spite of this, there is not

general agreement that the Federal Reserve needs the authority to set reserve
requirements for a certain percentage of deposits 1n order to control the money
supply.

Nevertheless, it is useful to determine whether the introduction of

interest-bearing consumer transaction accounts would lead to a significant decline
in the percentage of deposits subject to reserve requirements set by the Federal
Reserve.

It is assumed that the Federal Reserve's main concem is with transaction

balances, that is, demand deposits and other types of interest-bearing transaction
balances.
A preliminary analysis of this problem is presented in Table 6.

We simulated

the effect of nationwide NOW accounts with the use of deposit data from December
,1975.

Even a shift of as much as 40 percent of the funds currently deposited

in household checking accounts at commercial banks to NOW accounts at thrift
institutions, would result only in a moderate reduction 1n the percentage of
transaction balances subject to reserve requirements set by the Federal Reserve
nationwide.

About half of this reduction could be offset by giving the Federal

Reserve the authority to set reserve requirements on NOW accounts he 1d at Federally
chartered savings and loans.

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Federal Reserve Bank of St. Louis

Virtually no reduction would occur if the Federal

350
Reserve were given authority to set reserve requirements on NOW accounts
at all thrift institutions which were members of the Federal Home Loan Bank
System. This results from the fact that Federal Home Loan Bank members account
for about 98S of the deposits at savings and loan associations and about 20S
of the deposits at mutual savings banks.
We believe S.1668 will give the Federal Reserve adequate means to control

the nation's money supply.

It states that the Federal Reserve should be authorized

to set reserve requirements for all Federally-chartered institutions, including
Federally-chartered credit unions, State member banks, and State-chartered thrift
institutions belonging to the Federal Home Loan Bank System. The required reserves
of these institutions should be held either at the. Federal Reserve or at a depository acceptab 1e to the Fed.
The Federal Reserve should not have the authority to detennine reserve
requirements for State-chartered institutions that are not llll!lllbers of the Federal
Reserve System or the Federal Home Loan Bank System. Such institutions should
continue to be subject to reserve requirements according to State law or regulation.

Basically, we are asking that thrift institutions be regulated with respect

to reserve requirements in the same way as banks.

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Federal Reserve Bank of St. Louis

351
The Federa 1 Reserve' s Membership Prob 1em
In reducing the cost of Federal Reserve membership, we believe certain
principles should be fol lowed.

The cost of membership should be reduced by

approximately the same percentage for all sizes of banks.

We support this

approach because the factors which have increased the cost of Federal Reserve
meimership have resulted in approximately the same percentage increase in cost
for members of all sizes.

In fact, even though the increase in cost has been

the same for all sizes of banks, the level of the cost of menmership, under
current reserve requirements schedules, is substantially higher for larger banks
than sma 11 er ones.
There are two elements to the cost of Federal Reserve membership. The
first element depends on the interest rate a bank could earn if it were allowed
to invest those reserves in earning assets.

This rate of sacrificed earnings

is approximately the same for all banks, and has been the major element in the
rise in Federal Reserve membership costs in recent years.

Since the interest

rates on earnings assets are approximately the same for all sizes of banks, the
rate to be paid on reserves should be the same for all sizes of banks.
The second element depends on the amount of reserves which must be held,
and is larger for larger banks.

On demand deposits, banks with less than $2 million

in this type of deposit have a 7 percent reserve requirement, while banks with
more than $400 million in demand deposits have a 16.25 percent reserve requirement.
Thus., in general, the cost of Federal Reserve membership is larger for larger
banks.

Also, this graduated structure of reserve requirements means tlie

nonnal growth in bank deposits will tend to increase the aggregate cost of Federal
Reserve membership.

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Federal Reserve Bank of St. Louis

352
This member bank reserve requirement structure is an historical
accident dating back more than 110 years to the creation of the national
bank system.

It was discriminatory at that time against banks located in

money centers and justified in part by the role of these banks as quasi-central
banks.

That justification disappeared with the creation of the Federal

Reserve System in 1914, but the geographic reserve structure continued until
1972 and is even now reflected in the law.

The Federal Reserve since 1972

has required progressively higher reserve percentages as the total of demand
deposits in each bank increases.

There is no justification for this dfscrimf•

nation among member banks on the basis of size.
It has been said that payment of interest on reserves held at Federal Reserve
Banks would be a subsidy to banks.

This greatly oversimplifies the situation.

The funds which member banks maintain in Federal Reserve Banks are invested
prfmarfly·fn government securities which provide interest income for the Federal
Reserve. This interest income substantially exceeds the costs of providing
services to member banks and a portion of it is paid to the Treasury each year,
The Federal Reserve's investment income was about SS of its assets 1n 1975. Thus,
the Federal Reserve earned about $1.25 billion on $25 billion of reserves held
by member banks.
An estimate of the total cost of Federal Reserve membership can be obtained
by estimating the earnings which reserves kept at Federal Reserve banks would
produce ff they were invested in earning assets.

Such funds would likely be

used to purchase ·Treasury bills or held as correspondent balances.

The market

yield on 3-month Treasury bills averaged 5.80 percent in 1975 and about 5.00 percent in 1976.

An August 1975 survey of correspondent banks in the Kansas City

Federal Reserve Bank indicated an average earnings allowance on correspondent

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Federal Reserve Bank of St. Louis

353
balances of about 6 percent. This was just slightly below the rate on
Treasury bills at that time.

Multiplying the $26.7 billion of reserves at

Federal Reserve banks at the end of 1975 by the 5.8 percent average yield on
Treasury bills provides an estimate of the total cost of membership of about
$1.5 billion in 1975. A similar estimate for 1976 indicates a total cost of
membership of about $1.3 billion.

In other words,41nember banks could have

earned about $1.5 bfllfon more fn 1975 and $1.3 bfllfon fn 1976 ff they could
have invested funds which they held as reserves with Federal Reserve banks.
The earnings that banks sacrifice as a result of sterile reserves held at
the Fed can be vf ewed as a tax on banks. The amount of thf s tax has increased
as a result of the increase fn the cost of Federal Reserve membership. The
increase fn the cost of membership was primarily the result of an inflation
induced rise in market interest rates.

The proposals being discussed merely

authorize the Federal Reserve to reduce the amount of this tax to levels which
existed before the inflation· induced rise in interest rates.
Federal Reserve membership confers benefits on those who are willing to pay
the price.

These include services such as check clearing, provision of coin

and currency, safekeeping for securities, and access to the discount window. The
Federal Reserve has also recently put out for CDIIBlll!nt a proposed regulation that
110uld allow ft to charge expl fcit fees for the services ft offers -1>er banks.
The implementation of such a regulation would at least partially offset the reduction in the cost of membership occasioned by the payment of interest on reserves.
Altho_ugh larger banks use proportionately more of these services than smaller
banks, we suspect the Federal Reserve would not allow a regime of explicit pricing that allowed volume discounts.

Similarly, reserve requirements and interest

paid on reserves held should be nondiscriminatory with respect to bank size.

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Federal Reserve Bank of St. Louis

354
Federal Reserve spokesmen have made it clear that that the Board
desires the authority to pay interest on reserves as a means of making Federal
Reserve membership more attractive, particularly to smaller banks.

There is

an implication that ff the limitation on total interest payments is such as

to produce a payment believed inadequate for this purpose, the Board will look
favorably upon plans to pay interest to smaller member banks at higher rates
or otherwise to discriminate against larger banks.

This overlooks the fact that a

number of nonmember banks are large (in excess of $1 billion fn deposits),
but it has a greater flaw in compounding what is already a discriminatory
system for setting requirements against the deposits of member banks.

Unless

the burden of Federal Reserve membership fs eased on a uniform basis across
all sizes of banks, the trend toward larger and larger banks withdrawing from
the system will continue.

Thus, the results of discrimination may well be

counter productive, for the loss of one large member bank can easily offset the
attraction of many new sma 11 er members.
The consideration of the payment of interest on reserves simultaneousl.11'.
with interest bearing transaction accounts is in some ways misleading for
ft is an easy conclusion that interest on reserves is required to cover the
cost of payments to consumers.

The payment of interest on member bank

reserves should be viewed as a structural change in the banking system whfc:h
is a long-overdue step to lessen the cost to member banks of belonging

to the Federal Reserve System. This provides support to the nation's
monetary authority, and should be viewed in this context.

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Federal Reserve Bank of St. Louis

355
Other Bills Being Considered
Although our statement has concentrated on only two of the six bills being
considered during these hearings, we believe the conditions established 1n
S. 1668 with respect to interest rate ceilings, reserve requirements, and
treatment of reserves must be applied to many of the proposed recommendations in
the other four bills.

Over the last few years, our Association tias had the

opportunity to testify on a number of these issues before this Subccmfttee
an,t the House Subcommittee on f'inancial Institutions, Supervision, Regulation
and Insurance.

However, some of the proposals in the other four bills are new

and have not been discussed fn detail or acted upon by our Government Relations
Council.

s.
1.

For this reason, we can only state our tentative views at this time:
1665
Federal Chartering of Mutual Savings Banks. Title I limits Federal status
to only those institutions which are State chartered institutions at the
time of conversion to a Federal charter. When conditions concerning
parity on interest rate ceilings and reserves are adopted, we will be
willing to support this title.

2. Mana ement Powers of Credit Unions. Because these provisions would
comp etely reverse credit unions I traditional service to low-and
moderate-! ncome savers and borrowers, they wi 11 make credf t unions
comparable to other financial institutions. We see no reason to obje1.t to this change so long as it is accompanied by the provision
of S. 1668 equalizing the interest rates and reserve requirements
on credf t uni on deposit, share and other accounts.
3.

Central Liquidity Fund for Credit Unions. We have no objection to this
proposal as long as our conditions on interest rate ceilings and reserves
are adopted fn connection with the expansion of credit union asset and
11 ability powers.

Restructuring of the National Credit Union Administration.
objection to this proposa 1.

s.
1.

We have no

1666
Extension of the Interest Rate Control Act. We are opposed to this
proposal because it is inconsistent 1<nth the changes recommended in
1668.

s.
2.

lO<n Insurance of Public Funds.
and should not be adopted.

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Federal Reserve Bank of St. Louis

We believe this proposal is unnecessary

356
3. Variable Rate Mortgages. We support any experiments that may be helpful fn the development of variable rate or other flexible mortgage
i ns truments •
4.

~ansion of Lending and Investment Powers under Title V of the Home
itrs Loan Act. We would support the expansion of lending and investment powers far Federal savings and loan associations as long as ft was
accompanied by an equalization of interest rate ceilings, reserve
requireMnts, and treatment of reserves as proposed fn S. 1668.

Federa1 Chartering of Mutua 1 Savings Banks. When our candi ti ans on
parf ty of 1nterest rate cef l1 ngs and reserves are met, we w111 be wi 11i ng ta support the Federal chartering of m11tual savings banks. However,
we appose this particular provision because it would allow a converting
institution to begin a new line of investments just prior ta conversion
rather than being subject to the five year historical restriction of
Title I of S. 1665.

hlliL
Except for our opposition to the proposed extension of interest rate controls
in Title I, we have no objection to the provisions of s. 1667 ff parity on
interest rates and reserves are also accepted.

1:...lfil
We have no- obj ectf on to thf s proposa 1.

The American Bankers Association has attempted ·ta address the issues of
1nterest-bearf ng transaction accounts, competf ti ve equa11 ty among ff nancf a1
institutions, and the burden of Federal Reserve membership fn a constructive
way.

I believe that S._ 1668 deals directly with these major concerns.

general, we have no abjection ta any of these additional proposals as long as
they are accompanied by parity an interest rate ceilings, reserve requirements,
and treatment of reserves.

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Federal Reserve Bank of St. Louis

357
Table 1
Corrmerci a1 Bank Deposit Market Shares
1970 • 1976
~

Percent Growth in
Market 1970-75

Conmercial Bank'
Market Share 11

1975

1976 'I/

Percent
66.5

64.8

99.7

1) All Deposits

2) Demand Deposits

3) All Time and
Savings Deposits

51.7

53.9

52.5

4) IPC (individuals, partnerships, and corporations)
Time and Savings Deposits

48.3

49.6

48.7

5) IPC Regular Savings
Deposits

39.4

45.4

47.1

147

49.0

40.8

7) Household Time and
Savings Deposits

46.4

47.6

8) Household Regular
Savings Deposits

40.3

44.8

152

56.6

50.5

6) IPC Time and Savings
Deposits Excluding
Regular Savings Deposits and Large CD's

9) Household Time and
Savings Deposits other
than Regular Savings

68.8
100

1/ Not including Credit Union Shares.

y Preliminary
Sources: FDIC, Assets and Liabilities, selected dates, Federal Reserve Bulletin,
selected dates, NAMse Fact Book, selected dates, USLSA Fact Book,
selected dates, Federal Reserve Board, Flow of Funds Statistics. All
time and savings deposits at thrifts are assumed to be held by households. Line.6 uses data for insured commercial banks for Jan. 31, 1971
and Jan. 31, 1976. Lines 8 and 9 assume that 97% regular savings
deposits at commercial banks in 1975 were held by households compared
to 100% in 1970.

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Federal Reserve Bank of St. Louis

358
Table Z

Mortgage Loans Outstanding, by Type of Lender
First Quarter 1976
(Billions of Dollars)
One-to
FourFamily

MultiFamily

Total

Savings and Loan Associations
Cor.aerci al Banks
Mutual Savings Banks
Life Insurance Companies
All Others

$231.3
78.2
50.3
17.3

$257.2
83.7
64.2
37.0

ill.:.l

$25.9
5.5
31.9
19.7
35.7

Total

$503.4

$100.7

$604. l

Source: Federal Reserve Board

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Federal Reserve Bank of St. Louis

lli.:.l!.

359
Table 3
The Banking Industry's Contribution
to Housing Finance
F1 rst Quarter 1976
(Billions of Dollars)

Residential Mortgage loans
Mobile Home Loans
Home Improvement.Loans
Residential Construction Loans
Residential Land Loans
Federal Housing Agencies Obligations
Municipal Securities Supporting Housing
Loans to Other Housing Lenders

$ 83.7

Total

$221.2

Source:

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Federal Reserve Bank of St. Louis

Federal Reserve Board

8.7

5.9
8.1

2.3

14.5
78.0

360
Table 4
Percentage Increase in Total
Deposits and Mortgage Loans
1975 and 1976
(In percent)

Con-mercial Banks

lllutual
Savings Banks

Savings and Loan
Associations

1975
Increase in Total
Deposits

4.6

11.3

17.7

Increase in Mortgage
Loans

3.or\

3.1

11 .8

6.0

11.B

17.5

10.7

5.7

15.9

1976
Increase in Total
Deposits
Increase in Mortgage
Loans

Sources: FDIC; National Association of Mutual Sa.vings Banks;
United State League of Savings Associations.

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Federal Reserve Bank of St. Louis

361
Table 5

Percentage of Total Assets in
Mortgage Loans,
Selected Year-End Dates,
1965 - 1976,

(In per cent)
1965

1975

1976

Co111nercial Banks

13.2

14.2

14.5

Mutual Savings Banks

76.3

63.8

60.6

Savings and Loan Associations

BS. 1

82.4

02.4

Sources: FDIC; National Association of Mutual
Savings Banks; United State League
of Savings Associations

32-972 0 • 78 •
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Federal Reserve Bank of St. Louis

362
Table 6

Percent of Transaction Balances 1/subject to Reserve
Requirements Set by the Federa 1 Reserve

Percent of Household Demand Del'IOsits
Shifted to rmw Accounts at Thrift Institutions
0%
Types of Deposits Subject
Reserve Requirements
Set bl:'. Federa 1 Reserve

10%

20%

40%

Percent of Transaction Balances Subject to
Reserve Regui rements Set B):'. the Federa 1 Reserve

All Deposits at Member Banks

76.4%

74.0%

71.6%

66.4%

A11 Deposits at Member Bar.ks ,
NOW Accounts at Federally
Chartered Thrift Institutions

76.4%

75.3%

74.2%

72.0%

All Deposits at Member Banks,
NOW Accounts at Thrift Institutions which are Members of
Federa 1 Home Loan Bank System

76.4%

76.3%

Demand Deposits held by individuals, partnerships and corporations nlus
NOW Accounts at all financial institutions

Ass ump ti ons
1.

The ratio of IPC demand deposits at member co11111ercial banks
to IPC demand deposits at nonmember c011111ercial banks remains
constant.

All funds in NOW accounts at thrift institutions come from
household checking accounts at commercial banks.

Member and nonmember con111erci a 1 banks 1ose househo 1d demand
deposits to NOW accounts at thrift institutions in ~roportion
to their total volume of household demand deiiosits.

Different types of thrift institutions attract NOW account funds
in proportion to their total time and savings deposits. Credit
unions were not included in the analysis.

The ratio of household demand deposits to IPC demand deposits
is the same for member and nonmember con111erci a1 banks.

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Federal Reserve Bank of St. Louis

APPENDIX I

COMPARISON OP ADMINISTRATION AND ABA BILLS

s. 1664·
ADMINISTRATION BILL

1668

ABA BILL

Ownership and use of
HOW Accounts
{See Note 2 below)

Owner must be individual or nonprofit
association (including crcdft unions);
no restriction on use (Sec. 101) •.

Pine for violations
of HOW Account
restrictions

Repeals fine (in rewriting 12
1832, Sec. 101 omits fine).

Other kinds of
Savings Accounts
used to pay bills

Two types of accounts are authorized in
Section 101. Other types would be
allowed by State law or other provisions
of federal law (such as 12 U.S.C. 1464
(b)(l)). for instance, an S&L -y agree
to pay bills from a savings account as
the saver directs over the phone. The
account is not a "HOW'' account as defined in i:he bill because no "negotiable
or transferable instrwaent or other
similar item" is used to withdraw the
money. Apparently, this account would
be subject to a higher ceiling unless
the 4 agencies used their broad authority to treat it as a HOW account. That
could be done only if all 4 agencies
agreed to issue a "similar'' regulation
or order.

u.s.c.

Owner must be individual and account must
be used for hie personal purposes (~ec. 1).

Continues preaent proviaion subjecting institutions that violate restrictions on HOW
accounts to $1,000 fine for each violation
(12 u.s.c. 1832(c)).

All savings accounts from which transfers
to third parties -y be made are subject
to the same ceiling, regardless of how
transfers are made (Sec ■• 1, 2(c), and 6).

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Federal Reserve Bank of St. Louis

s. 1664
ADHIIIISTRATIOH BU.L

.ill!!!
4. · Bate Ceilings:
Uniformity

s. 1668
ABA BILL

Ceilings are uaifoni for all ROif accounte
(Sec, 104(a)),.but statutory rate differential continues for other accounts
(lower ceilings for comercial baoke than
for thrift institution■) unless changed
with approval of both Hou- of Congress
(Public Law 94-200, 12 u.s.c. 46lnote).

If institution offer ■ ld-part:,-payaeot
accounts, with or without interest, all
ita accounts are subject to aaae ceilings
aa bank~ (Sec. 6); statutory differential
ta repealed (Sec. 7(c)).

Institutions insured
by FDIC or FSLIC, and
other l'IILB members_

Ceilings apply to all interest-bearing
consumer deposits (existing law).

Same (existing law).

Federal credit unions

Ceilings apply to NOW accounts ouly
(Secs. 104 (a), 104 (e)).

Ceilings apply to all interest-bearing
consumer deposits (Secs. 2(c), 5(b), 5(c)).

Other insured credit
uaions

Ro ceilings (see note 3 below).

Ceilings apply to all interest-bearing
consumer deposits (Secs, 2(c), 5(b), 5(c)).

Uninsured credit
unions

Other uainaured,
~ e r inatitutiona

Ceilings apply onl:, if the:, hold over
20% of thrift account ■ in State where
no State ceilings apply (existing law).

Bate Ceilings:
Coverage

ceilings.

Ceilings apply if credit union offers
ld-party-paymeot accounts, with or without
interest (see 3 above, Sac. 2(c)),
Ceilings apply if they offer ld-party_pa:,ment accounts, with or without interest
(sea 3 above, Sec. 2(c)),

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Federal Reserve Bank of St. Louis

s. 1664
ADMINISTRATION BILL

1668

ABA BILL

Bate Ceilings: Agency
responsible for setting ceilings on NOW
accounts

3 of 4 agencies (RB, FDIC, l'IILB, and IICUA)
aust agree on HOii account ceiling, except
FD liay set initial ceiling if.DO agreement ia reached in 6 -ntha (Sec. 104 (a)) •

RB seta ceiling on HOW accounta after
consulting other agencies (Sec. 2(c)).

Bate Ceilings:
Expiration

Dec. 15, 1979, rate ceiling authority
revarta·to pre-1966 law except for HOW
account• (Sec. 301). Ceilinga for HOWs
continue for 3 years (4 years from enactment), when they expire unless renewed during the next 3 years by vote
of 3 of 4 agencies (Sec. 104(a)).

Bate Ceilings:
Grandfather clause

Over-ceiling rates on NOW accounta_in
existenc_e at ensctaent may continue
for 4 years after enactment (Sec. 104(b)).

Extension of reserve
requirements to
nomaembera of PRS

Reserve requirementa apply to HOW
accounts at all institutions insured
by FDIC, FSLIC, or HCIJA; all l'HLB
members; and uninaured savings banks
(Secs. 102(a), 20l(a)).

Reserve requirements apply to intereatbearing 3d-party-pa:,ment accounts at
l'HLB ■embers and Federal credit unions,
in addition to Fed -■her banks (Sec. 2(b)).

How reserves may
be held

Reserves uy be held as vault cash, at
Fllllank, or (for nomaeabers) at interaediary I'll ■ember bank, or at l'HLBank
(Sec. 202(a)).

Reserves uy be bald aa vault cash, at
l'RBank, or (for PIILB -bera) at l'HLBank
if it holds them aa vault caah or at
RBank (Sec. 2 (b)) •

10.

Dec:. 15, 1980, rate ceiling authority
reverts to pre-1966 law (Sec. 7(a)).

such provision.

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Federal Reserve Bank of St. Louis

s. 1664
ADMINISTRATION BllL

s. 1668
ABA BILL

11,

Phase-in of reserve
requirements for nonmembers of FRS

For nonmembers of FRS, required reserves
are reduced by 75% in first year, SO% in
second, and 25% in third (Sec. 2Ol(b)),

Ho phase-in ~rovision.

12,

Reserves on demand
deposits st FR
member banks

FRB sets requirement at not more than 22%
nor lesa than 5% (7% for banks with more
than $1S million of net demand deposits)
(Sec. 2Ol(a)).

FRB sets requirement at not more than
20% nor less than S% (Sec. 2(a)).

13.

Interest on
required reserves

FRBanka may pay interest on required
reserves they hold at rate fixed by
FRB; payments may not exceed 10% of
net eamings of FRBanks in previous
year (Sec. 2O2(b)).

Same, except rate paid must be uniform
regardless of aize of reserve balance
or nature of institution, and lilllit is
S% of required reserves held by FRBanks
at end of previous fiscal year (Sec. 2(b)).

14.

FRBanks as
clearing houses

FRBanks may receive "other items, ineluding negotiable orders of withdrawal"
as well as checks and drafts payable on
presentation, and accept deposits from
nonmembers on same tenas as FR members.
Nonmembers of FR must maintain clearing
balances at level FRB deema "appropriate";
law now requirea level sufficient to
offset their items in transit. FRB may
require FRBanks to act as clearing
house for nonmembers of FR, and may
fix charges (presumably for collecting
items) that depository institutions
impose on their cuatomars whose items
are cleared through FRBank (Sec, 2OS).

such provisions.

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Federal Reserve Bank of St. Louis

s. 1664
ADMlHlSTRATlOH BILL
15,

Effective date

Bill takea effect one year from enactment (Sec. 206),

s. 1668
ABA BILL
Bill takes effect one year from enactment,
except it takes effect 60 daya from enactment in H- England (Sec, 8), and
repeal of statutory differwtial takes
effect on enactment (aee 3 above, Sec, 7(c)),

~=
1. This table ia based upon readings. 1664 and the section-by-section analysis of it in the
CONGRESSIONAL RECORD. Where unclear, we have tried to resolve ambiguities by presuming the framers' intent.
2, In this table "HOW account" is used to cover other klnds of interest-bearing third-party-payment
accounts (such as share draft accounts at credit unions) as well.
3, The earlier FRB draft bill applied ceilings to all credit unions insured by HCUA, not just Federal
credit unions. While S, 1664 is not entirely clear on that point, the ceiling authority is inserted in a
provision that relatea aolely to Federal credit unions, and the earlier FRB draft's reference to other insured
credit unions is omitted. We assume an intent to ex~lude other credit unions frDIII coverage.

368
APPENDIX II
DEPOSIT POWERS OF RANKS
~ND THEIR COMPETITORS
BAHKS
ROW

WAT

Checking accounts

Nationwide

NOW accounts

MA, NH, C'I, ME, at, VT

Telephone transfers from
cuetomer' a savings accounts
to checking account

Nationwide

Federal regulation

State Chartered banks in:
AL, AR, co, CT, FL, GA,
ID, IA, KS, ICY, LA, ME,
MD, MA, Mr, NE, NH, NJ,
NM, NY, NC, ND, OK, OR,
OR, RI, SC, SD, '1'N, VA,
WA, WI
National Banks providing
they comply with branching
laws

State statutes and
regulation

Manned remote service
units or off-premiae
automated teller machinu

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Federal Reserve Bank of St. Louis

. Stat• and
Federal statutes

369
SAvtllGS AIID LOAN ASSOCIATIONS

HA, HB

State atacutes and interpretations;
federal ■tatute (federal a&la)

CT, ME, ll, VT

Federal. atatute

'tfon-:1.nt~-r•at bearing NOWs

CT• IL, ME• ff• I.I, WI

State statute• and interpretations

Preautbor:l.zed bill paying

llat:l.omr:l.de (federal a&la)

llous:l.ng Act of 1970; Federal llaae
Loan Bank Board -rags.

Bill paying by telepboue

All, CA, DC, I'!., BI, IIB,
Olt, PA, TX

State ud federal regulations

HOW accounts

Checking accounts ,

Manned roa,te aerv:l.ce wi:1.t■
and off-prell:l.ae automated
tallar aacb:1.ne■

, llat:1.omr:l.de (federal
AL,
lCY,
NM,
WA,

TelapboH transfer ■ from
aaviup :l.n federal •&l•
to demand deposit account ■

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Federal Reserve Bank of St. Louis

s&l■)

CO, CT, FL, IA, JCS,
ME, KA, Kl', NB, NJ,
NY, I.I, SC, SD, VA,
WI

ll&t:l.omr:l.da

Fedaral Rome Loan Bank Board regs.

sc•t•

atatutes
(itentucky by regulat:1.ou)

Federal llome Loan Bank Board rags.

370
MIJTlJAL SAVINGS IIAIIICS

!!!!Y
NOW Accounts

MA, NH

State atatute~ :md i:iterp?'e:atio~ i

CT, ME, II.I, VT

Federal atatute

CT, DE, IN, ME, MD, MN,
NJ, NY, 01, PA, II, VT

Charters, bylaws, atate statutes
and interpretations

Bill paying by telephone

CT, MA, MN, HJ, NY, PA,
II, VT, WA

State and federal r!!gu!.ations

Manned remote aervice
,mit ■ end off-pru.iH

CT, ME, MA, MD, Nil, NJ,
NY, OR, II.I, WA

State statutes

Clt-.cking accounts,
Non-interest bearing NOWs

autoMted teller mchinea

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Federal Reserve Bank of St. Louis

371
CREDIT UNIONS

NOW Accounts

11A

State

■ tatute

Checking accounts,
Non-interest bearing !fOWs'

HV, ll, UT

State

■ tatutes

Nationwide (federal etls)

National Credit Un:!.cin Ad~::'li.s,;ra

AL, C0 1 FL, ID, IA, MA,
KT, NM, RI, SC

State statutes

Manned remote service
1111it1 11114 off-premise
automated taller uchioe ■

Shara

dl!&ft ■

llationwide (federal

CU ■)

AL, CA., CO, CT, PL, ID,

a.r.d !:it-s:-p:-etatio

National Credit Un!.on Admini.3 :.ri.. -::!.c~•
Stat ■ ■ tatutes

and interpretatic::is

IL, IN, IA, D, MI, MN,
MO, HI', IV, NC, ND, OR,
OK, II, TN, TX, OT I VA,
V"r, WA, WI

Share certificates, lines
of credit, mrtgage loan•
to 30 year ■, etc.

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Federal Reserve Bank of St. Louis

■ tatuta

llationwide (federal CUs)

Federal

AL, AZ, CA, CO, ID, U,
LA, ME, MN, H'l', HI, NM,
OJ., RI, TN, TX, UT, VA

State "wild card" statutes

372
BIBLIOGRAPHY
American Bankers Association, Economic and Financial Research Division.
Studies on the Payment of Interest on Checking Accounts, December 1975.
Benston, George J. "An Analysis and Evaluation of Alternative Reserve Requirement Plans". The Journal of Finance, Volume XXIV, No. 5, December 1969.
Boehne, Edward G. "Falling Fed Membership and Evading Monetary Control - Wha'!
Can be Done?" Business Review, Federal Reserve Bank of Philadelphia, June 1974.
Chase, Samuel B. Jr. "The Impact of Payment of Interest on Demand Deposits, A
Critique of a Study of the Staff of the Board of Governors of the Federal
Reserve System". Prepared for the American Bankers Association, Washington,
D. c., June 1977.
Federal Reserve Bank of Boston. Report to the Board of Directors on the issues
and implications of banks' membership in the Federal Reserve System, September 1976.
Federal Reserve Board, Staff. The Impact of the Payment of Interest on Demand
Deposits. January 31, 1977.
Federal Reserve Board, Staff. "Effects of NOW Accounts on 1974-1975 Conmercial
Bank Costs and Earnings", by John D. Paulus, August 1976.
Kaminow, Ira. "Why Not Pay Interest on Member Bank Reserves," Business Review,
Federal Res_erve Bank of· Philadelphia, January 1975.
Knight, Robert E. "Comparative Burdens of Federal Reserve Meri>er and Nonmember
Banks," Monthly Review, Federal Reserve Bank of Kansas City, March 1977.
Management Analysis Center, Inc. The Chl:ing Imrct of the Interest Differential.
In progress. Being prepared for the
rican ankers Association, June 1977.
Mayne, Lucille S. Deposit Reserve R,uirements:
the American Bankers Associat1on, pril 1975.

Time for Change.

Meltzer, Allan H. "Credit Availability and Economic Decisions.•
Credit Allocation, University of Rochester, New York, 1975.

Prepared for

Government

South Carolina Bankers Association. The Payment of Interest on Checking Accounts,
by David C. Cates and Samuel B. Chase, Jr., February 1976.

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Federal Reserve Bank of St. Louis

373

STATEMENT OF THE
AMERICAN BANKERS ASSOCIATION
BEFORE THE

SENATE Cct-1MITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
ON THE
ROLE OF THE FEDERAL RESERVE IN
PROVIDING PAYMENTS MECHANISM SERVICES

October 11, 1977

374
Mr. Chairman and members of the Committee, I am Charles F. Haywood,
Professor of Economics at the University of Kentucky.

I am appearing today

on behalf of the American Bankers Association, and am accompanied by Thomas
Rideout, Senior Vice President, Wachovia Bank & Trust Company, N. A., tlinstonSalem, North Carolina and a member of the Executive Committee of the Correspondent Banking Division of the American Bankers Association.

We welcome the

opportunity to testify before your committee on the role of the Federal Reserve
in providing payments mechanism services.

The question was fundamental

in the

minds of policy makers when the Federal Reserve was originally set up, and is of
continuing importance today, particularly in light of the development of new
electronic forms of payments services.
The Provision of Payments Services by the Federal Reserve
in its Capacity as the Nation's Central Bank
The provision of paymen1s services is not a necessary function for the
Federal Reserve in its capacity as the nation's central bank.

The only nec-

cessary function for the nation's central bank is the management of monetary

policy.

In today's economy, we can see no inherent reason why the provision

of payments services must be exercised by the central bank in order to perform
this function.
However, at the time of the founding of the Federal Reserve, it was deemed
appropriate for it to perform a variety of payments services and it has traditionally

done so.

Before discussing the appropriateness of this role today, it will be

useful to review some of the services provided by the Fed, and some of the historical
factors which prompted it to provide payments services.
The Federal Reserve system augments the collection of checks on a nationwide
basis through its unique branching network throughout the country.

While the vast

majority of checks are cleared by direct exchanges between banks, the Federal

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Federal Reserve Bank of St. Louis

375
Reserve

provides a utility for interstate exchange not currently available

in the private sector.

It is.useful to note, however, that many of the large

banks have in recent years elected to bypass the Fed in favor of direct presentment of items even to far remote cities.

The Automated Clearing Houses operated in several cities by the Federal
Reserve have allowed an orderly transition toward electronic funds transfer
and benefited the American people by allowing the Treasury to speed payments
and reduce costs of processing Treasury payments.

The Fed has been inst1"lll'lental

in helping to develop this service.
The Fed WIRE, which allows the rapid transfer of funds from city to city,
has been greatly enhanced in recent years.

It allows major transfers of funds

to occur quickly and safely outside the check collection system.
Through its Coin and Currency operations, the Federal Reserve provides
the distribution networks for new cash from the Treasury into the hands of the
American people and the collection system for worn and mul tilated currency.
One of the reasons the Federal Reserve was established was because the
Congress perceived the public interest to be served by the establishment of a
uniform national currency.

In response to this concern, the Fed adopted a delib-

erate policy of attempting to eliminate non-par banking, the system whereby recepients of payments by check were charged fees for the privilege of depositing
those checks in their bank accounts.
ful.

For the most part, this effort was success-

Non-par banking was 'disliked because, at the time of the establishment of

the Federal Reserve, our financial system had evolved to the point where checks

were considered to be a substitute for currency.

People felt that, if the value

of a dollar used in a transaction was unrelated to the distance between transacting
parties, the same should be true of a check.

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Federal Reserve Bank of St. Louis

Also, there was a general belief that

376
non-par banking encouraged an inefficient payments system, as checks tended
to take

very circuitous clearing routes in the attempt to avoid exchange fees.

Problems of bank soundness were, in some cases, also associated with the high
costs

and inefficiencies of check clearing.

The establishment of the Federal

Reserve, with a system of required clearing balances for member banks, and the
provision of free clearing services to them, did much to restore public confidence
in the efficiency and soundness of our payments system.

Thus, one of the reasons

the Federal Reserve was established was because Congress perceived a role that
was not being fulfilled by the private sector.
In today's world, however, there is an active and efficient payments
mechanism provided by the private sector.

While we would certainly not recommend

that the Fed get out of the payments business entirely, it is not clear what the
appropriate role for the Federal Reserve in the provision of payments services is.
A complete withdrawal of the Fed from the payments business would be a wrenching
experience for the banking system and should be done on a gradual basis, if at all.
Nevertheless, we must note that more and more banks are finding Federal Reserve
services less valuable relative to the reserves they must hold, and are withdrawing from the System.

Surely this calls into question the appropriateness of the

Federal Reserve in providing payments services today.

Of course, one of the reasons

Federal Reserve services are becoming less valuable to banks is the manner in which
they are implicitly priced.

Banks that are willing to bear the excessive burden

of reserve requirements are given the services free.
not obtain services from the Fed at all.

Other banks, generally, do

A second factor lessening the value of

the Fede:ral Reserve membership has been the innovativeness of the private sector
in providing payments services.

As the income lost from investment in non ... interest

bearing reserves has become more and more costly, the private sector has become

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Federal Reserve Bank of St. Louis

377
more efficient in the provision of payments services and its market has expanded.
In fact, some payments services, such as the bank card, have developed entirely

in the private sector and have become very popular and cost-effective.

This

innovativeness in the private sector would also seem to call into question the

appropriateness of the Federal Reserve' s role in providing payments services.
In addition, we foresee several difficulties in pricing of existing Federal

Reserve services

and the provision of new ones.

The problem of determining proper

cost allocations is bad enough for regulators of private firms.

For the Federal

Reserve with its unique monopoly power to create money and its responsibility for
administering monetary policy, the situation would seem nearly impossible.

How

does one allocate overhead costs among such diverse activities as the administration of monetary policy through open market operations, the provision of

services as fiscal agent for the Federal Government, the supervision of statechartered member banks, the regulation of bank holding company activities, and
the provision of payments services which also can be provided by private banks?
Even if all the relevant data were kn01,n, we can think of no way to do this

on a rational basis.

Indeed, as new payments systen5 evolves, it becomes more

and more difficult to even know the relevant data.

And the relevant data must

be known if Federal Reserve involvement in a particular activity is to be justified

on the basis that the private sector is not providing adequate service.
It is for this reason that the American Bankers Association suggested to the
National Cononission on Electronic Funds Transfer, that in EFT areas where new

payments services are developing rapidly, -- automated clearinghouses might be an
example of this -- if Fed involvement is appropriate the service should be priced
on the basis of what the private sector would charge if it provided the service.
Even this rule is difficult to implement on a fair basis since vendors of payments
services in the private sector will frequently be charging different prices and

32•972 0 • 78
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Federal Reserve Bank of St. Louis

- 25

378
operate under different cost conditions.
belief that

This policy was proposed because of the

in some EFT areas there may be a "demonstration value" to having

the Fed proVide a particular service, with the private sector taking over the
function after the value of the service is realized and known by all.

This may

have been the case with check clearing at the time the Fed was established.

There

seems to have been a clear need to demonstrate the value of par banking. However,
with the increasing sophistication of correspondent banks, and the advent ·of
deposit insurance, many of the inefficiencies and riskiness have beeri removed·
from payments activities.

The provision of payments services is the main banking area in which the
Fed competes directly with the private banking system.

Yet with 12 regional

banks, each having several branches which serve primarily as operations centers,
the Fed already has a nationwide system of operations centers in place. There is
no way a single bank can be said to match this capability under the current banking
structure.

This makes accurate comparisons of the public and private clearing

systems even more tenuous.
Another example of the difficulties of explicitly pricing Federal Reserve
services was highlighted during recent consideration of S. 2055, proposed legislation dealing

with NOW accounts and the burden of Federal Reserve membership.

discussion of this legislation, the Federal Reserve seemed to justify discrimination
against larger banks in the payment of interest on reserves on the g:,:ounds that
these banks took greater advantage of "free' 1 Federal Reserve services.

Yet, surely

there are volume efficiencies in the provision of many payments services.
the Fed propose to give volume discounts?
such a policy.

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Federal Reserve Bank of St. Louis

Would

Explicit pricing would seem to suggest

379
In sum we believe a thorough investigation of the role of the Federal
Reserve in the provision of payments services is certainly appropriate at
this time.

However, the proper roles for the public and private sectors

cannot be determined by merely saying they should compete on an equal basis.
Access to the Federal Reserve's Services

If there is a proper role for the Federal Reserve in the provision of
payments services it would, at first, seem logical that such services

should be provided to all institutions.
with this approach at this time.
set up

Unfortunately, we cannot agree

When the Federal Reserve was originally

thrift institutions were not in the payments business, and it was

widely anticipated that all banks would eventually join the Fed.

Of course,

a significant portion of the banking system did not join the Fed, and in
recent years other institutions have been getting into the payments system.
The provision of payments services by the Fed is largely financed by the
income derived from the use of reserves that must be held by member banks.
These reserve requirements operate as a discriminatory tax.

If payments

services were provided to all institutions, reserve requirements would

become even more discriminatory.

Until something is done about the excessive

burden of reserve requirements, only member banks should have direct access
to Federal Reserve services.
Costs and Benefits of the Pricing of Federal Reserve Services
Two objectives frequently mentioned for the pricing of Federal Reserve
services are economic efficiency and the development of technologically
efficient payments systems.
Federal Reserve involvement in the payments systems has been justified
by some on the grounds that there is, in some sense, a failure in the private

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Federal Reserve Bank of St. Louis

380
marketplace.

Payments services have been perceived by some as having

economies of scale which cannot be reali:ed in the private marketplace and
should not be priced on a full cost basis, but only according to the marginal

cost of producing one extra unit.

Alternatively, it has been suggested

that payments services might involve a public good which has such widespread
benefits that they should be offered for free.
ll'hile we are skeptical of the accuracy of these views, it is useful to
examine the implications of these methods of pricing.

We have already men-

tioned the problem of cost allocations in a diverse public institution such
as a central bank, and the difficulties in knowing the relevant data when
technology is changing rapidly.

There is an additional problem in that

neither of these pricing methods would generate enough revenues to cover the

cost of producing the service.

Payments system activities would have to be

subsidized relative to other economic activities.
method would discourage private competition.

Also, such a pricing

For these reaso~~ it is our

belief that when the relevant data are difficult to know any new venture by
the Federal Reserve into the payments system area should only be on a basis
that does not discourage private competition.

Surely, when no one knows the

form the future payments system will take, this is the best rule.

Even

with such a rule, we believe the burden of proof should be on the Federal Re-

serve to demonstrate the failure of the private payments systems before it
undertakes any new activities.
Another potential objective in the pricing of Federal Reserve services

is the development of technologically efficient payments systems.

The de-

velopment of some EFT applications may be extremely risky for private
concerns to undertake.

Nevertheless; some of the applications may increase

the efficiency of the payments systems and the Fed may want to provide such

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Federal Reserve Bank of St. Louis

381
services on a temporary basis.

Under these circumstances, pricing of these

services may be based more on considerations of the temporary nature of the
Federal Reserve' s participation in the market than on considerations of
short run economic efficiency.

and delay their development.

.-\ high price will forestall use of these EFT services

A low price will accelerate use and acceptance

of the services, but delay development of private EFT systems.

One potential

approach in this situation is the method suggested previously.

That is,

charge what the private sector would charge if it "1ere offering the service.

How do these approaches to pricing compare with the current pricing
methods used by the Federal Reserve?

From the standpoint of an individual.

member bank -- the Federal Reserve sets a direct price of zero on services
provided and then imposes a tax on it.

The size of the tax is based on the

deposits of member banks and substantially exceeds the cost to the Federal
Reserve of providing the service.

This method of pricing has resulted in

at least one and possibly two distortions.

The first distortion is caused

by setting the price of access to Federal Reserve services above either the
average or marginal cost of producing them.

This results in a smaller than

optimal number of banks making use of these services.

This is currently

being discussed as "the Federal Reserve' s membership problem".

Setting the

direct cost of these services equal to zero for member banks may create a
second distortion.

Some member banks may use an excessive amount of the

services from an efficiency standpoint.
Direct pricing of Federal Reserve services alone will only eliminate
the second distortion.

Any approach to direct pricing must include a sig-

nificant reduction of the high price in terms of reserve requirements which
banks

Jm.lSt

pay to gain access to Federal Reserve services.

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Federal Reserve Bank of St. Louis

This could be

382
accomplished by a reduction in reserve requirements, pa:1nent of interest

on required reserves, or allowing certain types of earnings assets to
qualify as reserve assets.

At one time the Federal Reserve put out for comment proposed changes in
Regulation J which called for explicit ??'icing of services and credits against

these prices for reserves held.

Such a pricing scheme is anti-competitive

in that it reinforces the incentive member banks have to use only those
services provided by the Fed, and neglect private market alternatives.

Our

comments to this proposed regulation are attached to our statement and discuss

this in further detail.

In addition, this proposed regulation illustrates

very well the temptation that exists to use explicit pricing as a tool to stem

the erosion of Federal Reserve membership.

If this were to happen, the broader

questions of economic efficiency and an efficient payments systems could easily

become hostage to the membership question.
Impact of the Federal Reserves' Current Role in the
Paymen~s Mechanism on Correspondent Banking
The current Fed policy in providing payments services is to charge a
high admission fee, but to charge nothing per unit once access is established.
In essence, the Fed currently is financing its payments mechanism by a tax
on member banks in the forin of required reserves.
The situation encourages the formulation of correspondent relationships

to spread the high cost of initial access to the services; member banks shift
their burden of cost to non-members by charging an implicit fee for Fed
services to which they, as members, have unlimited access.

While this aspect

of current Fed pricing tends to encourage the volume of correspondent relationships, the zero unit price for use of services for me~ber banks has

inhibited the development of payments sytems in the private sector.

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Federal Reserve Bank of St. Louis

Thus,

383
the current structure of access to Fed services has a sharp impact on the
nature of private correspondent activities; Illember banks are encouraged to

act as conduits through which non-members can make use of the Fed clearing

facilities.
To assess the impact of the Fed's current role on the development of
correspondent services, it is necessary to have a point of reference.

the Fed's services were priced at zero with unlimited access for all financial institutions, there would be no incentive for the private sector to

compete in the payments systems market.

This conclusion is also valid if

the Fed employs marginal cost pricing, with the operating losses being off
set by a direct or indirect tax subsidy.

If the deficit is financed by

a one-time fixed entrance fee for the use of the services with the per
unit charged based on marginal costs, the system would be similar to the
current one.

Correspondent relationships would be encouraged in order to

share the expense of the cost of entry -- but the per item charge would
tend to encourage participants to economize on the use of the service.

Pricing on the basis of what it would cost banks to provide the services
would provide a healthly competition from the private sector.

However,

individual banks may still be at a disadvantage in competing in this market,
due to the fact that the Fed has a nationwide presence which no single bank
can match.

Individual banks must form joint ventures to match this presence.

In sum, Mr. Chairman, we are skeptical that enough information is
known so that the Federal Reserve can adequately venture into new payments

system areas without inhibiting healthy competition.

If it does, the

standard of pricing should not be any direct measurement of Federal Reserve
operations, but the cost to the priyate banking industry of providing a
similar service.

The burden of proof should be put on the Federal Reserve

to demonstrate the widespread public benefits or economic efficiencies

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that justify an expanded role for the Fed in the payments systems area.
doubt that such benefits exist.

The "issue" of access to Federal Reserve

services exists because of the discriminatory tax placed on member banks
in the form of excessively high reserve requirements.

The Federal Reserve's

membership problem must be dealt with first, before consideration is given
to direct access by non-member banks and non-bank depository institutions.

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lXfrtlllV[ OIIUCTO!t

GO',CANMENT RELATIONS
Grr.1ld M.Lowrie

202/467•4097

4 November 1977

The Honorable Richard G. Lugar
United States Senate
5107 Dirksen Senate Office Building
Washington, D. c. 20510
Dear Senator Lugar:
On October 11, 1977, at the oversight hearing on the role of
the Federal Reserve in providing payments mechanism services,
you posed a·question to Dr. Charles llaywood, who was testifying on our behilf, about the extent to which required reserve
ratios might be reduced for Fodera! Reserve member banks without ~mpairing the effectiveness of Federal Reserve monetary
policy. We are pleased to have this opportunity to respond
for the record.
·rhe American Bankers Association h.-1s long supported the view
that required reserve ratios of Federal Reserve member banks
should be reduced. In 1957 the Economic Policy Commission of
the American Bankers Association published a study entitled,
Member Bank Reserve Requirements. The key conclusions of that
study were-as follows:
1.

"That the chief function of reserve requirements
is to serve as a fulcrum for the use of the
discount rate and open-market operations in
influencing the volume of bank credit and money."

"That the present high requirements should
be substantially reduced over the years ahead
to enable the banking system to accommodate
the monetary and credit needs of a growing
economy."

"That when reserve reform is undertaken,
we should move in the direction of a geographically uniform system of reserve
percentages."

"That vault cash should be treated as a reserve
asset."

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AME.RICAN
BANKERS
ASSOCIATION

C.ONTINUING OUR LlffU CJf

SHEETNO.

Beginning December 1, 1959, member banks were permitted to
count a portion of their vault cash to meet reserve requirements, and jince November 23, 1960, all vault cash has been
included in the legally required balances. At the end of
1976, vault cash accounted for $8.6 billion of the $35.5
billion total of member-bank required reserves. As banks
must hold a certain amount of vault cash regardless of the
level of legal reserve ratios, inclusion of vault c?sh as a
reserve asset has made the burden of reserve requirements
less than it would otherwise have been.
Prior to July 18, 1962, there were three categories of member
banks with differential required reserve ratios. The categories were ·central reserve city banks, reserve city banks,
and country banks.
The first.two categories were merged in
1962. Since November 1972 the Federal Reserve has not formally employed the reserve city and country bank terminology.
Instead, differential reserve ratios have been imposed by
size of bank and, additionally in the case of time deposits,
by certain maturity designations. However, the size categories used by the Federal Reserve for demand deposit reserves
are closely related to the old reserve city and country bank
classifications of banks. A "geographically uniform system
of reserve percentages," as recommended by the Association
in 1957 has yet to be established in fact, though the present
system does not explicitly differentiate by geographical
location.
We also wish to note that when the Association's study was
published in 1957 required reserve ratios on demand deposits
were 20 per cent for central reserve city banks, 18 per cent
for reserve city banks, and 12 per cent for country banks;
the required reserve ratio on savings and time deposits for
all member ban~s was 5 per cent. Currently, required reserve
ratios for demand deposits vary between 7 per cent and 16.25
per cent depending on the amount of demand deposits held by
the bank. For savings and time accounts, they vary between
1 per cent and 6 per cent depending on the amount of time and
·savings accounts held, the type of account, and maturity of
account. Comparison with 1957 ratios is difficult, but in
general there has been some modest decrease in average reserve
ratios.

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AMf.RICAN

LUNllNUINUOUK llTTlR. or

BANKERS
ASSOCIATION

SHE.£.TNO.

This modest decrease in the level of reserve requirements,
has not hindered the ability of the Federal Reserve to
conduct an adequate monetary policy.
Indeed, as you know,
the Federal Reserve recently endorsed provisions of S.2055,
which called for reduction in the statutory minimum required
reserve ratios. Evidently, the Federal Reserve feels there
is room for further reduction in required reserve ratios
without any undue hindrance to monetary policy.
We have noted these changes since our 1957 study to demonstrate
that dialogue with the Federal Reserve has resulted in improvements in the structure of reserve requirements.
Regrettably, progress has not been sufficient to mitigate the burden
of reserve requirements to the extent needed.
It appears that
the Federal Reserve now has a.fuller appreciation of the need
to reduce the burden of reserve requirements. Continuing
dialogue might well be productive of further change. The door
to such change could be opened by a simple technical amendment
eliminating the statutory minimums for required reserve ratios.
Under 12 USC 462, the minimum required ratios on demand deposits are 10 per cent for reserve city banks and 7 per cent for
country banks; the minimum for savings and time accounts is
3 per cent. Eliminating the statutory minimums would increase
the discretionary authority of the Federal Reserve to make its
own determination of the level of reserves consistent with the
need to mitigate the burden of Federal Reserve membership as
well as the need to assure efficient implementation of monetary
policy.
We mention the possibility of eliminating the statutory minimums
as one alternative that might be considered. We do not propose
it at this time as an official position. However, we do favor
reduction of reserve requirements. Expansion of the Federal
Reserve's discretionary authority in this regard would also be
consistent with the Association's long-standing position in
support of the independent status of the Federal Reserve.
As to the extent to which required reserve balances might be
reduced, we think that there is a rationale for reducing such
balances by at least $10.5 billion. At the end of 1957 the
gold certificate reserve of the Federal Reserve Banks was
approximately $22.l billion. The gold certificate reserve at

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AM[RICAN
BANKERS
ASSOCIATION

<.ONTINUINt,(,AIK lllllR Vf

SHLE.TNO.

the end of 1976 was $11.6 billion. The decline in the gold
certificate reserve was associated, of course, with an outflow of gold from the United States in the late 1950s and
the 1960s. This loss tended to decrease member-bank reserve
balances. However, the effect on reserve balances was offset
by Federal Reserve purchases of U.S. Government securities
in the open market. The Federal Reserve thus gained interestbearing assets in replacement of the non-income gold certificates. The interest-bearing assets were shifted from the
private sector, mainly the banking system, into the Federal
Reserve.
An alternative would have been for the Federal Reserve to
reduce required reserve ratios conunensurate with the decline.
in the gold certificate reser~e. Dr. Haywood, who represented
the Arn.erican Bankers Association at the October 11, 1977
hearings, recommended such an approach to reduction in reserve
requirements in the early 1960s. A gradual reduction in reserve ratios would have been possible during the 1960s.
Required reserve balances today would be about $10.5 billion
less than they .are, and the Federal Reserve would be holding
$10.5 billion less in u. S. Government securities.
We estimate that the Federal Reserve's income would have been
reduced by.about $687 million in 1376 if it had held Sl0.5
billion less in securities. The Federal Reserve's net earnings
in 1976 were $5,982 million, of which $5,870 million were paid
to the Treasury. A reduction of $687 million in the Federal
Reserve's income would not be matched dollar-for-dollar by
a reduction in the Treasury's income. Transfer of $68.7 million
from the Federal Reserve to the private sector would result
in some increase in Treasury tax revenues, as much as $330
million, or perhaps, even more. Net loss to the Treasury
would be in the range of $300 million to $400 million.
In fact, there is no need for the Treasury to sustain any loss
in revenue.
It would be possible for the Federal Reserve to
phase in a reduction in reserve requirements over a period
of several years or so in such a way that growth in Federal
Reserve net earnings would be slowed but the level of such
earnings and payments to the Treasury would not be reduced.
The following data on Federal Reserve earnings paid to the
Treasury, indicate a growth trend that could accommodate a
phased f2duction in reserve requirements without decreasing
payments to the Treasury.

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AMERICAN
BANKERS
ASSOCIATION

CQNTINUINUOUR lLmR OF

~HlLTNO

Federal Payments to the Treasury
(millj ans)
1957
1962
1967
1972
1976

542.7
799.4
1,907.5
3,231.3
5,870.5

Of course, a gradual phase in of the reduction in reserve
requirements would mean that it would . take a longer time to
achieve an effective reduction in the burden of Federal
Reserve membership.
There is disagreement both within and outside of the banking
industry on the role played by reserve requirements in the
administration of monetary policy. Nevertheless, even if
reserve requirements are important as a supplement to open
market operations in the administration of monetary policy, a
statutorily specified minimum reserve requirement is irrelevant
for this purpose. What is important is not the level of reserve requirements, but the ability of the Federal Reserve to
chang 7 the amount of required reserves at a given point in
time if monetary and credit conditions warrant such a change,
In this context, elimination of the statutorily specified
minimum reserve requirements would give the Federal Reserve
sufficient latitude to significantly reduce its membership
burden while still retaining the flexibility needed to administer monetary policy.
In closing, we wish to repeat that our long-standing positibn
has been that reduction of reserve requirements is desirable.
The extent of such reductions should be left to the discretion
of the Federal Reserve.
Legislative action should focus on
the mitigation of statutory restrictions on the Federal Rescrve's
discretion, such as reduction, or perhaps elimination, of the
statutory minimums for required reserve ratios.
Sincerely,17

/) . .l
(1v...U

,;j)
,/

,,-

wfV,)-J

derald M. Lowrie
GML:mfc

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390
Outline of Project to Estimate the Impact
of the Pricing of Federal Reserve Services
I.

Purpose - To develop alternative scenarios for the pricing
of Federal Reserve services and estimate their
impact on the Banking industry.

II.

Parameters of the pricing process
A.

Services to be priced. ABA task force says that all
Fed services should be priced, These would include
such things as:
1.

Check collection services

Automated clearinghouse services

Wire transfer services

Coin and currency services

Net settlement services

Securities safekeeping services

Bank examinations

Services provided to other governmental agenciss

Any new services provided

Factors to be considered in determining prices:
1.

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Federal Reserve Bank of St. Louis

What is to be done about membership burden
a.

Interest on reserves

Reduction in reserve requirements

Government securities held as reserves

Nothing done to relieve membership burden

Cost factors
a.

Cost concept used
(1)

Fully allocated Federal Reserve costs, including cost of capital and taxes

(2)

Something less than fully allocated Fed cost
(a)

Marginal cost

(b)

Average operating cost, no allocation
of overhead

391

(3)

Costs that would be incurred by the private
sector if they performed the service

(4)

Costs are ignored, membership burden is relieved
by one of the methods stated above, and prices
are set so as to have zero gain, or loss, to
Treasury

Other cost distinctions
(1)

(2)

(3)

Fed district
(a)

Uniform price schedules in all
Fed districts

(b)

Price schedules depend on operating
costs of Fed district

Usage of services
(a)

Volume discounts

(b)

No volume discounts

(c)

Others--e.g., are there economies in
the joint usage of particular services?

Geographic location of bank
(a)

Prices uniform across country or, at
least, within Federal Reserve District.

(b)

Prices vary according to the location of
the bank

Other dimensions of pricing problem
a.

Access
(1)

Priced services available to all depository
institutions

(2)

Priced services available only to member
bnnks

(3)

Current access rules are maintained/i.e.,
services which are currently provided to
non-members will be provided to them under
a pricing regime. No new services will
be provided to non-members.

Availability - i.e., how quickly is the service
provided

Others?

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392
III, Factors affecting bank structure

IV.

Ability of correspondents to pass on added costs to
respondents.

Responses of respondent banks to the added costs that
are passed on.

Extent to which measures taken to relieve membership
burden would offset added charges and negate the need
correspondent banks would feel to pass on added costs.

Extent to which private sector will develop new payments
systems outside the Fed.

Responses of member and non-member banks to the development
of such systems. How would these responses affect the
membership question?

What is to be done?
A.

A matrix of prices is to be developed. The matrix should
show the prices for the services listed in part IIA under
the different pricing scenarios that could be delineated
using the factors listed in IIB.

Note: We understand that some of the data needed
to develop the cost estimates will be internal
Fed data that we do not have access to. However,
a fair amount of cost data is published by the
Fed, It will be the responsibility of the consultant to use this data in conjunction with
other available data to develop the best possible
estimate of the costs.
B.

The effect of each of the pricing scenarios on bank structure
is to be evaluated. Some possible factors to be considered
are listed in part III. The consultant may suggest other
factors.

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393
The CHAIRMAN. Thank you very much.
Let me start out with a question to you, Mr. Perkins.
You oppose the idea of a discount rate that is tied to some other
rate, like the Treasury bill rate, as contained in the amendments before
.
.
us, sayin~ in your ~stimony t~at that is inflexible.
What 1s your basis for saymg that~ The Fed would, m my Judgment and I am sure in yours, continue to have complete control over
the discount window, could open or close it as it deemed necessary.
Mr. PERKINS. That is true, and I think you can make a very cogent
argument that a market rate, an audit market rate on the discount
rate, which is what the proposal is, would be fairly smooth, and would
be in some ways something that might be attractive.
Our opposition is on the basis that the discount rate changes are
about the oldest tool in the monetary policy kit. They are widely
understood everywhere as a signal and they can be important as a
signal in certain times.
I pointed out that the last time it was used that way was quite recently when the exchange markets were under such terrible pressure.
It can calm the market at a time when the pressuref, were culminating
in a very bad fashion.
I would say, however, that the other side and more practical side
was the point I tried to make, in a period of recession or coming recession when the Fed wants to ease money, the best way to do it or a
very easy tool to use is by lowering the discount rate which leads the
market and starts to force rates down before a market rate would do
that.
The CHAIRMAN. On this question of the signal, the reading of tea
leaves, the burning of entrails or whatever it is, suppose this afternoon the Fed reduced the discount rate, I believe it is 7¼ percent now,
suppose it reduced it to 7 percent.
What signal would this convey to John Perkinsi
Mr. PERKINS. It would go a long way toward completely eliminating
the thought, rates are going any higher as far as the Fed is concerned,
at least that is their current estimate, and I think you would have a
rather strong further rally in the bond markets and have a real impact
on banks in turn.
The CHAIRMAN. Wouldn't there be other bankers of comparable
stature who might say that "it doesn't mean a thing," that it simply indicates that the Treasury bill has recently fallen from 7.2 to 6.7 percent
and the Fed is anxious not to be too far out of line from that i
Mr. PERKINS. I think that is an obvious interpretation. I am simply
saying in the current climate, with some uncertainties to whether the
conventional wisdom about rates going to get a little higher as the
year goes on, is being questioned, !lnd it would be interpreted, I think,
the way I said first.
. The CHAIRMAN. I thank you, and I am going to excuse myself for
Just a second and recognize Mr. Hanley.
Mr. HANLEY. I will ,address this question to Chairman LeMaistre.
In his testimony before this committee some days ,ago Mr. Campbell,
a representative of the Independent Bankers Association, didn't exactly view this pending legislation with great enthusiasm. Certainly,
his observation has to be taken under consideration.

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of St.0Louis

394

So I ask, is it not desirable fur this committee to report out a bill
which takes care of lf::he important problems associated with membership, monetary oontrol, the competitive squeeze on smaller banks, and
the efficiency of the payments mechanism, whether or not these goals
are achieved by enhancing membership in the Fedeml Reserve System 1
Now, if you agree that this is the ca:se, could you discuss which. of the
proposed bills most effectively would accomplish this goal 1
Chairman LEMAISTRE. Let me say first that I do think that the membership problem of the Fed is perceived by them as being a serious
threat to their independence. It seems to me that perhaps a great deal
of consideration should be given to that. But I don't think that the
membership problem is necessarily tied to the implementation of monetary policy.
Now, as to the issue of equity among banks, ce,rtainly I think the
Congress should be interested in seeing that thev all oomoote on equal
terms. And to me it seems only logical that tlhe Fed be allowed to pay
interest on these sterile reserves, wh'ich are the largest part of the
burden of Federal Reserve membership, or that those reserves be kept
in some kind of interest bearing security.
Now, I notice that in one of the bills there is a provision for a Federal Reserve study of the effect of investing the reserves in securities,
and I th.ink that is good.
I think ,that should be encouraged because it seems to me that if some
rm-urn on 'these funds which ,are now earning nothing could be achieved,
either 'by direct payment by the Fed or by permitting investment of
reserves in securities, then we would move toward a situation where the
banks would begin to compete 'in a more open, free atmosphere, booause
l th'ink the next step would be to remove the prohibition on the payment of interest on demand deposits, and the present prdhibition
against paying more than a certain •amount on savings ,accounts.
It seems to me these are all restrictions on the private enterprise
svstem that ought to be removed if and when ,they can. And T think the
Congress is properly giving serious thought to these. If it appe1ars from
our s'tJatement that we are opposing everything, we are not.
What we are saying is that perhaps it can be done a little better; the
thrust of these bills is good.
Mr. HANLEY. Would it be accurate to say that of ithe bills pending
before this committee, as of this date, the one that would come closest
to accomplishing the end goal, perhaps, would be the Stanton bill as
amended by Mr. Reuss 1
Chairman LEMAISTRE. In what regard, Mr. Hanley 1
Mr. HANLEY. The overall: of the number of bills we are considering,
and certainly the Stanton hill as amended by Mr. Reuss is not the entire
answer to the quekition, but ,as of this time would you say thalt it is a
reasonably good ·approa<lh to the elimination or at minimum the alleviation of the problem 1
Chairman LEMAisTRE. I think that it certainly is a step in that
direction.
The difficulty seems to me to be that if whatever means is used brings
about universal membership, then what happens to the St•ate syst(lmS 1
There is, as Mr. Leonard pointed out, a great threat to the viability of a

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395
Stwte supervisory system if ,all of its members-all of its componentsbecome members of the Federial Reserve System.
I think that there is a grerut deal to be achieved in our dual banking
system by preserving just that factor that in the past has encouraged
innoffltion, such as the experiments that we now see in New England
and other places.
I think that these have boon good for banking, ,and I would not like
to see us put all of the institutions in ,a single line of march where they
all did exactly the same thing all of the time under the same authority.
It seems to me that if we destroy the dual banking system or damage
it, that we are .taking a great risk of doing just that.
Mr. HANLEY. I guess what I was attempting to establish is this:
Are we fundamentally on the right track with the vehicle that I
have already ,alluded to? Certainly there will be changes in that measure and you gentlemen this morning have made some very interesting
comments. I know I have picked up a number of ideas already whereas
we might improve upon that basic vehicle that we are working with.
What I am attemptmg to determine is if, in your judgment, this is
a reasonable approach. I think that I can draw a conclusion from
what you said that in all probability it is a reasonable approach at
this time.
Chairman LEMA1sTRE. I think so.
Mr. HANLEY. Thank you.
Mr. Wicks, I think your bank is a classic example of the problem
and, as you said in your testimony, that was a very difficult decision.
You were patient, having considered that possibility back in 1973, and
then really delayed action on it for this 5-year period in the hope
that something would occur legislatively or otherwise that would relieve you of that problem, and your position then would have you
remaining as a member of the Fed.
First Trust & Deposit Co. is a part of a holding company in which
some of the banks have remained as 'Federal Reserve members. Is it
not true that all but one bank of a holding company may leave the
Federal Reserve and still enjoy Federal Reserve services without
being subject to the Federal Reserve requirements?
Will you please tell us which of the bills before us today, in your
judgment, would effectively solve the problem?
Mr. WICKS. Yes; we are ,a member of a holding company, and the
largest bank in the holding company remains a member of the Fed~
eral Reserve System. This is of some aid. However, I don't believe
that this is the only reason why we would get out of the Federal Rec
serve, or any bank would. I think any bank could get the same services from a correspondent bank as they could get from a bank in the
holding company.
Also, I don't believe, but I might have to ask some of the panel
members here, I don't think there is any law that says one bank must
stay in the holding company.
·
If they were all State-chartered banks, I believe all banks in the
holding company could withdraw from the Fed and I do think we
could get pretty much the same advantages we are getting today by
using correspondent banks rather than the bank holding company
banks.

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I believe that the principles that are discussed here in these bills
are the ways in which we should be thinking. I think it is a matter
of the approach to it as to whether or not we are ready to have the
Federal Reserve System pay competitive rates for the sterile reserves
that are kept there. If the rates are not competitive with correspondent
banks, I would see no reason why State banks would stay in the Fed
or go back into the Fed.
You were discussing the Stanton bill with the revisions of Chairman Reuss. As I look at that, I would say, if I understand the amendments, that this would not provide enough income for the banks or
enough interest to pay on those deposits to keep banks in the Federal
Reserve System. As I understand it, and we would only use the amount
that was charged for services plus the amount that would be earned
through the discount window, and the figures that I have seen would
indicate that that would not be sufficient to have us go back into the
Federal Reserve System.
I would think this would be true of most State-chartered banks
that are not members, that they would not see any advantage in going
back in.
I also believe it is true of the charges that would be made for services. I think they do have to be competitive with the correspondent
banks and if they are not I think there is a free market out there, if
it is not competitive, again, I think the banks would go to the correspondents for their services.
, Mr. HANLEY. I appreciate that response and I interpret you again
as saying that this is not the all perfect vehicle for the reason you just
mentioned but, essentially, it is a pretty good start here.
Mr. WrnKs. I think the principles that are in these bills are certainly the direction that we should be thinking about, yes.
Mr. HANLEY. Thank you, Mr. Wicks.
Now, I defer to the author of the bill and ranking minority member
of the committee, friend and colleague, Congressman ,T. Wi1liam
Stanton.
Mr. STANTON. Thanks very much, Mr. Hanley.
Gentlemen, let me express my personal thanks to all of you for
coming, and some of you from quite far distances, in order to
enlighten us.
The more we have delved into this subject matter, I can tell you,
the more we realize that other Congresses have gone down this route
quite a few times in the past, and perhaps even we have gone a little
hit farther than they have in getting to this point. But, it is something
that we want to address and, hopefully, if there is a solution, to try
to find it.
My first question to all of the panel would be concerning Mr.
Leonard's statement, on page 4, he stated that a reduction of 1 percentage point in reserve requirements for certain member banks would
largely solve the equitable treatment problem.
Of course, what the hearings got started on and what we wish to
address ourselves to is the loss of membership by members of the
Federal Reserve System. Immediately you come to the fact the one
existing problem is the inequity between members and nonmembers
and why it has become very obvious so many members are leaving
the Fed.

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But, I would be interested from the panelists to know, do you all
agree with Mr. Leonard that a reduction basically of 1 percentage
point in reserve requirements for certain member banks would largely
solve the equitable treatment problem 1 Could I hear from all of you
on that subject~
Mr. Wicks1
Mr. WICKS. Yes ; if you want to start at this end.
Mr. STANTON. Sure.
Mr. WICKS. I frankly don't think 1 percentage point would cause
us to change our feeling about Fed membership. I don't think that
would be sufficient of a reduction of our costs to cause us to go back
into the Fed, and I think that would be indicative of other banks
in our position.
Frankly, I think as long as we can get greater income outside, I
think it is our obligation to find the best income we can as presidents
of banks.
Mr. STANTON. Before I continue down the panel, Mr. Wicks, you
are sort of very special because you have had this experience of withdrawal. What kind of incentive would you need to go back in~
Mr. WrnKs. To go back in? If we could receive the services that we
can get from correspondent hanks and the income that we can get by
investing the funds that we have available, if we get the same income
we would certainly go back into the Fed because we would like to be
members of the Fed.
There is no reason for us to withdraw except for that purpose, and
it seems to me it is a very simple thing as far as our judgment is concerned as to whether we would go back or not. It is simply whether or
not we could end up as well on the bottom line.
Mr. STANTON. Who is next?
Mr. LEONARD. Mr. Stanton, there are various reasons why a bank
might withdraw from the Fed over and above, and different from
the reserve requirement issue. Sometimes that gets to be the straw that
breaks the camel's back, so to speak. But services they receive versus
services they can receive from a correspondent, and so forth, all have
an influence on them. Reducing reserves by 1 percentage point would
just lessen the weight of that straw that might break the camel's back.
Mr. STANTON. It would be a combination of factors then~
Mr. LEONARD. It would just lessen that factor significantly enough
probably, and this plus other factors would overcome their objections, resulting in ,a decision to stav in the Fed.
I think Mr. Wicks' bank is a little bit of an exception. I think you
will find that most of the banks that withdraw from the Federal Reserve System are not $500 million banks. Also, in Mr. Wicks' case I
understand that his bank is not engaged in correspondent banking
whatsoever, and most banks weigh the economic factors.
_
The banks that are in the Fed today are not in the Fed -because they
love the Fed; they are in the Fed because it is profitable for them to be
in the Fed irregardless of reserve requirements.
Mr. STANTON. Chairman LeMaistre?
Chairman LEM.nsTRE. I would have to saY' that I think the decision
made by most of the banks that have left the Fed is based simply on
economic reality. For them, it costs less to be outside than it does to be

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398

on the inside. But as :far as the need for membership is concerned, I am
not persuaded that the Fed needs members to conduct monetary policy.
I think there are other reasons for requiring membership in the
Fed, such as that it should be an independent agency or that it should
have a constituency that can give it some strength within the Government. But I don't subscribe to the view that membership is essential
to conducting an effective monetary policy.
So I would say that the banks themselves are making a simple business decision: Can I have a better year? Will the bottom line look
better if I am not in this organization than it will if I remain in?
I don't think the individual hank should be required to become a
member to its own detriment or for the purpose of implementing monetary policy.
Mr. PERKINS. I guess I would not disagree with Mr. Leonard that
there are a lot of factors in any decision of the type of whether or not
to be in the Fed. But, in our experience with many, many banks,
clearly the determining factor is the cost of keeping the required reserves, and in my judgment, the 1 percentage point would not make
any difference.
But I would like to ask my associate here, Mr. Olsen, on that point.
Mr. OLSEN. Thank you. Unless I misunderstand the suggestion, I
would just change one small word, a reduction "to" 1 percent rather
than "of" 1 percent would effectively solve the membership burden.
May I also add while I have this opportunity that the original bi11
that you submitted without the amendments represents today, in my
opinion, the best solution that we have before us here.
Mr. STANTON. I am glad to hear that. I will say in return I did read
your testimony, too, before the Senate, in October of 1977, so I do
know how you :feel on that subject.
Mr. OLSEN. Thank you.
Mr. STANTON. One last question.
Mr. Perkins, you spoke in your testimony on page 3 to the fact o:f
the study that the ABA was undertaking in regards to reserve membership, the pricing o:f services and its effect on the structure of the
banking industry.
Do you have any time schedule for completion o:f that study?
Mr. PERKINS. We discussed that last night because, obviously, you
are trying to handle it now and we are talking about a study. The proposal or the answer on that is that it will be some time, particularly
in this whole pricing question, before the Federal Reserve implements
whatever regulations they propose.
In the meantime, we would expect this study to generate some :factual
data and to come in in parts. So that between now and the yearend
we ought to have all of it, and most long before that. We can use this
data as a part of the analysis of the Federal Reserve's proposals. They
are proposing to come up with data, in just a few weeks, on the pricing issue.
Mr. STANTON. You did say you probably would have this study completed by the first of the year?
Mr. PERKINS. I think so; yes.
Mr. STANTON. Thank you very much.
The CHAIRMAN. Thank you, Mr. Stanton.

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Mr. Derrick?
Mr. DERRICK. Thank you, Mr. Chairman.
Chairman LeMaistre, let us pursue this matter of monetary policy.
I happen to be of the opinion that as far as this country is concerned, probably the greatest service the Federal Reserve renders is
setting monetary policy. I realize that they act as an accounting agency
and a bookkeeper and correspondent bank and so forth for banks, and
I know that is important to the banking industry.
But, I think that the Fed agent acts as a very responsible tool, as
an offset against the Congress in this capacity.
Now, the Chairman of the Federal Reserve, Mr. Miller, was before
us last week, and he stated without any reservations that he thought
it was necessary to have membership or participation in the Fed for
him to effectively set monetary policy, and he went a step further, as
I resall his testimony, and said that he felt he could be more effective if he had more membership.
Now, this apparently is not your opinion, and although you have
discussed it a little bit this morning, I would like to go into it maybe
a little deeper; but tell me, first of all, do you think that the Fed
serves a useful purpose by setting monetary policy?
Chairman LEMAISTRE. Sure; I think it is the primary purpose.
Mr. DERRICK. I assume you did, but just for the purpose of the
record. So my next question is, if you are not going to have Fed membership and participation, what tools would be available to the Fed to
set monetary policy?
Chairman LEMAISTRE. Let me start off by saying I am not an
economist.
Mr. DERRICK. I am not either, I assure you.
Chairman LEMAISTRE. And I have seen a number of studies on that
very subject, and all of them come down to the final results that the
need is information. The Fed needs statistics, it needs knowledge of
what the aggregates are and that sort of thing, and that those things
are useful to it or necessary to it in implementing monetary policy.
Now, you don't have to be a member to give information. So I say
that the membership question is not really critical to monetary policy.
Now, I am not saying membership is not important, however. I do
agree with Mr. Miller that the Fed ought to maintain a substantial
membership. But I have a different reason for thinking so.
Mr. DERRICK. Now, I don't suppose that you think that merely information is going to be sufficient. Surely if that were the case, we could
have a much less sophisticated operation in the Federal Reserve System
if all we had to do to set monetary policy was collect information.
As I see it, that is an important part of it, but the membership in the
Fed and the participation in the Fed allow the implementation of that
information. Of course, everyone in the Congress and business and
so forth acts from a basic altruistic motive, but sometimes we need a
little something to hold over their heads.
That, to me, is what the membership provides. You have probably
done more research on it than I have, and I am aware that there are
some economists that agree with you, but I don't think the Chairman of
the Fed agrees with you.
·
Chairman LEMAISTRE. I don't know; I have never asked Chairman

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Miller directly. But I did read his testimony and I gather he does
not agree. I still say that the evidence adduced by all of these various studies indicates that information made available to the Fed to
help them conduct open market operations is what is really needed.
Mr. DERRICK. We could really, I might suggest to you, transfer this
bookkeepin~ and information gathering over to the FDIC and just
do away with the Fed and let them go along; you would go along
with that, wouldn't you i
I am being facetious; you don't have to answer thait, Mr. Perkins.
Mr. PERKINS. I would really like to ask Mr. Olsen to answer that.
He has devoted a great deal of his professional life in this area, and
I think has read all of the litem.ture and thought a great deal about
it.
In general, I would agree with the basic position that Chairman
LeMaistre espoused, but only in part, and I would like to let Mr.
Olsen, answer it.
Mr. DERRICK. Let me say my great concern is, although Congress
has great wisdom, I don't think they have the ability or that it
would be in this country's best interest for the Congress to set monetary
and fiscal policy. I don't want to do anything tha,t is going to weaken
the ability of the Fed to set this monetary policy.
Mr. OLSEN. Effectively, the question of memberShip and monetary
policy are separate and I think that, in :fiact, if you trace back through
the history of the Federal Reserve. from its origin you will find that
the question of membership was originally placed and considered
for reasons other than the conduct of monetary policy.
In fact, the Federal Reserve monetary policy was sort of an evolution within ,the Federal Reserve ·after its original establishment.
· There is no need for the Federal Reserve, to, in effect, have membership. The first question to ask is what constitutes membership i
It means that they keep reserves at the Fed, which has been discussed a great deal here, and the second is that they receive certain
services from the Federal Reserve.
Now, the way in which monetary policy is conducted is through
several devices :
The most important is through the conduct of what we call open
market operations and this is how the Federal Reserve, in effect, puts
.reserves into the banking system.
Now, it would seem to imply as though the reserves flow uniformly
immediately to all of the membership banks 'and/or from the member
banks, and this is the reason why it is important to have a large network of the banks as members. However, the Federal Reserve conducts
moneta.ry policy by buying or selling government securities through
a small group of approximately 20 t:hat are recognized government
security dealers, most of which are commercial banks.
So it is through that, on that fulcrum, in effect, that monetary
policy is conducted through the open market operations in putting
reserves into the banking system. So that the most important tool
is not something which is dependent upon having a large membership represented.
Mr. DERRICK. Thank you.
My time is up, but let me just say surely you understand or give me

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credit for understanding that membership means just evidence of
participation; what I am talking about is the participation in the
Fed, and whether they have a membership or not is really beside the
point.
I understand the workings of the Fed and thank you for your
lesson.
The CHAIRMAN. Thank you, Mr. Derrick.
Judge Kelly1
Mr. KELLY. Thank you, Mr. Chairman.
Gentlemen, I want to apologize for being delayed in arriving here
this morning and it may be the question I am going to ask has to some
degree been covered.
But the Nation, the Federal Reserve, the world~ is in some peril
because this committee is getting ready to do something. Now, is
the situation with regard to the Fed such that what we are getting
ready to do is justified 1
Can we, can the Fed limp along with the degree of indigence it
has, probably with more effectiveness, if we would do nothing1 I
don't think we will take the opportunity to do nothing. But on the
out chance that we mig'ht, if doing what we are getting ready to
do is not justified, I want to ask the question.
In other words, one of the questions is the loss of membership and
so forth, and do you feel that probably the situation would be better
without any action or do you think that we need to do what it appears
we are a.bout to do i
Chairman LEMArsTRE. First, let me say I don't think there is any
simple answer to this question and, obviously, it has been coming up
for so long before the Congress that I know the Congress doesn't look
for a simplistic answer.
But I also have to say that something should be done. I don't think
you should walk away from the problem. I am not convinced, however, that universal membership is the answer. I think the other
proposals are much better. That is, permission to pay interest on the
reserves which heretofore have been earning nothing and pricing the
services which have been furnished free to members so that t:hey
will be availahle to all, and I even suggested maybe opening the discount window to more than Fed members-to all'banks alike-would
be helpful.
I think that the most hopeful of the proposals is to permit the Fed
to reauce the burden of membership so that there is a reason for
remaining in it or joining it, and not compelling everybody to become
a member of the Federal Reserve System.
Mr. KELLY. Let me ask you this.
The Federal Reserve System has been in effect for how long, 50
years1
Chairman LEMAISTRE. Since 1914.
Mr. KELLY. All right. Then what has transpired in recent times that
has caused this situation to become critical, because we have not passed
any laws that created this, have we?
Chairman LEMArSTRE. I don't think it is due to legislation, no. I
think it is due to the-Mr. KELLY. Is it just general deterioration or has there been an

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abrupt change in circumstances or is this some sort of response to current political pressure or the news media or why are we doing this 1
I mean, did we just suddenly discover that we have a problem after
all of these years?
Chairman LEMAisTRE. No. This is not something new. It has been
going on for a long time, for at least 10 years. The process of attrition
has been going on.. It has accelerated recently.
Mr. KELLY. Attrition in membership?
Chairman LEMA.ISTRE. Yes.
Mr. KELLY. Do you foresee in any of the suggestions that have been
made as a solution that there is apt to be more harm done with the solution than living with the problem we have been living with i
Chairman LEMAISTRE. If the solution were to require universal posting of reserves by all banks, there would be an incentive to join the System'. Since you had to put up the reserves, you might as well be a member. In that circumstance I think there might be a threat to the dual
banking system, and a danger to the State supervisory systems.
Now, the other alternatives which have been proposed I think probi.tbly would help, and would result in checking this continued movement away from the Federal Reserve System.
Mr. KELLY. Could I just ask one question: Do you think high interest rates possibly have been an aggravation of this~
Chairman LEMA.ISTRE. Yes; to the extent that they increase the
cost of doing busines.5 on the part of the bank. Anything that has raised
its other costs has made them look closer at the burden of staying in the
Fed and posting reserves which produce no income.
Mr. KELLY. Then are we, if in attempting a solution we are going to
get some good things and some bad things, aren't we really trying to
work at the wrong end of the horn, that high interest rates are caused
by mismanagement of the economy, that is, Government management
of the economy, because there was mention made about the wisdom of
Congress here, and I think that the individual Members have great wisdom but they just simply are not using it in the solution of the Nation's
problems.
We are in the process primarily of getting elected and responding to
what is politically expedient, so it does not make any difference how
smart we are if we are not using our smarts to solve the problem, so it
does not make any difference.
What I am wondering is if really we are not trying to just patch up
to avoid the re,sults of mismanagement? I would like your comment on
this.
Chairman LEMAISTRE. For whatever reason the difficulty has grown
greater. I admit that. But I must say I don't think that that argues
for an arbitrary fixing of interest rates.
It seems to me if the marketplace is in trouble the marketplace will
correct its troubles, and the more we can allow competition without
unwarranted interference, the better chance we will have of straightening the whole thing out.
So I would say the proposals move in the right direction in that they
move toward freeing up the opportunities that the Fed has to retain
membership, and also allow the banks to determine which of the services they want to buy or where they want to buy them.

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Mr. HANLEY. The time of the gentleman has expired.
Mr. Gonzalez ?
Mr. GONZALEZ. Thank you, Mr. Chairman.
I have two questions for Chairman LeMaistre.
The Federal Reserve has claimed that it needs regulatory supervision over and familiarity with the financial condition of banks that
have access to the discount window.
First, under current practices, does the Federal Resenre h1we such
knowledge in the case of national banks who are regulated by the
Comptroller and, second, in the case of nonmember banks, in your
opinion, would the intervention of FDIC in favor of a worthy bank in
contemporary difficulty be sufficient to protect the Federal Reserve and
the public from the dangers of ill-advised lending at the discount
window?
Would you then recommend that we enact language to permit such
an intervention as to be interpreted as sufficient showing that lending
to a nonmember bank is in the public interest?
Chairman LEMAISTRE. The first part of your question-of course, the
discount window is available to national banks. As to the availability
of the discount window to nonmember banks, I think the law is so
written that it can be made available. It has been interpreted, however, in such a way that, at least since 1966, there has been no activity
in lending to nonmember banks at the discount window.
My suggestion is that some means be devised to make that service
available to all banks, and the first and most obvious reason for that
is that if a bank is in difficulty, in danger of failing, it is much less
disruptive to work out some kmd of purchase and assumption agreement so another bank assumes the liabilities and purchases the assets
or those of them that it would like to have, or work out a merger or
work out some orderly disposal of the problem.
To do that sometimes a loan is necessary. I remember at least one
which I cite in the statement. The bank in Orangeburg, S.C., was not
permitted to borrow at the discount window and FDIC made an ad0
Vance of considerable size for that little bank to keep it going until
we could arrange for its orderly disposal.
We knew at that moment it was insolvent. It was frozen, and it was
necessary to keep something in place until we could work out the
purchase and assumption by another bank.
That did work out in that particular case. It was an emergency, and
it seems to me that that points up that if we as the insuring authority
had been permitted to simply guarantee' to the Fed that a discount
window loan to that bank would be repaid, either by us as the insurer
or by the bank itself, that we might have had a little less of a problem
there.
The suggestion I make is that the discount window be opened to nonmembers upon certification by the FDIC that these circumstances
exist, and that there is reason for propping up the bank for that much
longer and accompanied by a guarantee.
Now, that might put the insurance fund ,at risk. But it would be a
very rare case where you would not be able to recover that loan in the
liquidation of a failed bank.
Mr. GONZALEZ. You don't see any jeopardy to the Federal Reserve

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in that type of a situation of any vast extent or any great problem if
we were to provide language to permit such things 1
Chairman LEMArsTRE. I can't see any threat whatever to the Federal
Reserve.
Mr. GoNZALEZ. Thank you very much.
Mr. Perkins, I had one question maybe for the record because the
chairman may indicate that we have to go register our vote.
But, in your testimony you state and I quote:
For the foreseeable future, a strong membership base will be very important
to the conduct of monetary policy.

Now, I wonder if you could elaborate, if we don't have time now,
for the record, on what in your opinion would constitute a strong
membership base, what membership pattern would you like to see or
suggest, and is there a percent of the total banking deposits that should
be held in membership banks?
Is there a size or geographic distribution of member banks that
should exist?
Mr. HANLEY. If the gentleman will yield, unfortunately we do have
~ vote on the floor, and if we may request that the question be answered
in writing to Mr. Gonzalez we will appreciate that.
·
Mr. PERKINS. Certainly.
Mr. HANLEY. The hearing will stand in recess for 10 minutes.
[ A short recess was taken.]
The CHAIRMAN. The committee will be in session again.
I believe Mrs. Fenwick was recognized.
Mrs. FENWICK. Yes.
I took down a few notes while you were testifying, and I understand your concern for the dual banking system and your fear that
universal reserve requirements might hurt this dual banking system.
I wanted to ask you, who do you think should set the interest rates,
the Federal agencies, Home Loan Bank Board and so on, all of them
together, who should?
Chairman LEMArsTRE. You mean if you don't rely on the free market
to set them~
Mrs. FENWICK. Would you just leave it to the free market?
Chairman LEMArsTRE. I would certainly say that the Federal Reserve could set its discount rates, but as nearly as we can, the free
market forces ought to determine what the interest rates would be.
Mrs. FENWICK. But I iam surprised that you say that the open
market is the controlling element in the monetary supply.
Did I understand you correctly¥
Chairman LEMAISTRE. I said it was the most dominant element, one
that is most useful to the Fed.
Mrs. FENWICK. We heard testimony the other evening from ·a group
of economists who all felt that the monetary supply was by far the
most telling ·and important element in inflation, far more than interest
rates.
Would that ,accord with your view 1
Chairman LEMArsTRE. I don't disagree with that.
Mrs. FENWICK. Bu:t, if according to Mr. Leonard's 'testimony the
State hanks resent the Federal Reserve getting data, all of the data
they want, how can the Federal Reserve operate effectively i On page
8, Mr. Leonard stated that the Fed should not have the unrestrained

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right to any ~nd all data, and yet you say that the only way the Federal
Reserve ·and the open market and the 20 hanks working with the Federal Reserve can help in controlling money supply, is to have data.
How are 'they going to do it i
l'f you have a relatively small membership, falling continually, if the
components of the dual banking system have a right to withhold data
and information the Federal Reserve asks for, how do you control
the monetary supply~
Chairman LdfAISTRE. I am not sure they have the right to withhold
information. I ,advocate that. the greatest provision possrble he made
for furnishing all the statistics that the Federal Reserve needs.
Mrs. FENWICK. Should this be a requirement i
Chairman LEMAISTR'E. It could well be. At the moment I say I don't
think it is necessary ibecause I think it is available to them anyway.
Mrs. FENWICK. Apparently the Fed should not have unrestrained
right to any and all data it might request or in the form I might request it.
I can see there might be difficulties in the form, causing paperwork,
but I don't see how the Federal Reserve can function at all if it has a
diminished membership and if it has not the right to acquire data it
needs in order to conduct sound monetary policy.
Mr. LEONARD. I did not mean the Fed could not have free access to
the data they need for setting the monetary policy. However, I think in
the request for data there should be some consideration given to the
cost/benefit of that.
Mrs. FENWICK. What does that mean, cost/benefit i
Mr. LEONARD. If they ,are not going to do anything with the information when they get it and it costs the banks w hundreds of thousands
of dollars, there is no reason to give the information in the first place.
They should determine what they are going to do with the data otJher
than fill up a room with paper. Certainly the Fed should have all the
information they need for a sound monetary policy.
Mrs. FENWICK. How do you suggest that could be arranged except
through the commonsense of the Federal Rese,rve Board i
Mr. LEONARD. I would hope the good commonsense of the Federal
Reserve Board would prevail.
Mrs. FENWICK. I gather you feel it hasn't, if I understand correctly.
Do you approve, Chairman LeMaistre, of the interest on checking
accounts, on 'the new movement in that direction i And ,also more importantly, I want to ask you something that has puzzled me.
If a higher rate of interest is allowed to the thrift institutions because of the sooial desirability of home building and homeowning,
why have we reached a point where all banks are not allowed to
enjoy ,the benefits which ure open to the thrift institutions, if ,they meet
the socially desira:ble proportion of mortgage loans, whatever that
might ibe set to be~
Why have we gotten into this curious situation whereby a bank
which has one name can do something ·and get certain tax arrangements
denied to 'a ibank with another name, doing precisely the same desirable
social action, to precisely the same ratio or proportion, but unable to
enjoy either the rate of interest or the tax benefits~ How did we come
to that~
Chairman LEMAISTRE. I would have to say the Congress fakes part of
the blame.

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Mrs. FENWICK. Do you think we ought to get rid of it i
Chairman LEMA.ISTRE. Yes; I do. I think the differential should be
removed and I think the limitation on the interest payments on savings
should be removed because I think the value of money is something
that can be determined. It is like determining what is the rent on a
house. It is worth a certain amount, and it is wrong to say to the saver,
"You may not have what your money is worth."
I think we should £ace up to the £act that some things have to be done
before that will be a viable step. We have to do something about usury
rates; we have to make sure we are not allowing a bank, or in effect
letting the market require a bank, to pay more money than it can afford,
but if you take off the limitations on the cost of loans-in other words,
if it can charge what the market requires and pay what the market
dictates, then 1t sooms to me we would be in a much better position.
Mrs. FENVHCK. We would have to have some usury laws though,
would we not? Some controls so _there wouldn't be enormous charges i
Chairman LEMA.ISTRE. I have no objection to usury laws, but I do
think usury laws which set an unrealistically low rate are counterproductive. They do not furnish funds to the J?eople who need them.
Mrs. FENWICK. It seems to me the whole bankmg institution, coming
to it from the outside as I do, is somewhat irrational. It doesn't seem
to follow any kind of commonsense pattern. We seem to have decided
that it is a good thing to have housing and so we give certain banks
certain privileges if they do have a large proportion of housing mortgages, but I understand that some of our thrift institutions have no set
proportion of mortgages. Is that so?
Chairman LEMAisTRE. The idea of encouraging housing obviously
is admirable. Nobody will quarrel with that. The question in my mind
is whether what we have done has been effective, whether the thrift
institutions have been able to meet the needs for housing, and whether
they have been able particularly to meet it in times of high interest
rates when there are other opportunities and funds ca:tmot flow into
that particular type of institution.
I think the Hunt Commission had a very sensible suggestion. If you
want to encourage housing, why not give the instrument which .finances
the housing some benefit, no matter who gives the loan, whether a bank,
insurance company, or thrift institution. If in fact the loan is made
for a socially desirable purpose and the Government, in its wisdom,
thinks that is to be encouraged, then let that instrument have some
benefit, either a reduction in tax or something of that sort.
Mrs. FENWICK. Thank you very much. My time has expired.
The CHAIRMAN. Mr. Green.
Mr. GREEN. I would like to return to the question of the adequacy
of the data on deposits from nonmember banks that Mrs. Fenwick
raised.
Mr. Chairman, I would like unanimous consent to submit for the
record an article from the July 10, 1978, Wall Street Journal, entitled
"Fed Use of Incorrect Money Supply Data May Spur Economic Woes,
Analysts Say."
The CHAmMAN. Without objection, that will be received into the
record.
[The article referred to by Mr. Green follows:]

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(Wall Street Journal, July 10, 1978)

Feil Use of Incorrect Mo~ Supply Data
May Spur Economic Woes, Analysts Say
By Enw ARD P. FOLDESSY
Bta/1 Reporter of Ta&: w ALL STRE&T JOURNAL

NEW YORK-Inaccuracies ln gathertng

and compiling information on the nation's
money supply may be leading the Federnl
Reserve System astray in carrying out rrm-

etary policy and could result in an eoonon'ic
tailspin.
That, at least, ls the ylew of a growing

number of ecOnomists and 3.nalysts wtn
closely monitor the Fed's activity and its

impact on the economy.
The money supply ls the Iola! of private
demand, or checking accoun~ deposils pl111
cash in public hands. It has become an l.m
p.,rtant Consideration in recent years for
Fed credit·policy decisions.
.
Because the supply reflects funds readily
available fpr spending, it is considered an
important determinant of economic actl'tity
by inany economists. Too slow a growth. ifs
believed, will cause the economy to stacoate. but too fast a growth will do little stcept spur inflation.
The Fed's goal, therefore, has been tob:y
to walk a narrow path between those ex·

tremes to lay the groundwork for a sustainable. balanced economic growth.

Poor Quality of Numbers

But walking that tightrope is hemming
difficult, if not impossible, because of the relatively poor quality of money supply mm
bers, analysts say. In the past 1½ years, the
money stock numbers have been almost coosistently revised upward as more detailed·
Information became available and absolute
errors discovered, they note.
Throughout most of that period, the Faieral Reserve had been operating under the
assumption that money supply growth was
sJower than was actually the case. Thus. analysts say, the Fed supplied more moneycreating reserves to the banking system

tJia.n

prudt;nt.

"With the (upwardJ revisions ot the
money supply, the outlook for inflation am
interest rates has worsened so much that
the hkelihood of a recession dunng the next
12 months bas · become sub;tantially
greater," warns Lawrence Kudlow, a vice
president of Paine, Webber, Jackson & OJro
tis Inc.

Da\o·id M. Jones, an t?Conomist for Aub'ey
G. Lanston & Co., notes that '"the Fed in underestimating the money supply will tend to
-hold up on its credit tightening:" Eventu- .
ally, he reasons the Fed is "forced into
more drastic tightening because it waited 91
long to apply the brakes in the first place."
At the hub of the problem is the fact that
many banks aren't members of the Federal
Reserve System and thus don't rell)rt figures to the Fed on a weekly basis. To obtain
a money stock calculation, the Federal Reserve must estimate the amount of dep)stts
at these nonmember banks.
The Fed has a fairly accurate measure of.
the deposits at these institutions only m
times a year-when the hanks file th!lr
quarterly information reports with the F«ieral Deposit Insurance corp.
To estimate deposits at nonmember
banks. the Fed looks at deposits at,rmre
than 5,000 small member banks. It com
pares those figures with the nonmeml':e'
quarterly figures and calculates a ratio between the t.wo groups. It then forecasts the
ratio through the next quarter. The ratio is
applied to the weekly 5,000 group to get an

PStimate of nonmember deposits.

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Thus each quarter, the Federal Reserve
revises the money supply nwnbers to reDect
the new quarterly reports of nonmembers
and recalculates the ratio.
Of the past slx benchmark revisions,.llYe
have raised the money supply level from
that originally estiffiated, while one reduced
"it In addition, the Federal Reserve last
month revised several weeks of numbers to

correct a processing error.
Upward Revision
The latest quarterly benchmark reviskln
took effect with figures covering the 'Wl'!ek:
ended June 14. Those revisions showed that
, the money stock h~ risen at an 8.1% dip
over the previous 12 months. compared with
an originally estimated 7.5% rate. The rise
was especially significant because 'the Fed.
had previously stated that It couldn't Iderate a growth of more than &½%- over a lorV
period. Thus, the . rerulon simply mmpounded an already poor showing.
·
The May growth rate for the basic rmney
supply, Ml, has shown a."l even larger lm
pact Originally, the May growth was put at
a 5.9% annual clip. The benchmark revimcn
ralsed It to 6.9%. It was further boooled to
. 8% after a revision to correct a processing
error.
"It tends to shake one's confidence in
tbe figures,'' states William Griggs, a senior
vice president of .r. Henry Schroder Bank &
Trust Co. "Maybe Ml isn't what we should
be looking at." He suggests the Fed smuld
be guiding policy by looking at "what's happening to bank credit, and what's happening
WIDt~rest rates.and the economy.".
Paine-Webber's Mr. Kudlow suggests the
Fed should do something about getting 1111'1!
accurate money supply numbers. "The Fed
has to devise better ways to work with the
FDIC and the state hanking agencies ID
gather more deposit information,'' he says.
Norimember banks repre~ent a large part

of the nation's deposits. Alan C. Lerner, a
senior vice president of Bankers Trust Ch,
New York, estimates that about 30% of the
nation's deposits are held by such institutions, up from only 15% several years ;qp.
Part of the reason is that more and mre
banks are dropping out of the Fed to avdd
stiff reserve requirements, money kept at
the Fed to back the banks' deposi.s. In add!.·
tion, many of these banks have been growing faster than member banks.
The Federal Reserve admits it has a
problem in estimating the money supply.
Says a spokesman, "It's something we'd like
to improve," but adds he believes the ana.lysts are overreacting to the situation.
The spokesman disclosed the Federal Reserve Is currenUv worklnr with the FDIC to
collect weekly data from a sample of abwt
:llO nonmember banks. Once satisfied the
data are accurate, .the Fed intends to add
them to the weekly calculations.
·
The Fed itself is untrustlng of the money
supply numbers. Late last fall, for example,
the money stock surged. Because of the lack
of confidence in the numbers, the Fed clme
to ignore the increase, according to I.anston's Mr. Jones. The Fed instead attrlwte:l
the bulge to special factors, saying the increase reflected less efficient use of flDD
by corporations. Mr. Jones states that lata"
figures showed, however, that the bulge was
real, reflecting a boom in ·"credit BIii.
money for sharply expanding spending."

408

Mr. GREEN. As I understand it, the percentage of nonmember deposits as opposed to the total deposits has increased from approximately 15 percent to approximately 30 percent in recent years. I
gather, and your testimony indicates, Chairman LeMaistre, that at
present we have a system whereby there is a full report on those deposits on a quarterly basis and there is a sampling on a weekly basis in
the interim. Am I correct on that i
Chairman LEMAISTRE. We are collecting from 580 banks, as I recall
it.
Mr. GREEN. Yet apparently the data the Fed are using, or at least
their estimates derived from that data, seem to have an effect of systematically understating the money supply, at least based on the upward revisions they have to make on the basis of the quarterly data.
That is demonstrated by the fact that five of the six last quarterly
adjustments have had to be upward adjustments. For example, I believe the June 14th adjustment shows that the money supply had risen
by 8.1 percent whereas the Fed's estimate based on the sampling data
had been 7.5 percent.
I guess my concern is this: You indicate the legislation I submitted,
H.R. 13549, is not necessary. Of course I acknowledge that what I proposed to do or something similar to that could be done administratively without legislation.
Chairman LEMAISTRE. That is the thrust of my statement. The statistics are available. They can be collected if they are needed.
Mr. GREEN. I guess my concern is that your testimony indicates that
the Fed and you are not going to be taking a look at the situation
until mid-1979. It would seem to me on the basis of the data I have
cited that it is pretty clear that the system, as it now exists, is not
working correctly and is causing significant problems in terms of the
Fed open market operations as a result of the interim underestimate
of the growth in the money supply.
Would it not be well to look at it more quickly~
Chairman LEMAISTRE. I think that could be done. The date of 1979
was set in 197'7 when we started collecting this. We agreed in 2 years
we would look at it. There is no reason why we couldn't look earlier.
However, I am not at all sure the adjustment was made necessary
by misinformation in the 27 percent held in nonmember banks. I
think the adjustment was due to !'lome improper estimates across the
board. Certainly we can proceed to collect from a larger sample, from
all of them or whatever is necessary. I am not aware that we have
been asked to increase the size of the sample in recent months. But
we do not have to wait until 1979 to consider the question.
Mr. GREEN. Again, if I may turn to Mr. Leonard, the sample I proposed, based on discussions I had with economists in the field, was a
sample from at least 1,000 nonmember banks, including all those having deposits exceeding $100 million.
ould that be onerous in your
eyes?
Mr. LEONARD. No, if it was necessary for the Fed to be more accurate
in its predictions.
Mr. GREEN. That is all I have.
The CHAIRMAN. Chairman LeMaistre, I want to take this opportunity to pay my tribute to you as an outstanding public servant and

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a fine gentleman. It has been a pleasure to have you helping us over
these years. I know every member of the committee wishes you all the
best.
Chairman LEMAISTRE. Thank you, sir. You are very kind.
The CHAIRMAN. I have a question £or several people. I will start
with you, Chairman LeMaistre.
Suppose we were to replace the existing structure of reserve requirements, which as you know varies, rind even the amendment proposed
by some members of this committee which is before us, keeps that variation. In your testimony, you indicated that you didn't agree with
that, as well as with the existing system.
Suppose we were to replace the system of varying marginal reserve requirements with a single, uniform rate applicable to all deposits of member banks, exempting, let 11s say the first $30 or $40 or
$50 million of total deposits. In your judgment, would this constitute a significant improvement in monetary control, over what we now
have?
Chairman LEMAISTRE. I have to come back to what all the economists have said and that is, it doesn't really affect monetary control;
that the operation of our monetary policy doesn't depend really on
how much is kept in reserves.
The CHAIRMAN. To the extent we do have reserves, to the extent that
a decision is not made to do away with reserves and rely on open market policy and the discount window, would i,t not be a more effective
method of monetary control than one such as we now have where a
dollar deposited at the Continental Illinois or Citibank has a different
monetary value from a dollar deposited at the State bank in Podunk?
Chairman LEM:AISTRE. I would say in my opinion it would definitely
encourage membership, if by setting a uniform rate you lowered it
from the top rates today and reached somewhere between the low and
thfl top.
The Federal Reserve itself in 1972 restructured the reserves and PJlt
a graduated system-which it seems to me is a little counter to what
they are saying is necessary no)V-SO I would say it would be more
equitable.
I would defer to Mr. Olsen though as to the ultimate effect of it.
The CHAIRMAN. I am interested in the equity aspects of it, of course,
but I want to put the question again. In terms of monetary control,
even though you have cited the testimony of numerous respective experts that reserve requirements don't mean a thing, as far as monetary
cont:r:ol ~s concerned, suppose those experts are wrong and suppose the
Fed 1s right?
Chairman LEMA1STRE. And that could be.
The CHAIRMAN. ,vould we not get then a surer and less diffused type
of monetary control ? If you had a single uniform reserve requirement
then, with our present system where a dollar happens to be deposited,
that has a great deal of purelv fortuitous effect on monetary policy.
Chairman LEMAISTRE. Mr. Chairman, I think you are right.
As far as monetary control goes, we probably :would achieve a better balance. I am not sure that you wouldn't really be moving counter
to the proposals to increase membership though because obviously this
would raise the level of those who are a,t the lowest level now and if

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they are already worried about what it costs them, to add to their
membership burden, it would probably encourage them to get out.
The CHAIRMAN. My question really has nothing to do with membership because I was impressed by your testimony and that of others
which said what we are really concerned with is to assure an effective
monetary policy, to ~tan efficient payments system and to eliminate
arb1trary forms of discrimination against particular types of financial
institutions. That happens to be the ABA's triology but it sounds
pretty good to me, and membership is not mentioned.
Chairman LEMAISTRE. Without regard to membership, I think it
would be better, yes.
The CHAIRMAN. Mr. Leonard, I would like to ask you the same
question.
Mr. LEONARD. My answer would be essentially the same as Chairman
LeMaistre.
Being a bank administrator, it would give me some concern if you
came out with the idea that member banks were required to carry zero
reserve on the first w dollars in deposits. Most of the bankers in prudent
operations of the bank would still continue to maintain some type of
liquidity type reserve. However, there is that element who retains
reserves because the law says they have to have a reserve.
The CHAIRMAN. However, as a State bank regulator, you could impose whatever liquidity reserve requirements you wanted on your
State banks, member or nonmember.
Mr. LEON ARD. For liquidity purposes, yes. If the national banks then
would retain that liquidity reserve reqmrement, I think what you are
saying would be very well.
The CHAIRMAN. I think there is a point to the criticism that has been
made during these hearings. It was actually made by Chairman LeMaistre this morning when he said on page 4 that because o:f deposits
being subjected to different requirements and different size classes.
A shift of funds among member banks has precisely the same effect of blurring
the precision of monetary policy that disturbs the Federal Reserve when non)llember banks are inV'Olved.

Would you agree with that general proposition?
Mr. LEONARD. Yes.
The CHAIRMAN. How about you, Mr. Perkins?
Mr. PERKINS. Two points.
One, uniform reserves across the whole system would be quite desirable, I think, :for theoretical as well as :fairness reasons.
The question of setting those reserves though at one fixed figure in
the law, I believe would be a mistake. I believe the Congress should set
a ceiling amount.
We suggested that the minimum could be as low as zero, and that the
adiustment of reserves should be left as a tool of monetary policy.
I don't disagree with the theory on the question of reserves, the economic reason why you can use the market operations--but the :fact
is, it is a tool to effect the level o:f :free reserves in the system which
on probably relatively limited occasions might be something good to
have in the bag.
Mr. OLSON. I tend to agree. I emphasize the lack of uniformity
in reserve requirements as the source o:f some degree of volatility, if

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you will, in the changes in the monetary aggregates. The reason the
Federal Reserve has difficulty at times in hitting its targets can be
attributed to the differences in the reserve requirements as the public's
preference for holding deposits swings from demand to time deposits.
Uniformity of reserve requirements, I think, would be desirable.
Setting the reserves by statute, however, troubles me. It troubles me
because, as you say, reserves aren't that important and it hasn't been
used, but I can't see the purpose of setting it in f'.tatute. Similarly with
the discount rate, I am troubled when something is fixed bv statute
in t.hat particular area when there is no purposes for fixing it by State.
The Federal Reserve can hold it unchanged administratively, and in
fact have used it infrequently.
The CHAIRMAN. It doesn't though. That is part of the trouble. Congress is partly at fault. The Fed is also at fault and I think the blame
lies in both places, coexistent with this system which Mr. LeMaistre
and everybody else has criticized. Where the deposit of $1 in one bank
rather than a bank of another size can make tremendouss differences
and drive people ont of their wits.
One additional question: Suppose Congress did set a minimum limit
of zero, no reserve requirements in effect, and whatever maximum
Congress decided on: 5, 10, 15, 20 percent, whatever it is. and suppose
vou had some years of a responsible bank-oriented Federal Reserve and
t}iey had the requirement at zero, and then suppose the composition
of the Board changed.
You in the bankmg system would have rendered yourself vulnerable
to a quasi-tax liability hitherto undreamed of, would you not?
In other words, if you were at zero and for another 10 years the
world had been settled on the creed that reserves are terribly important, it would be an easy matter for the Federal Reserve Board to tax
tl1 e banking system an additional $20 billion a year by saying, "Oh,
my, we have got to get out of this open market business and raise
rePerves and be responsible."
Mr. PERKINS. I think that is clearly a threat when the possibility
exists, but that is a possibility we would have to hope would be faced
carefullv and in a reasonable, statesmanlike way.
The CHAIBMAN. One final question. You said zero reserves. I think
you will admit that is about as much as you can ask for. What about
something in between our present structure which goes from 3 percent
for time and 7 percent and on up to 22 percent I think for banks of
your size.
What about some sort of a compromise which gives some flexibility
to the Fed, but not the complete swing of the pendulum flexibility(
you are talking abont. Whnt ahont a minimum of ii percent and no
maximum, or a maximum of 15 percent, or something like that? Something less stupendous than from zero to infinity.
Mr. PERKINS. I wasn't thinking of zero to infinity. I think our
position was the top level needs to be lowered and I am sure I don't
know what that figure properly would be. It would obviously have to
be done over a period of time and geared into the open market
operations.
Whether your SUP"P.'ested ficrures. 5 to 15 Percent, make sense, I
would certainly opt for a lower ceiling than that.

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The CHAIRMAN. Mr. Gonzalez.
Mr. GONZALEZ. Thank you, Mr. Chairman.
In reading over the testimc5ny, Mr. Perkins, I notice what appears
to be an inconsistency. Maybe it isn't.
On page 3 you say :
The need for mandatory universal reserve requirements on transaction accounts held by all depository institutions in order to assure an effective monetary
policy has not been demonstrated. We opposed this proposal as unjustified and
likely to harm our Nation's innovative system of dual banking.

Then on page 4 you say :
We disagree with the proposal that would legislate inflexible reserve requirements because this would tie the hands of the Fed in its ability to use changes
in reserve requirements as a tool of monetary policy.

I can't reconcile those two statements. Either you are right about
reserves susceptible of being used as a monetary policy tool or there
is no fear it doesn't or does.
Mr. PERKINS. It does appear contradictory, but I think both statements would hold up in the sense that, as we said in the first statement,
and as has been discussed here, the reserve requirements are not necessary for monetary policy. There are alternative ways to effect a level
of reserve in the total system. Namely, open market operations.
On the other hand, the availability of the tool of adjusting reserves
required can affect the level of reserves in the system that can be used
by the banks or held sterile by the banks. There may be an occasion
when you would want to reduce the amount of free reserves in the
system, for example, that could be used by the banks. That would be
done by raising reserve requirements rather than simply taking the
reserves out of the system through open market operations.
Mr. GoNzALES. Also in your statement, on page 6 of your testimony
with reference to the fact that the withdrawal of members has resulted
in a loss of $200 million to the Treasury, I notice you refer to the fact
that this was a figure given by Chairman Miller, which is true, but
which also has raised a question when he made that statement and that
is, isn't it a fact though that, had a plan been devised in 1970 say, to
hold at that level the membership then present, that the cost of doing
that would have probably exceeded the $200 million?
In other words, I don't think you want to leave the impression that
the erstwhile cost of $200 million in reality could have been avoided.
Mr. PERKINS. I don't disagree. Use of a figure like this by itself can
be quite deceiving. Obviously, there are all kinds of factors that say
if so and so had happened in so and so, then it would have computed
up to m dollars. That was simply used, I think, as a suggestion of
just the withdrawal based on a very theoretical concept, but there are
all kinds of other things involved.
For example, what about newly chartered banks, if they don't enter
the System?
Mr. GONZALES. Thank you very much, sir.
Mr. MITCHELL. The gentleman from South Carolina.
Mr. DERRICK. Thank you, Mr. Chairman.
I have a question that is not an original question with me; I won't
make any pretense, I will just read it.
Suppose the discount rate were linked to the Treasury bill rate

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:formula but the Fed had the power to depart from the formula
which would be for 1 week and renewable.
Wouldn't this provide ample flexibility and at the same time assure
that administrative changes in the rate would not give misleading
signals?
Now, when the discount rate is raised or lowered, we cannot always
be sure whether the Fed is easing or tightening because the Treasury
bill rate may have previously moved in the same direction.
Under the provision I have in mind, an administrative change would
not be misinterpreted. Increasing the rate more than called for by
the formula would unambiguously indicate a tighter policy. Decreasing it below the rate called for by the formula would unambiguously
indicate an easier policy.
Would you comment? Would you like a copy of the question?
Mr. PERKINS. I am not sure it is all that simple.
If you had a system like that, it may, for example, right now the
Treasury bill rate is probably lower, say a week or two ago, than it
would have been otherwise, but it was affected by the fact that in a
series of financings and refinancings the Treasury followed, chose not
to increase Treasury bills to finance a deficit but to use intermediate
term and longer term securities. So, you get all kinds of factors that
press on a particular rate when you are doing it that way.
I don't really think it would be that simple.
Mr. OLSEN. There was one part of the question I would ask you to
repeat. You say for 1 ·week and then it could be renewed?
Mr. DERRICK. Renewable, that is correct.
Mr. OLSEN. How would they go about getting it renewed then,
because coming to Congress or-Mr. DERRICK. I am told by a vote of the Board.
Mr. OLSEN. By a vote of the Board ...Well, what troubles me about
the tying it to the Treasury bill this way, is again, you are financing
something in statute that is in the monetary policy area. When you
are dealing with the market forces, I would feel that a degree of
flexibility is desirable if I ·were conducting monetary policy. It is
troubling to fix it in the statute.
I personally see no objection, and I would feel the Federal Reserve
should administratively, from time to time, have the discount rate
closer to a market level or higher level. But financing it to the Treasury bill in a statutory fashion means that you cannot anticipate the
times when the Federal Reserve might be free to do that.
If they are going to be able to change it for a 1-week period subject
to renewal, my question is, why must you fix it in statute?
Mr. MITCHELL. It is only fixed, of course, if the Board wants it
fixed, and that is the flexibility.
Mr. OLSEN. They would not otherwise change it.
Mr. DERRICK. The Board is the master of its own destiny.
Mr. OLSEN. I would assume under such proposal the Fed might well
opt for an extended period of time renewing it every week to have it
deviate from the Treasury bill, which would mean it would not be a
major change from the situation you may have now, except the Federal
Reserve w0t1ld be reviewing it every week.

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Now, that might create some problems from the standpoint of the
market's reading of it.
Mr. DERRICK. Of course, it would necessitate their taking that positive action though.
Mr. OLSEN. Yes. There is one other aspect of this Mr. Perkins touched
on also, and that is that the discount rate is viewed abroad differently
than it is at home and, given the breadth of the dollar market internationally today and the exchange rate situation, this is important.
The discount rate here is viewed abroad comparable to the bank
rate in England or the bank rate in Germany, so the ability to change
the discount rate here does have a signal and a meaning abroad
that would be impaired if you were to tie it to a Treasury bill this way.
Mr. PERKINS. I think on that point, on the international side,
whether or not this is desirable at a time when the dollar is being
questioned so widely, a congressional action on the discount rate would
be very upsetting in the international financial markets, just because
of the tradition of these hundreds of years of the way it is viewed
abroad.
Mr. DERRICK. Does Chairman LeMaistre or anyone else care to
comment?
Thank you very much.
I yield back the balance of my time, Mr. Chairman.
Mr. MITCHELL. Mr. Stanton is recognized for 5 minutes.
Mr. STANTON. Yes. We don't want to hold you here, but we don't
have this opportunity very often to get such a divergence of views.
Getting back to this subject which we have zeroed in on, due to the
Chairman's comments on the subject of payment of interest or reducing ,reserve requirements, theoretically, if you were to carry that out,
then the subject of paying interest on reserves, the type of interest
could become a moot question, am I correct on that, Mr. Olsen?
Mr. Perkins-Mr. LEMAISTRE. I think certainly if there are no reserves, it
wouldn't be a problem, but the burden would be reduced either way.
Mr. STANTON. Mr. Leonard, I wondered if you could tell, I think it
was Chairman LeMaistre in his statement who spoke of 36 States
now, I think, that allow State nonmembership banks to hold reserves
in different types of deposits of interest-bearing securities, different
types of securities. Where did the historical, nonpayment of interest
come into the Federal Reserve or, at the same time, why did the States
go out on their own in declaring the different types of deposits that
could be held?
Mr. LEONARD. I am not really sure I know where the history came
from on the sterile reserves for Federal Reserve banks in the 30-odd
States that permit their State banks to carry at least all or part of their
reserves in interest-bearing-type instruments, and so forth.
I presume it was just the wisdom of the State legislature in their
various States.
Dr. KREIDER. Mr. Stanton, on the question of the States paying interest or permitting reserves to be in the form of interest-bearing
assets, and I am sure Chairman LeMaistre did not mean to overstate
that, but simply stating 30-some States in one form or another do this,
is, in fact, an overstatement.

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In the overall picture, a relatively small percent of the total reserves
of State-chartered nonmember banks is in the form of interest-bearing
reserves. It is a small percent of the total. We could get estimates on
that for the committee if the committee would so desire, but it should
not be assumed that that is a big factor in State-chartered reserves.
Mr. STANTON. That is mainly what I wanted to get at, is how big
a factor it was.
Mr. MITCHELL. Gentlemen, you have been most kind.
I have many more questions which I will not put because you have
been here so long. Forgive my temporary absence.
Mr. Grassley has joined us. I don't think he has had an opportunity
to rais~ questions, and then Mrs. Fenwick on the second go-around,
and that will wrap it up.
Mr. Grassley is recognized for 5 minutes.
Mr. GRASSLEY. Thank you, Mr. Chairman.
I would start out by asking Mr. Wicks, when your bank was a
member of the Fed how often did your bank use check-clearing services
provided by the Fed?
Mr. WICKS. We used the check-clearing services on a daily basis.
Mr. GRASSLEY. So you did that instead of going through a correspondent bank?
Mr. WICKS. That is correct.
Mr. GRASSLEY. OK. I ought to follow this up, Mr. Wicks. At least
while you were a member you had a good, complete, thorough business relationship with the Reserve?
Mr. WicKs. Excellent, yes.
Mr. GRASSLEY. And at least for the period of time you were in it
you found adequate need to use the services and did, in fact, use them
as completely as you could.
Mr. WICKS. We certainly did.
Mr. GRASSLEY. Next I have a question for Mr. Leonard.
On page 4 you list items that should be addressed by a congressional
program to correct the membership problem. Your fourth item is to
permit the private correspondent banking system to compete more
effectively for correspondent business. Now, what changes does this
involve other than the obvious one that the Fed is going to have to
have a competitive pricing system for its services if we go that route?
Mr. LEONARD. You mean if you go the route of the Fed pricing their
services?
Mr. GRASSLEY. Yes. Obviously, in that particular case you are suggesting that the Fed is going to have to price its services competitively
as opposed to just the subject or the proposition of pricing per se.
Mr. LEON ARD. Yes. The pricing of the Fed, if they are going to price
their services, should not be subsidized by taxpayers' money. The Fed
ought to price their services at no lower than private enterprise can
afford to provide that same service.
However, in connection with the pricing of services, the correspondent banking system gives considerably more services to their correspondents than does the Fed, for example, in financial advisory, municipal bond accounts, those types of things that are not available at
the Fed.
Mr. G1tABSLEY. Also, then, I am wondering if from your standpoint,
you feel that the Federal Reserve has a cosfaccounting system that is

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going to be able to give us very definite figures on what exactly these
costs will be, so that it will be easy for us to compare the prices charged
by the Fed vis-a-vis those charged by correspondent banks? Or do you
think we will get into problems here where the Fed could find justification for having lower costs for some reason or other?
Mr. LEONARD. I would hope that the Fed would have the capability
of coming up to you all with a cost analysis on what it would cost.
With the economists and accountants and everything else they have,
certainly the Fed has that capability.
I don't know if they have done it yet or not.
I have some reservations about whether or not the Fed can offer a
service at the same price private enterprise can. The Government
sometimes has problems internally or something else where they always seem to cost more than what private enterprise costs. That is my
personal opinion, but it gives me some concern sometimes.
Mr. GRASSLEY. I carried on this discussion with Mr. Miller when he
was here, and he assured us that even though the Fed has not quite
reached this point yet that its cost accounting would be able to provide
these figures, that we would definitely know if they were competitive
or not.
But he did speculate that it might be some period of time after the
installation by the Fed of the pricing mechanism before we could expect them to be fully competitive because of, I guess what I would call,
startup costs.
I just point that out to you, because they are saying that point is
going to come. I wonder, Mr. Chairman, if I can have time just for
one last question j
I have a message my time is up. Could I ask another question of Mr.
Wicks~
Mr. MITCHELL. The gentleman's time has expired, but we are in a
very expansive mood this morning.
Please proceed.
Mr. GRASSLEY. I was wondering, Mr. Wicks, what if the cost of carrying sterile reserves was cut in half, or maybe I should not say just
in half, but at least cut considerably, would you imagine that this
would stop the decline in Fed membership~
Mr. WICKS. I think it would be a definite £actor, yes. I don't know
as it would stop it. I think again looking at all of the opportunity costs
of being a member of the Fed still would be the decision that would be
made by any banker as to whether he should stay in or not.
Mr. GRASSLEY. As inflation increases, interest rates go up; as the interest rates go up, then there is a greater cost to the individual banks
because their reserves are sterile. Is there not then some connection between the Fed's ability to keep inflation under control, to keep interest
rates down and hence· the cost of sterile reserves down and the protection and encouragement of membership?
Mr. WICKS. I think that is a very definite factor. As the inflation
goes up, as interest rates go up, the opportunity costs of going out
of the Fed are greater, and this is certainly a very important part of,
I think, the decision of members to pull out.
Mr. GRASSLEY. From the standpoint of the Fed being a very strong
mechanism in our war on inflation, then fighting that battle more
aggressively would, in £act, stop the decline in Fed membership.

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Mr. WICKS. I think it would be a definite factor, yes.
Mr. GRASSLEY. Thank you, Mr. Chairman.
Mr. MITCHELL. The gentlelady from New Jersey.
Mrs. FENWICK. Thank you.
I would like to go back to the question of the reserves.
Mr. Perkins, at one point, said that the mandatory universal reserve
requirements would be damaging and, Chairman LeMaistre, if I understood it, also felt that this would damage the dual system. On the
other hand, I have just heard in later testimony from Mr. Perkins
that a theory of' universal reserves is good.
The lack of uniformity, said Mr. Olsen, in the reserve requirements,
makes it difficult for Federal Reserve to execute monetary policy because public demand shifts from one form to another.
What do I hear; am I correct in understanding that you believe,
all of you, that some form of universal reserve requirement would be
useful, equitable and desirable, provided that it were not set by statute,
but were left to whom?
That is what I am trying to get, to whom would you leave the decision as to what those reserve requirements should be, or to which
agency or group of agencies or to whom, Mr. Olsen?
Mr. Perkins, who would be setting that? I realize it would have to
shift if there were variations in the monetary situation.
Mr. PERKINS. There are all kinds of possibilities. I would think
that with the Federal Reserve charged with the Nation's monetary
policy as the central bank, that that would be the most likely administrative place.
Mrs. FENWICK. Would you be satisfied to see that i
Mr. PERKINS. There are really two questions: One is the setting of
reserves and the other is the question of reserve requirements, compulsory for all institutions. Our position has been that in our States
Federal system we would oppose that.
Mrs. FENWICK. I know, but doesn't that sound like a contradictory
position i On the one hand you are saying, yes, we must have reserve
requirements, and in the second place you are saying they should not
be mandatory.
Mr. PERKINS. No; I don't believe I said we must have reserve
requirements.
Mrs. FENWICK. You don't believe in having reserve requirements
theni
"The theory of universal reserve requirements is good," you said;
didn'tyoui
Mr. PERKINS. Yes.
Mrs. FENWICK. What were you talking about i What is good, if not
universal reserve requirements i
Mr. PERKINS. Good in the sense that to the extent that you have
equality you don't have unfairness built into the system of advantages
or disadvantages.
Mrs. FENWICK. But aren't you in favor of that?
Mr. PERKINS. Yes; I am 'in favor of having what we have also
referred to as an equal playing field among different types of
institutions.
Mrs. FENWICK. Yes, but Mr. Perkins, follow through.

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How do you suggest doing it~ Who is going to do it~
Mr. PERKINS. Our suggestion was that possibly we look at the total
federally chartered institution and maintain the State-Federal separation for the nonfederally supervised and chartered institutions.
Mrs. FENWICK. Yes, but who is going to set these universal requirements that you say would be useful~
Mr. PERKINS. I would think the Federal Reserve would be the
proper body with the proper-Mrs. FENWICK. But you just said that was not a good thing.
Mr. PERKINS. Now, wait, you asked me if you did thatMrs. FENWICK. No; I am saying, one, am I correct in quoting you
as saying, "The theory of universal reserves is good." But the level
required, as I understand it, "should be left to the open market."
Do I quote you correctly~
Mr. PERKINS. I don't believe so; no, ma'am.
Mrs. FENWICK. "The theory of universal reserves is good." You did
say that.
·Mr. PERKINS. Yes, on the basis of equity all across.
Mrs. FENWICK. Then you certainly are 'for equity.
Mr. PERKINS. Yes,ma'am.
Mrs. FENWICK. ·Who is going to set this universal reserve requirement?
Mr. PERKINS. I think while the theory is good we would oppose a
universal requirement because of the other more overriding considerations of the State-Federal.
Mrs. FENWICK. More overriding than equity?
.
Mr. PERKINS. When you put it that way-Mrs. FENWICK. You see, I am trying, Mr. Perkins, you cannot imagine how illogical this whole bimking things looks.
Mr. PERKINS. There are lots of illogical parts to it, yes, ma'am.
Mrs. FENWICK. I have listened carefully to all of you who are so
nuaJifieil, 11nd certninly I am not, but I am trying to understllnd the
distilled wisdom. If a theory of universal reserve requirements is equitable and just, surely we must try to approach it. Now, if we are going
to try to approach 'it, how do you approach it in such a way as to
not throw over the whole applecart?
Mr. PERKINS. I don't believe I am making myself clear.
Mrs. FENWICK. No.
Mr. PERKINS. But when we say we are having to weigh different
desirable aspects of things-Mrs. FENWICK. But how do you control monetary µolicy?
According to Mr. Olsen, the lack of uniformity in reserve requirements as public demand shifts from one to another makes it difficult
for the Federal Reserve to execute monetary policy.
Mr. PERKINS. Well, he is talking about a different kind of universal. He is not talking about universal reserve requirements there.
He is talking about the fact that depending on what size bank you are
at a particular moment, that there are differences in the reserve
requirements. But only to the member banks.
Mrs. FENWICK. The lack of uniformity. which certainly suggests
uniformity.
Mr. PERKINS. Yes.

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Mrs. FENWICK. Now, uniformity covering whom, covering which
banks?
Mr. PERKINS. Our suggestion was it would cover, if it went that
route, federally chartered depository institutions.
Mrs. FENWICK. So what you would like to see is the theory of reserves being set because it is equitable and just, but it should apply
only to Federal banks, leaving the State banks to be inequitable and
unjust?
Mr. PERKINS. At some point we have to perhaps pay a price in
equity or inequity for what we consider very important things, such
as the State-Federal, the whole concept.
Mrs. FENWICK. The only justification for the dual system we have
had today was from Chairman LeMaistre, as I understood it which
was that you get innovations such as the NOW accounts in the New
Eng-land States, and so on. I don't know that it is worth paying in
justice and equity for so little, is it?
Mr. PERKINS. I think that is obviously a very difficult question, but
at some point the question of not having one overall Federal operation
as opposed to havmg some diversity in the system, I think, has a lot
of nluses, such as innovation.
Mr. OLSEN. Could I share partly in that answer, Mrs. Fenwick?
Mrs. FENWICK. Yes, Mr. Olsen.
Mr. OLSEN. First, I want to make a distinction between the uni~
versal reserve requirements and the fact that you now have different
rates of requirements among institutions, an'd types of deposit reserves--time deposits are lower against demand deposits.
That creates problems in monetary policy, the fact that you have
rlifferences. Now, universal reserve requirements, which the Federal
Reserve Board has proposed, means extending reserve requirements
to all depository institutions. They have intimated that possibly i:f
this were done, they would not pursue the matter of enabling the
banks to earn interest on those.
Now, that obviously would be offensive to those banks that are not
now members of the Federal Reserve and who earn interest on their
reserves. In other words, they would be forced to go back into a system
that they left. They would be opposed to that, and that is inequitable
to force them back into holding noninterest assets.
Mrs. FENWICK. I agree, but I don't see why you would have to force
them into holding nonearning assets simply if you set reserve requirements. Why couldn't you set reserve requirements that would allow
for interest bearing reserves?
Mr. OLSEN. You could do that; yes, you could.
Mrs. FENWICK. Wouldn't that be the sensible thing to do and get
justice and interest, too?
Mr. OLSEN. That has not been proposed at this point, but that would
be justice, yes.
I might add one other point, that the Federal Reserve sets reserve
requirements today. Many States, as I understand it, set their reserve
requirements along with the Federal Reserve, in many cases, not universally, but some.
Mrs. FENWICK. My time has expired, but, honestly, I could listen all
day.

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Mr. MITCHELL. The gentlelady's time has expired. But I, too, was
fascinated by your spirited line of questioning.
The committee will adjourn now because we have ihad the witnesses
for quite a while and it is almost high noon. I am glad we have come to
an end of this session of the hearings on that rather spirited line of
inquiry which all of us found fascinating.
Gentlemen, thank you very much for being here. You have been very
patient and kind and cooperative, and we are most appreciative.
For the members of the committee, the last round of hearings will
be scheduled. next Friday at 9 o'clock.
Gentlemen, thank you very much.
Mr. PERKINS. Thank you, Mr. Mitchell.
Mr. WICKS. Thank you, sir.
Mr. LEONARD, Thank you.
Chairman LEMA.ISTRE. Thank you, Mr. Chairman.
Mr. MITCHELL. The committee stands adjourned..
[Whereupon, at 12 :00 noon the committee adjourned, to reconvene
on Friday, August 11, 1978.]

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Federal Reserve Bank of St. Louis

MONETARY CONTROL AND THE MEMBERSHIP
PROBLEM
FRIDAY, AUGUST 11, 1978

HousE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, D.O.
The committee met, pursuant to notice, at 9 :05 a.m., in room 2128,
~he Rayburn House Office Building, Hon. Parren J. Mitchell presidrng.
Present: Representatives Reuss ( chairman of the committee),
Mitchell, Spellman, AuCoin, Cavanaugh, Vento, Stanton, Hansen,
Fenwick, and Green.
Mr. MrTOHELL. This hearing will now come to order.
Today we continue our hearings on proposals designed t.o improve
the implementation of monetary policy, promote competitive equity
among banks, and ease the problem of Federal Reserve membership.
We have had before us three bills and an amendment to one of these
bills: H.R. 13476, H.R. 13477, Federal Reserve proposals submitted
by request; H.R. 12706, the Stanton bill, and an amendment to the
Stanton bill.
Our hearings so far have illuminated some problems with eaeh of
these proposals and have brought forth many constructive suggestions.
As a result of these hearings, we now want to consider another proposal which appears to have a great deal of merit and we would welcome any comments that the witnesses may have on this proposal as
well as those considered in the testimony you have submitted.
I understand that all witnesses have.been informed of the new proposal but I appreciate that you have not had much chance to study it.
The new proposal is a very simple bill consisting t>f two titles: First,
it would authorize the Federal Reserve to obtain whatever information
it needs for purposes of better monetary control from all depository institutions through the appropriate regulatory agencies; and second,
it would restructure reserve requirements so that the first $100 million
of reservable liabilities of commercial banks would be exempt from
any reserve requirement, while all commercial banks would be subject
to reserve requirements on such liabilities over $100 million-with
reservable liabilities meaning demand deposits, time and savings deposits and overnight bank borrowings. These reserve requirements
would be subject to a uniform rate of 6 percent, with the Federal Reserve authorized to increase or decrease that by one-half percent for
purposes of monetary control only.
Thus all banks of less than $100 million in reservable liabilities will
be exempt, while the bigger banks will all be treated alike in terms of

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reserve requirements, whether members of the Federal Reserve System or not.
I would emphasize that nothing in this proposal would change the
supervision or regulation of banks as between Federal and State authorities. Nonmember banks of over $100 million, while required to
hold reserves, would not be brought under Federal Reserve regulation
in anyway.
One of the major advantages of this proposal is that the cost to the
Treasury would be only about $150 million, several hundred million
dollars less than any of the previous proposals.
Our witnesses today will be: Henry Schechter, director, Tupartment
of Urban Affairs, AFL-CIO; Jerry Jordan, senior vice president and
economist, Pittsburgh National Bank, Pittsburgh, Pa.; Prof. Paul
McCracken, University of Michigan; Prof. Thomas Mayer, University
of California at Davis; William M. Crozier, Jr., chairman and president, BayBanks, Inc., Boston, Mass., and Mr. Bernhard W. Romberg,
president, Payment and Administrative Communications Corp., New
York,N.Y.
Gentlemen, we welcome all of you and we are most grateful that you
could take time out of your busy schedules to be with us this morning.
. Other members of the committee will be joining us shortly. If you
have been following the papers recently, the Congress is working incredibly long hours and I think there might be some battle fatigue
beginning to show. We do, however, expect a good turnout of the members this morning.
We have received copies of statements and I would appreciate it in
the interest of time if you would submit the statement for the record
in its entirety and perhaps try to summarize your testimony in 10 or
15 minutes. Thank you.
I think logic would dictate we start on my left with Mr. Schechter
and proceed down the line.
STATEMENT OF HENRY SCHECHTER, DIRECTOR, DEPARTMENT OF
URBAN AFFAIRS, AFL-CIO

Mr. SCHECHTER. Mr. Chairman, I appreciate the opportunity to present before your committee the views of the AFL-CIO dealing with
proposed legislation on reserve requirements of depository institutions.
The proposals involve the interests of private financial institutions and
of the public. They would have a bearing on the financial structure and
stability of the national economy. These are matters in which the
AFL-CIO has had a continuing concern.
The conditions giving rise to the bills under consideration can be
stated briefly. Over the past decade there has been a decline in bank
membership in the Federal Reserve System. The Federal Reserve
Board claims that it tends to weaken the financial system, as more
financial transactions are carried on outside of Federal Reserve regulatory channels and the implementation of monetary policy becomes
more difficult. The decline in the Federal Reserve membership has been
attributed to the fact that member hanks are required to hold a relatively large proportion of assets in noninterest bearing reserve accounts
than nonmember banks or other institutions.

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To deal with the Federal Reserve System membership problem,
two basic courses of action are under consideration in proposed legislation. One is to authorize the Federal Reserve banks to begin to pay
banks interest on reserve deposits, at a continuing annual expense of
several hundred million dollars a year to the U.S. Treasury and the
American taxpayers. The other is to re<J_uire nonmember banks and
other depository institutions, whose deposits are insured by the Federal
Government, to have the same noninterest bearing reserves as member
banks on demand and similar deposits, with some exemptions £or
smaller institutions.
E,ach of these two major courses of action can be assessed in light of
the overriding need £or effective control of monetary policy and therefore the need to halt Fed membership erosion.
PAYMENT OF INTEREST ON RESERVE DEPOSITS

In connection with proposals £or the Fed to pay interest on reserves,
it should be noted that presently the Federal Reserve pays no interest
on member bank reserves. After paying a statutory 6-percent dividend
on stock held by member banks, and adding as much as necessary to
each Federal Reserve bank's surplus to keep it equal to its paid-in
capital stock, the rest of the Federal Reserve bank's net earnings are
turned over to the Treasury. Therefore, the total amount of annual payments of interest on reserves would reduce the annual Federal Reserve
payment to the Treasury by an equal amount.
Furthermore, i£ the Federal Reserve banks have accumulated excess
surplus funds, such excess surplus funds are a result of past misjudgments of how much of Federal Reserve net earnings needed to be retained in the Fed surplus, instead of being turned over to Treasury at
the time.
Such funds really represent deferred payments due to the Treasury.
That interpretation would seem to -be in accordance with a statutory
provision that in the event of dissolution of a Federal Reserve bank,
after payment of debts and par value of stock, remaining surplus funds
are to become the property of the United States. The use of such excess
surplus funds to help pay interest on reserves would represent a diversion of Treasury revenues, just as would the use of current year Fed
earnings to pay interest.
Finally, the excess surplus funds are limited and could not offset the
Treasury losses after 2 or 3 years.
In estimating costs to the Treasury of interest payments on reserves,
therefore, a transfer of excess Federal Reserve bank surplus funds to
the Treasury should not be looked upon as an offset to the interest payments. The total annual Treasury revenue loans from payment of interest on reserves has been estimated at $765 million under the proposed Federal Reserve formula in H.R. 13477, the Interest on Reserves
Act of 1978, and $450 million under a formula in the proposed Reuss
amendment to H.R. 12706, the Federal Reserve Membership Act of
1978. These estimates and those to be cited later appear on page H6780
of the Congressional Record of July 14, 1978, as part of Chairman
Reuss' statement introducing the bills. H.R. 12706 itself would direct
the Fed to pay interest on reserves at a rate not to exceed the average

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rate on Treasury 3-month bills in the preceding calendar quarter, an
uncapped amount.
The payment of interest on required reserves of depository institutions is neither necessary to deal with the related problems of Fed
membership attrition and achievement of more effective monetary
policy, nor desirable from a public-interest point of view.
It is elementary that interest payments on reserves would provide
commerci,al banks with a substantial windfall at the expense of the
Treasury and American taxpayers.
The so-called burden borne by banks in complying with the reserve
requirements is part of the cost of conducting a business which must be
a joint public-private venture, in order to minimize general economic
instability. Depository institutions are given Government franchises to
operate, and protected from injurious competition by the regulatory
authorities who control the chartering of new institutions and
branches.
Tho depository institutions are the guardians of other people's
money which can best be safegua,rded under a monetary supply that is
regulated to meet the needs of the economy without becoming too excessive or too tight. Congress has assigned that mission to the Federal
Reserve, with due authority to require the maintenance of adequate
reserves. The mooting of reserve requirements, therefore, is a necessary
cost of the banking business, and one that the business has lived with
and grown over the past 64 years.
There are two other provisions in the proposed bills that have been
brought into the discussion of interest payments on reserves. One
is the innovation of charges for services by Federal Reserve banks
against depository institutions receiving interest payments on reserve
deposits. Such charges would be made, as implied in H.R. 13477 and
as directed in H.R. 12706 and under the proposed amendment to
H.R. 12706. Aggregate charges have been estimated at $410 million
annually.
At the same time, under H.R. 13476, the Federal Reserve Requirements Act of 1978, embodying the Fed's proposal for mandatory
universal reserve requirements, and H.R. 12706 with Chairman Reuss'
proposed amendments, changes in reserve requirements would reduce
outstanding reserves by an estimated $5 billion. The reduction in
reserves and interest that can be earned thereon would mean an estimated annual revenue loss of $350 million to the Fed and Treasury,
and that much of a gain to the depository institutions.
UNIVERSAL RESERVE REQUIREMENTS

The AFL-CIO is firmly opposed to the payment of interest on
reserves as a ma.tter of public interest and also because the intended
purposes can be met through universal reserve requirements along the
lines that have been proposed in H.R. 13476, the Federal Reserve Requirements Act o-f 1978, with some modifications.
The Federal Reserve Requirements Act o-f 1978 would establish
mandatory universal reserve requirements -for all depository institutions whose deposits are -federally insured. It would be applicable
to insured commercial banks, nonmember as well as Fed member;
mutual savings banks; savings and loan associations; and credit unions.

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However, reserves on time and savings account deposits would be
required only of Fed member banks, not for other depository
institutions.
Reserves would be required of 'all depository institutions with
respeot to demand deposits and transaction accounts. The latter are
deposits or ,accounts on which the depositor or account holder is allowed to make withdrawals by negotiable or transferable instrument
or other similar item for the purpose of making payments to third
persons or others. Among such accounts would be demand deposits,
negotiable order of withdriawal accounts, and share dra.ft accounts.
The definition of transaction accounts given in section 101 of H.R.
13476 does not include funds which can be automatically transferred
from savings deposits into demand deposits. This would seem to be
a serious omission from the viewpoint of effective monetary policy.
To meet that deficiency, the definition of "transaction accounts" in
section 3 (b) ( 2) in the amendments to H.R. 12'706 proposed by Chairman Reuss should be substituted for the definition in section 101 of
H.R.13476.
The proposed requirement in H.R. 13476 that equal reserves against
demand and other transaction accounts be maintained by nonmember
institutions, should remove the major inducement for member banks
to leave the Federal Reserve System. Furthermore, reports from all
depository institutions, as to compliance with reserve req_uirements,
would provide the Federal Reserve with an improved basis for effective
regulation of the money supply.
For small nonmember institutions there would be an exemption
from reserve requirements against transaction accounts under both the
Federal Reserve proposals in H.R. 13476 'and also under proposed
amendments to the Stanton bill, H.R. 12706.
The exemption would be $5 mi1lion under H.R. 13476 and $10 million
under the proposed amendment to H.R. 12706. It is desirable that
small banks, generally serving sma11 communities, should be protected
against competition from larger institutions. What the appropriate
amount of exempt transaction accounts should be :for this purpose
we do not know.
Nonmember institutions could maintain reserve deposits at member
banks. Many nonmember depository institutions, particularly small
banks and thrift institutions that have transaction accounts, already
maintain deposits at large member banks. To that extent, part of the
nonmember reserve requirement under H.R. 13476 are probably already being met.
As far as thrift institutions are concerned, the great majority have
the overwhelmingly major part or all of their deposit liabilities in the
form of time and savings accounts, which would not be subject to any
reserve requirements. The inflow of savings available for mortgage
loans should not be adversely affected. Furthermore, in order to avoid
the imposition of new supervisory authority over thrift institutions,
the compliance of such institutions with reserve requirements should
be supervised by their present Federal regulatory agencies, such as
the Federal Home Loan Bank Board and the National Credit Union
Administration.
For all of the foregoing reasons, universal reserve requirements pro-

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426
vided for in R.R. 13476, with suggested modifications, should prove
adequate to deal with the problem of loss of Fed membership and the
consequent increased difficulty of implementing monetary policy.
There should not be any need for payment of interest on reserves at a
large and continuing annual cost to the U.S. Treasury.
CHANGES IN MONETARY POLICY TOOLS

The proposed amendment to R.R. 12706 would make two other noteworthy changes in Federal Reserve powers for implementation of the
monetary policy. One would call for the Federal Reserve discount
rate on loans to members to be set at the same level as the Treasury
bill rate. This would have the intended effect of precluding the opportunity for arbitrage profits when the discount rate is below the
bill rate. The Fed would still be in control of the discount rate because
it can exercise controlling influence over the bill rate through its open
market operations. There would thus be no significant loss of the
efficiency of a tool of monetary policy, while there would be a protection against the use of Fed credit through the discount window to
gain arbitrage profits.
Another monetary policy tool would be completely eliminated from
the Fed's kit by another proposal in the amendment to R.R. 12706,
that would be to establish specific statutory requirements for member
banks. They would replace a statutory range of reserve requirements
within which the Fed can lower or raise the reserve requirement level.
The rationale is that the Fed can implement monetary policy with
open market operations and discounting, and changes in reserve requirements have been made infrequently. Nevertheless, it is the infrequent occasion, such as a liquidity crisis, when Congress' schedule
might not accommodate necessary quick action to adjust reserve requirements. The shift to fixed statutory reserve requirements, therefore, could cause the loss of some needed flexibility.
I have seen the newest draft bill calling for uniform reserve requirements. I think this is a move in the right direction. It goes in
the direction that I have indicated in my statement. My question is,
I have not had time, certainly, to try to study the details to see what
the impact would be, -and I would raise one concern with respect to the
uniformity and narrow flexibility to the level of the reserves that
would be required; that is, the extent to which there could be response
to provide greater liquidity in the event of a real liquidity crisis.
After all, we established the Federal Reserve System after we had
experiences such as the financial panics, as they used to be called,
of 1873, 1893, 1907, accompanied by many bank failures.
I just d0n't know if a 6.5-percent reserve requirement for commercial
banks with deposits of over $100 million would be able to meet that,
with a half percentage point margin on either side for flexibility.
I think in the desire to treat the everyday problem of mechanics and operation of costs to the Fed in charging for the services versus
some reduction in requirements to make that sort of balance, we
should not lose sight of the basic purpose of being able to provide
liouidity.
I reaiize smaller banks do have larger correspondent banks with
access to the Federal Reserve, but at the time of the liquidity crisis

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those larger banks would also be involved with their own concerns.
They would be concerned primarily with their own liquidity. They
might not want to risk providing additional extensions of credit to
relieve liquidity problems for some of the smaller banks. I throw that
up for consideration and think it merits some further consideration.
Mr. MITCHELL. Thank you very much, Mr. Schechter.
Mr.Jordan.

STATEMENT OF JERRY L. JORDAN, SENIOR VICE PRESIDENT AND
ECONOMIST, PITTSBURGH NATIONAL BANK, PITTSBURGH, PA.
Mr. JORDAN. I appreciate this opportunity to present my views on
the subject of reserve requirements and related issues. The prepared
statement I have submitted addresses some basic principles: the way I
woulq approach analyzing questions of the level of reserve requirements, the types of deposits that would be subject to reserve requirements, and the institutions that would be subject to reserve requirements. I will not go through that statement this morning. It refers in
part to proposals of a couple weeks ago and I want to spend my time
commenting on the latest proposal that Mr. Mitchell has described.
The proposal that I have read over is called "a bill to facilitatb the
implementation of monetary policy and to promote competitive equality among commercial banks."
I like the proposal. I like the simplicity of it and I think it gets to
the fundamental problem of reserve requirements as far as monetary
control is concerned.
My views on this subject, from the standpoint of an economist, are
concerned with formulation and implementation of monetary policystabilization policy-so I cannot assure you that commercial bankers,
from large or small institutions, are going to agree with my views.
I speak as an economist, and not as a banker, on these issues.
The first subject I want to take up is on reporting requirements.
On this topic I will comment, in part, from remarks in my prepared
statement. I think there should be a new statistical measure reported
by the Federal Reserve that conforms to the theoretical concept that
is associated ,vith the narrow definition of the money supply-currently referred to as M 1 • I think it should consist of all currency in the
hands of the public, plus all transaction-type balances at any financial
institution, regardless of whether or not there is a reserve requirement on it and regardless of any kind of interest rate ceiling considerations. As long as there is a regulation Q-type ceiling on time and savings deposit interest rates which is below the rates available on competitive market instruments, all accounts from which transactions can
be made directly, whether these are called demand deposits, negotiable
orders of withdrawal-or N01:V accounts-NIN01:V accounts, share
drafts, pay by phone, or the new automatic transfer accounts, should
be maintained separately from time and savings accounts at all institutions for bookkeeping purposes.
Data :from these transactions should be collected :from all the institutions :for inclusion in this new narrow definition of the money
supply, M 1 , and the issue of the amount and the form of any reserve
requirements on them and the interest rate ceilings on them can be dealt

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with separately from decisions regarding reserve requirements or interest ceilings on nontransaction-type deposits or accounts, such as
savings and time deposits at all financial institutions.
·
All financial institutions hold some form of reserve balances, even in
the absence of legal requirements. They hold them in the form of idle
cash and idle balances at other institutions-correspondent banks or
regulatory institutions.
I know of no evidence that legal reserve requirements greater than
the level that would be held anyway are necessary for effective control of the money supply, but it does not follow that the imposition
of reserve requirements on some transaction balances at some financi,al
institutions, while not at others, does not affect the reliability of monetary control techniques.
Studies have shown that when you have shifts in balances among
different size classes of member commercial banks that are subject to
different levels of reserve ratios, then you have absorption or release of
bank reserves. When a balance goes from a small member commercial
bank subject to low reserve requirements, or a nonmember bank subject to none, to a large member bank subject to a high reserve requirement, that absorbs reserves. If that is not offset by the Federal Reserve, you have a contraction in money. Similarly, shifts and balances
from the large banks subject to high reserve requirements to smaller
banks, whether subject to reserve requirements or not, releases reserves and expands money. So to me the question of uniformity of
reserve requirements is much more important than the question of
universality. In fact, universality of a tiered structure of reserve requirements, as currently exists and as was proposed by the Federal
Reserve, could actually make matters worse.
I would argue that the emphasis today, or in your deliberations,
should be on the kind or form of uniform reserves on whomever they
are imposed. This is part of the reason why I find the latest proposals
so appealing.
The question of interest on reserves is absent from the latest bill.
I think that is desirable-to eliminate the discussion of interest on reserve balances. Required reserves which are at a level above desired reserves-the amount of reserves that would be held anyway is a form
of taxation on the institution-a license fee or right to do business
as a member commercial bank. To then pay interest on those reserve
balances is a form of a tax credit, or tax rebate. and I really don't see
the point of giving the authority to the central bank to, in a sense, set
tax levels. I would rather have a uniform reserve ratio that is set at a
fairly low level and then not have any interest paid on those reserves.
The proposal that the reserve requirements he statutory is desirable
so long as it is at a sufficiently low level nnd it is uniform. If the current tiered structure of reserve equipments is retained or one of the
earlier proposals by both the Federal Reserve and others suggesting
a new tiered structure is imposed, I do not think it would be desirable
to be statutory whether universal or not.
The current proposal for a 6-percent reserve requirement, applied
to all reservable liabilities-deposits and overnight borrowings of
all commercial banks over $100 million-is desirable and having it
statutory would be desirable. I understand that the proposal would

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allow for the reserve ratio to be changed by one-hal:f 0£ a percentage
point in either direction for monetary policy purposes. I have no
strong objection to that. I don't think it would do a great deal 0£ harm.
I also don't think it would do a great deal of good.
The Federal Reserve, through its powers to conduct open market
operations-buying and selling securities-has all 0£ the capability
necessary to conduct monetary policy. The changes that they have
made in reserve requirements in recent years have been either specifically stated as not for monetary policy purposes, or in £act they
have gone in the wrong direction. I just don't see the necessity 0£ that.
The current proposal exempts the first $100 million 0£ deposits at all
commercial banks and it provides £or indexing that amount to keep
pace with inflation. As long as we are subject to the kind 0£ inflation
that we are, I think indexing is necessary and I think that the proposal incorporated in the bill is a desirable one and I hope that it is
maintained.
The form 0£ reserve requirements is not specified in the bill. Here I
would like to make some suggestions:
Certainly vault cash at all commercial banks should continue to be
allowed to meet reserve requirements-this has been the case since
1959 and I think that it is desirable-plus reserve balances at the central bank, at least on all transaction balances. However, the bill says
6-percent reserves on all reservable liabilities, including time and
savings deposits, and I do not think that the form 0£ the reserves on
the longer term savings certificates should be idle balances. I would
suggest anything over 90 days, running out to 8 year savings certificates, need not be held in the form 0£ idle reserve balances. To tell
a commercial bank that it has to hold a 6-percent idle cash reserve
against an 8-year savings certificate for liquidity purposes doesn't
really seem to be necessary.
We have suggested maybe 3 percent, which is about the current average reserve requirement on time and savings accounts, be held in idle
cash balances at the Federal Reserve and that the additional reserves,
the other 3 percent, be held in the form 0£ U.S. Government securities
in the portfolio 0£ the commercial bank. So on transaction balances
there would be a 6-percent idle cash reserve at all commercial banks
over the $100 million level-that would also include day in and day
out savings deposits. In other words, anything less than the 90 days
would be subject to the 6-percent idle cash reserve requirement.
Then on all time and savings certificates over 90 days, the 6-percent
reserves would consist of 3 percent in idle cash, as a suggestion, and 3
percent in Government security holdings.
I would also suggest that Treasury Tax and Loan accounts should
not be subject to reserve requirements. The U.S. Government's Treasury Tax and Loan account balances are not a part of the money supply. No one considers them in any theoretical or empirical way to
be money, and when Treasury balances fluctuate up and down, as they
do quite wildly week to week, or even day to day, this absorbs and
releases reserves in the banking system. The Federal Reserve has to
forecast that and try to offset it-so-called defensive operations-and I don't see the necessity of requiring that banks hold idle reserves
against Government balances, so I "'ould like to see that eliminated.

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Other proposals have previously been made that are not part of
the current bill, and maybe should be considered at a later time,
because I think the:y are desirable.
I think the elimmation of lagged reserve requirements would be a
good idea. If we didn't have the:tn already no one would be suggesting
that we impose lagged reserve requirements. We have continued them
for reasons of inertia, and I would like to see that question seriously
addressed.
Also, the proposal for staggered reserve requirements-having reserve settlements only on banking days and not over weekends and having one-fifth of the banks settle on each bank day of the week would be
desirable. That would smooth out the fluctuations in the balances over
the week. We wouldn't have the problems of interest rates running up
sharply on Wednesdays, or dropping sharply on Wednesdays, as currently is the case.
The question of the discount rate being tied to market rates is not
part of the latest proposal and I thought that it was a very good idea
and I would like to see it reconsidered at a later point if it is not going
to be included at this time. Changes in the discount rates have at most
an announcement effect on monetary policy, often, I think, a misleading announcement effect. That thing gets more attention than I think
it deserves.
I think the rate should be tied to something like the last couple of
~eeks' Treasury bill rate, but at a premium. There should be a penalty
· of, say, 50 points above Treasury bill rates. Then there should be a
rig-ht to access to the discount window. It should not be a privilege.
I think all commercial banks, and I would go so far as to say all financial institutions that issue transaction balances, should have the right
to access at the discount window as long as it is at a penalty rate. The
purpose is for the central bank to be the lender of last resort in the
event of a financial crisis, and I think whether it is a credit union, a
savings and loan association, or nonmember commercial bank, large
or small, that if they run into clearing problems or financial difficulties, they should have access to the central bank's discount window as
long_ as they are paying a little premium for it and not receiving a
subsidy from the taxpayers.
If it is not a right and not a premium-if there is a subsidy because
the discount rate is below current market rates-then I think appropriate regulatory authorities for nonmember banks and thrift institutions should have some say-so in the access to the window because,
after all, it is the taxpayer's pocket that is involved.
My proposal would be to tie the discount rate to market rates at a
penalty and let all institutions, members, nonmembers, and thrift institutions have access to it.
I think I will stop at this point and answer any questions you would
like.
[Mr. Jordan's prepared statement follows:]

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Statement by
JERRY L. JORDAN
Senior Vice President and Economist
Pittsburgh National Bank

Mr. Chairman and Members of the Committee:
I appreciate this opportunity to present my views
on proposed legislation dealing with reserve requirements
on transaction-type accounts at financial institutions,
the payment of interest on reserve balances, the pricing
of Federal Reserve services to private financial institutions, and related questions.

I have studied the pro-

posed legislation as well as statements by Chairman Reuss,
Congressman Mitchell, Congressman St. Germain, Federal
Reserve Chairman Miller, and other witnesses that have
appeared before this committee in the past two weeks.
In my prepared statement I have not attempted to take
a position on each issue that has been raised during these
hearings, but I look forward to an opportunity to answer
your questions.
The initial part of my statement is directed towards
a few basic issues which I believe are important to consider when addressing the general subject of reserve

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requirements.

My views on Federal Reserve pricing of

services and on a number of other regulatory issues appear
at the end of my statement.
A

discussion of the types of deposits and the insti-

tutions which are subject to mandated reserve requirements,
the appropriate level of reserve requirements, and the
question of whether interest should be paid by regulatory
authorities on such reserves, should begin with some
analysis of the purpose of reserve requirements.

I will

comment on three possible reasons for having legal reserve
requirements.
First, if non-interest bearing reserve requirements
are viewed merely as a form of taxation, then a proposal
by the central bank to pay interest on reserves is merely
a way of reducing this form of taxation.

If that is all

that is involved

a desire to reduce this particular

form of taxation

then why not do so explicitly by

reducing the level of the reserve requirements?
If the primary purpose of reserve requirements is
to impose a tax on institutions, and the reason for having
a graduated structure of requirements is to compel larger
institutions to pay proportionally more tax (as a result
of higher reserve requirement ratios}, then it is not
at all clear why financial institutions of the same size
whether they are commercial banks, mutual savings banks,
savings and loan associations, or credit unions -- should

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b~ subject to different rates of taxation.
Second, if the. purpose of reserve requirements is
to protect depositors from loss of their funds and to
promote the viability and efficiency of the financial
system, then an assessment should be made as to the appropriate level and structure of reserve requirements
in order to achieve that purpose.

There is no evidence

that the graduated structure promotes safety and efficiency; there is no evidence that a commercial bank that
is a member of the Federal Reserve and subject to a reserve requirement of 16¼ percent on demand deposits over
$400 million is safer and more efficient than a similarly
sized institution that is not a member of the Federal
Reserve System and is not required to hold idle reserves.
On the other end of the scale, there is no evidence that
an idle cash reserve requirement of 7 percent makes a
member institution with $5 million in demand deposits
a safer place for a depositor to hold funds than a nonmember instit'ution -- .whether it be a commercial bank
or a thrift institution that offers transaction-services
such as NOW accounts, pay-by-phone, or share drafts.
Third, if the purpose of reserve requirements is
to enhance monetary control, then the tiered structure
of reserve requirements is even less defensible.

Not

only is there.!}£ evidence that a tiered structure of reserve requirements increases the ability of the monetary

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authorities to influence the level of the money supply,
there is some evidence that a tiered structure has made
it more difficult to control the money supply than would
a uniform structure.
The distinction between uniform and universal reserve
requirements is useful.

Uniform reserve requirements

means that institutions that are subject to reserve requirements on certain types of deposits are all subject
to the same reserve requirement ratios and satisfy their
reserve requirements by holding the same types of assets.
Universal reserve requirements means that

ill

institutions

offering a certain type of deposit or account that is
subject to reserve requirements by any institution would
be subject to the same reserve requirements.
Several issues are involved in assessing whether
or not reserve requirements should be uniform and whether
or not they should be universal.

First is the question

concerning the appropriate measures of the nation's money
supply that are controlled by the central bank as part
of the process of formulating and implementing monetary
policy.

Both the theoretical and the empirical issues

have been addressed in numerous places.

The recommendations

by the Special Committee on Monetary Aggregates, commissioned
by the Federal Reserve and chaired by Professor Leland
Bach, are still relevant and worthy of further consideration.

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My view is that there should be a new statistical
measure that conforms to the theoretical concept that
is associated with the narrow measure of the money supply,
currently referred to as Ml.

It would consist of currency

plus all transaction-type balances at any financial institution, regardless of reserve requirements and interest
rate considerations.

So long as regulation

type ceilings

on time and savings deposits exist and are below market
rates on competitive financial assets, all accounts from
which transactions can be made directly -- whether they
are called demand deposits, negotiable order of withdrawal
(NOW) accounts, non-interest bearing negotiable order
of withdrawal (NINOW) accounts, share drafts, pay-byphone, or automatic transfer accounts -- should be maintained separately from time and savings accounts at all
institutions.

Data on these transaction accounts should

be collected from all institutions for inclusion in the
narrow definition of money stock (Ml), and the issue of
the amount and form of any reserve requirements on them,
and any interest rate ceilings on them, should be dealt
with separately from any decisions regarding reserve
requirements and interest ceilings on non-transactiontype deposits or accounts at all financial institutions.
Accurately collecting and aggregating all transaction~
type balances is an essential step towards effective
monetary policy management.

However, there is disagree-

ment as to whether it is a sufficient step for the conduct

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of monetary policy.

On this question, I believe that

the Federal Reserve tries to have it both ways.

At one

time, such as in the proposed Reserve Requirements Act
of 1978, (H.R.13476), the Fed argues that imposing reserve
requirements on all transaction-type balances at financial
institutions is necessary for control of the money supply.
However, in

actual practice, the Federal Reserve does

not operate on a reserve aggregate concept, such as total
reserves or the monetary base, in spite of persistent
recommendations to that effect over the past decade.
So long as the Federal Reserve continues to focus
on the daily and weekly average Federal Funds rate as
an operating target in its efforts to influence the monetary aggregates, the Fed's arguments about the necessity
for universal reserve requirements are without merit.
If Federal Reserve officials believed their own explanations for past overshoots and shortfalls in the growth
of money, or their own analyses about the prospects for
money growth in the future, then they should be telling
this Committee that the subject of reserve requirements
is irrelevant to the way in which they conduct monetary
policy.
It is undeniable that all financial institutions
will hold some reserve balances -- in the form of both
vault cash and idle balances with other institutions for

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clearing purposes -- even in the absence of legal minimums.

I know of no evidence t~at legal reserve require-

ments greater than the levels that would be held anyway
are necessary for effective control of the money supply.
However, it does not follow that the imposition of reserve
requirements on transaction balances at some financial
institutions, and not at others, does not affect the
reliability of monetary control techniques.
Previous studies have shown that under the present
system, shifts in balances among different size classes
of member commercial banks that are subject to different
reserve requirement ratios contribute more to the variability between the money supply .and the monetary base
than do shifts in balances between member and non-member
institutions.

Universal reserve requirements would con-

tribute very little to the Federal Reserve's ability to
control the money supply if reserve requirement ratios
are not applied uniformly.
If minimum idle balance or cash reserve levels at
some institutions, such as large member commercial banks,
are set above the amount the same institutions would hold
in the absence of legal minimums and also above the ratios
held by other institutions, then the precision of monetary
control is affected.

Any shift in balances from institu-

tions with high legal reserve ratios to institutions with

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low or zero legal reserve ratios releases reserves or
high powered money into the banking system which have
the potential for a multiple creation of money balances
unless offset by open market draining operations.

Con-

versely, shifts in balances from financial institutions
that have zero or low reserve requirements to institutions
that have much higher reserve requirements absorb reserves
and cause a contraction in the amount of money in the
economy unless offset by the central bank.
There are seasonal as well as cyclical patterns in
the movements of various types of deposits that are different between large banks and small banks, urban banks
and rural banks.

Consequently, the precision with which

the Federal Reserve could control the money supply by
operating on total reserves, or the monetary base, depends
upon the Fed's ability to forecast and offset the effects
of shifts in balances between different types and sizes
of financial institutions.

That is the situation today,

and it would continue to exist even under proposals to
extend the tiered structure of reserve requirements to
all financial institutions.
I believe that if the objective in making proposals
for a change from the present system is to enhance their
ability to control the money supply, then the Federal
Reserve should be arguing for a single, uniform reserve

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ratio applied to all balances of the same type.

In ad-

dition, the Fed's operating procedures should be changed
so that total reserves or the monetary base replaces the
Federal Funds rate as a short-term operating target.
Statutory reserve requirements, as proposed in the
amendments to the Stanton bill, would be desirable if
set at a sufficiently low level.

I believe a larger

amount. of transaction balances could be exempted from
legal minimums, and I would suggest that something in
the range of the first $20 to $30 million of transaction
balances should be exempted initially.

In these infla-

tionary times, there also should be some provision for
indexing that amount over time.

However, as previously

stated, a graduated scale of reserve requirements, as
proposed in the amendment to the Stanton bill, would not
be desirable.
I would make two proposals in this regard.

The first

is that a uniform cash or idle balance reserve requirement
of less than 10 percent be imposed on transaction balances
at all institutions subject to the reserve requirements.
Something on the order of only 6 to 8 percent may be
adequate.

Second, if there is felt to be justification

for imposing higher reserve requirements on larger institutions, then the incremental reserves over and above
the uniform base amount should be held in the form of
U.S. Government securities.

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For example, the first $25

440
million of transaction balances at any institution would
be exempt from any legal reserve requirement.

From $25

million to $100 million in transaction balances would
be subject to a 6 percent minimum reserve that is met
by holdings of vault cash and balances at the Federal
Reserve.

Then for balances above $100 million, possibly

on a graduated scale, 6 percent would be held as vault
cash or balances at the Federal Reserve and the additional
percentage would be met by the institution's holdings
of government securities.
At this point, I want to take up the subject of the
payment of interest on reserve balances.

In principle,

I am opposed to any payment of interest by the Federal
Reserve on reserve balances.

Interest should not be paid

on the vault cash held by member banks unless a general
form of inflation indexation is adopted wherein all citizens have an opportunity to earn interest on their holdings
of currency.

In addition, as I stated at the outset,

since the imposition of a reserve requirement is a form
of taxation, then the payment of interest on reserves
is nothing more than a tax rebate and I believe that it
would be more desirable to lower the tax rate rather than
to maintain high tax rates and grant rebates.
Federal Reser,ve officials have argued that their
authority to change the level of reserve requirements
is necessary for monetary policy purposes.

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I agree with

441
the arguments and questions put forth in the July 27
statement by Chairman Reuss to the effect that there is
no evidence to support such a contention.

Consequently,

I have no trouble supporting the proposal for statutory
reserve requirement ratios.
At this point I would like to state my position on
a few more issues related to the subject of reserve requirements.

No matter what the outcome of deliberations

regarding the level, the uniformity, and the universality
of reserve requirements on transaction balances, I do
not see the necessity nor the desirability of any legal
reserve minimum on time and savings balances at any institutions.

Furthermore, U.S. Government balances at com-

mercial banks, known as Treasury Tax and Loan accounts,
are not part of the money supply and there is no reason
to impose reserve requirements on them.

Fluctuations

in the Treasury's balances absorb and release reserves
in a very erratic manner and influence the relationship
between total bank reserves, or the monetary base, and
the money supply.

This serves no useful purpose.

On another issue regarding the subject of reserve
requirements, I do not believe that the present system
of lagged reserve requirements is desirable.

There is

empirical evidence suggesting that such a system reduces
the ability of the Federal Reserve to control the money
supply, and I would urge a return to a system of coincident

32-972 0 • 78 • 29

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reserve requirements.

In addition, the proposal to stagger

settlement dates within the week would be desirable.
Turning to the subject of the discount rate, I support the amendment to the Stanton bill which would tie
the discount rate to the average Treasury bill rate over
the past two weeks.

However, I would suggest that the

discount rate be specified at a premium over the average
Treasury bill rate in order to eliminate any subsidy at
all during periods of rising interest rates.

Specifi-

cally, the discount rate should be pegged at one-half
percentage point (50 basis points) above the average
Treasury bill rate.
Finally, on the subject of the pricing of Federal
Reserve System services, I agree with the Stanton bill
that the prices of Federal Reserve services should be
set at competitive market levels.

I think that it is

necessary for the efficient allocation of resources that
the Federal Reserve impute a cost of capital that is at
least equal to the average interest rate on outstanding
government debt, and that they also impute a corporate
income tax rate in setting their prices.

I also agree

with Congressman St. Germain's concern about the range
of Federal Reserve services that are provided, and I
believe that competitive market pricing by the Federal
Reserve would help to determine which services private
institutions can provide at least cost and which ones

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must carry a subsidy from Federal taxpayers.

In general,

I believe in the proposition that a government agency,
such as the Federal Reserve System, should provide only
those services that the private market system cannot or
will not provide.
In conclusion, I agree with much of the Federal
Reserve System's analysis as it appears in Chairman Miller's
statement, regarding the problems of maintaining the present
system, but I do not agree with the Fed's prescriptions
as to what to do about it.

I hope that the outcome of

these hearings will be legislation that makes it possible
to more accurately measure and control the nation's money
supply, and that the amount and form of reserve requirements which are imposed are only those which are necessary
for effective formulation and implementation of monetary
policy.

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Mr. MrrcHELL. Thank you very much for some very interesting
recommendations.
Mr. McCra,cken.

STATEMENT OF PROF. PAUL W. McCRACKEN, EDMUND EZRA DAY
UNIVERSITY PROFESSOR OF BUSINESS ADMINISTRATION, UNIVERSITY OF MICHIGAN
Mr. McCRACKEN. Thank you, Mr. Chairman. I appreciate this opportunity once again to appear before this committee.
I am not going to read the statement which I submitted earlier. I
am going to submit an amended version of that in view of the developments of the last several days.
As I understand the items in the new bill which you outlined in
your opening comments, I find myself generally quite sympathetic
with it and if I were a member of this committee, I suspect I would
vote for it. It seems to me the basic elements that have been proposed
here constitute a substantial step in the right direction.
Obviously the capacity to expand and improve our economic information system in this area is highly desirable. One of the impressive
things we have seen historically is the magnitude of revisions which
frequently are made and which leave us with the conclusion that not
only are we not sure where monetary policy ought to go, but at the
point at which decisions had to be made we weren't even sure where it
had been. Anything that can be done to improve this would obviously
be desirable.
On the question of imposing lower and uniform reserve requirements on what Mr. Jordan has called reservable liabilities, that
strikes me also as a significant step in the right direction.
Thesl'I very wide ranges within which decisions can be made are
rrobably more comfortable from the standpoint of the regulatory authorities, but, on the other hand, wide ranges for targets also tend to
make for sloppy management of policies.
· After all, if the target is big enough, it is not very easy to miss it,
but it is not very significant either.
I would like to expand a bit on a point which Mr. Schechter made
at the end of his comments. Mr. Jordan also alluded to it in a slightly
different connection. Having a half a percentage point up or down
would not trouble me. I don't think it is a very significant thing. It is
not, however, really directed at the kind of leeway which ought to be
central to changes in reserve requirements.
I do not see changes in reserve requirements as having any significance in the ongoing management of monetary policy. It is hard to
conceive of any situation where open market operations could not
handle what might be achieved by a half a percentage point one way
or the other.
On the other hand, Mr. Schechter did allude to potential situations
where there would need to be some authority. Suppose you get major
changes, which can occur rather suddenly. He alluded to the problems
we faced in certain panic situations.
I would point out also that in the thirties we had a problem the other
way around. We had a situation there for a while where for every

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dollar of required reserves member banks had more than $1 of excess
reserves.
I, of course, have had no opportunity to study the language of the
new bill, so it may be there, but I should think the Federal Reserve
ought to have the authority, perhaps for a limited period until the
Con~ess could review the matter, to alter in a major way the reserve
reqmrements. Suppose there were an international crisis and we had a
massive inflow of funds from abroad, such as we had in the thirties,
which produced the sloppy reserve situation at that time.
That is the kind of a situation in which, it seems to me, authority to
alter in a major way reserve requirements ought to be given.
On the proposal to exclude the first $100 million of these reservable
liabilities, in principle having some kind of lower limit exclusions
strikes me as making sense.
I have not examined this in detail. I would have no opinion on that
specific issue.
As I understand it-and once again this may be erroneous-that
$100 million is to be indexed by the rise in nominal GNP, not the
price levels.
I think I would suggest to the committee that the escalator for this
indexing be the price level and not nominal GNP. A part of the expan~
sion in the economy in nominal terms will be taken care of by an expansion in ,the deposit liabilities of existing institutions, but a part of it
ought to be taken care of by the gradual growth in new institutions,
as we have seen in the last 25 years.
I should think the primary objective of this kind of an escalator
ought to be particularly in this era of uncertainty about the price
level, to make sure that that $100 million is kept intact in real terms
and not, as it were, seeming to signify that each of the existing institutions ought to have a proportionate share of the growth in the
economy. It is not a major point, but I think there is a logic there
which would deserve some further consideration by the committee,
The suggestion that all banks have access to the discount window
certainly is a sensible provision in the bill.
I also like the idea tha,t regulatory authority-and I assume exami"
nation authority-would remain in, I suppose, the State banking authorities and the FDIC and so forth.
I think this is important. Our kind of pluralistic system still contains a great many advantages. I don't believe in monopoly where
we can avoid it, and I think there is some desirability in not having
the central bank have a total monopoly of these matters.
I realize that in a very early incarnation in my career I was at the
Federal Reserve Bank in Minneapolis, and there I tended to see it
the other way around, but now I am speaking as a citizen.
Now, in conclusion, I would suggest to the committee that it keep
on the agenda of unfinished business a further exploration of the
proposal to extend reserve requirements to the transactions balances
of all institutions; not just all commercial banks.
I think the intramarket competition situation as between banks
and other institutions and the inequities that have been involved there
are substantial. That problem is substantially reduced by reducing
reserve requirements, so the problem is becoming less urgent.

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However, if we look at the relationship between changes in economic
activity and monetary changes, it is interesting to note that just in a
purely statistical sense, it is changes in Ma which are most closely associated with changes in gross national product, not changes in M1 or
M 2. In fact tJhey array themselves in reverse order-Ma, M2, M1.
This suggests that if our quest here is to modify our current procedures in order to provide for more effective execution of monetary
policy, it may well ·be that at some point we ought to consider extending reserve requirements not only to all commercial banks, but to
financial institutions more broadly.
On the question of paying interest on reserve balances, in general I
would he sympathetic with that. I think rt makes sense.
If we were to carry on with the very high reserve requirements we
have had, I would consider it an urgent matter. If we move to much
lower reserve requirements, then t1he issue also becomes less urgent.
I do not see in principle the logic of imposing reserve requirements
on certain institutions for monetary control purposes and not on the
liabilities of other institutions when the statistical evidence suggests
that those monetary liabilities are just as pertinent to the proper management of monetary policies as the reservable liabilities of the commercia,l banks themselves.
I think you are coming up with a bill which will make the situation
better. I would also suggest that tJhe committee consider that there is
unfinished business here which requires further consideration at an
appropriate time.
Thank you very much.
[Mr. McCracken's prepared statement follows:]
PREPARED STATEMENT OF PAUL W. McCRACKEN, EDMUND EZRA DAY UNIVERSITY
PROFESSOR OF BUSINESS ·ADMINISTRATION, UNIVERSITY OF MICHIGAN

Mr. Chaimmn. I appreci:ate 1thli!s op·portunity to •apipear again before the House
Committee on Banking, Finance and Urban Affairs-a committee before which
I have appeared many times lboth as a g-overnment official ,and •as a private c'i't:izen.
In his remarks before the House on July 14 the Chairman of this Committee
descrii bed the matters 'before you this morning as "legis'llation to enhance the efficiency and competitiveness of our financial system and improve the conduct of
mone-tary policy." He did nolt, I believe, over-state the 'importance of this legis'lation. There is needed work to do in these areas, and it is important th•at some
legislative ,actJion be taken. There are, I believe, two reasons for the urgency orf
action. For one thing the empirical evidence 1s increasingly persuasive that the
'IJasic path ifor moneta•ry expansion is also the path along which the economy will
also move. During the last five years the simple ratio obtained by dividing GNP
into the more lbroad1y defined money stock (Ms) two quarters earlier has averaged 64.9 percent. And for only one orf the 20 quarters during thiis period did this
ratio faU outside a ,range of one percentage point on either side o'f ,this avemge.
(The l'atio was 63.6 percent in t'he third quarter of 1975 when there was a problem of monetary dehydration.)
As one emrmines the track record for the results of monetary policy, it is also
clear rthat the technology of managing these policie'S needs 'improvement. These
matlters have /been diiscussed /before your comml:ttee many times and require no
'further lbelalbol"ing here. It is •a fact, however, rtha,t mtes of monetary expansion
have on occasion been erratic-with the result that a major instrument orf economic st!abiH~ation has itself been a source of economic instlalbility. While central bankers, in •spli.te of the awesome edifices within which most societies house
them, are ordinary mol'tal·s •and 1ike the ,rest of us make their full quota of
mistakes 1in judgment, the frequency with which they miss their own mrgets
suggests tha;t ,there are some insti:tutional and structural problems needing attention. It i•s also pertinent 'to this legislation to note that the money stock whose
1

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changes, 1n the technical sta ttstical sense, best explain changes in GNP is Ma-not the more narrowly defined M, or even M,.' ,ve cannot ask the Federal Reserve
to manage ,a more steady- expansion of this >broadly defined money supply and at
the same time leave ,almost half of 'it outside the ambit of Federal Reserve
management.
Second, Mr. Reuss was correct in his concern about the efficiency of the
financial system. In a sense all financial institutions are intermediaries by
which flows of funds from savers are put to work in our economy. Inefficiencies
in any industry are a legitimate matter of concern, of course, but in our financial
system and its institutions inefficiencies and distortions can exert in subtle and
pervasive ways a magnified effect in producing misallocations of resources.
And the pricing system is the sophisticated communications network by which
signals are given to use more of this or less of that. When the pricing system
is immobilized or circumvented, and resources are allocated by decree or cajolery
or sermon or regulation, the results are apt to be at best sub-optimal. That
has been a clear lesson of history, and it is all at least as applicable to our
financial system as to other segments of the economy.
Let me turn now to the specifics of the proposed legislation. The Federal
Reserve's proposal to extend reserve requirements to all transactions deposits
deserves affirmative action, and I would support it. Differentiation of reserve
requirements according to type of deposits rather than type of institution has
always made sense to me. Such deposits as NOW accounts will certainly be
merchandised as de facto checking accounts, and they ought to be subject to the
reserve requirements pertinent to such deposits. Whether that deposit, which is
de facto a checking account, is in the Chase Manhattan Bank or the Ann
Arbor Credit Union makes no difference in terms of the appropriateness of
imposing reserve requirements.
The suggestion of exempting, say, the first $10 million or so of deposits from
reserve requirements probably makes sense as an administrative convenience.
It is not, of course, justified as a means of strengthening the competitive position
of small banks.
Indeed, customers are apt to have far more alternatives in financial markets
served by large banks (and availability of alternatives is the operational
meaning of competition) than in markets served by small banks-where a bank
may be the only financial institution really available to customers.
Narrowing the range of the reserve requirement percentages, within which
regulatory discretion can be exercised, is a sensible move. If the range for
reserves against demand deposits should be as wide as from 7 to 22 percent,
or for other transactions balances from 3 to 12 percent, there is a real question
as to whether there should be limits at all. The infrequency with which reserve
requirements have in fact been changed historically suggests that these limits
could be narrowed substantially.
This tendency for agencies to lean toward wide ranges of discretionary
authority is understandable, but it should be resisted. If the target is wide
enough, it will certainly not be missed, but what hitting the target means is
then consistent with widely varying outcomes. The present target of a 7%
to 10 percent per year rate of growth for M1, for example, on a sustained basis
would at the low end establish the basis for a 4 percent per year rate of inflation, and at the high end a price level rising at 6½-7 percent per year. A target
to be meaningful should be one figure, with the common sense understanding
that there will be moderate short-term variances arollnd that target.
,vide ranges for targets, in short, are apt to mean sloppy management of
policies.
It is, of course, well to keep in mind that historical discontinuities do occur,
and the management of policy must have the capability to adapt to them. In
the 1930's, for example, member bank reserves expanded so rapidly that for
every dollar of required reserves member banks had more than a dollar of excess
reserves. It might, for example, be prudent for the Federal Reserve to have the
authority-with perhaps the affirmative vote of, say, five members and a report
to the Congress on the findings leading to the action-to go outside the narrowed
range of their normal reserve requirement for limited periods.
1

1 If changes in GNP in the current quarter are expressed as a function of changes in the
money stock-Le., AGNP,=f(AM,~. AMt-2, AMt-3 )-the coefficient of determination using
1113 Is 0.63, substantially above the 0.56 for M2 or 0.36 for M1. This means that changes in
Ma In thp three prior quarters explain In the statistical sense 63 percent of the changes
in GNP. These results come from a study by my research assistant, Harry Wang.

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Naturally the proposal for more effective information and statistical systems
is to be supported, and it is not a minor matter. Wide differences between preliminary and final data mean that at moments of decision we do not even know
where we have been-let alone where we are going.
The proposal to apply the pricing system to Federal Reserve operations and
services is a particularly significant feature of this legislation. When an incremental or additional cost of an incremental use of resources is zero to the user.
it should come as no surprise that the usage will then be high. Moreover, this
then puts the institution offering "free" resources in the position of a monopolist,
and monopolies whether the U.S. Government Printing Office, the Postal Service,
or the Federal Reserve are apt to behave like monopolists-such as inadequate
pressures to reduce costs, or resistance to innovation.
Federal Reserve charges for such services as shipments of coin and currency,
check-clearing, and security safe-keeping are, therefore, to be applauded. It is,
of course, important that the charges be explicit, and that they reflect a full
accounting of costs including profits. The necessity for earning profits on
capital utilized is the discipline our economic system imposes on users of capital
resources to force economic utilization. If other institutions find ways to perform
these services for society more economically than the Federal Reserve, they
should not be prevented from doing so by some kind of social subsidization of
the central bank. Moreover, there will then be more possibility for innovationsomething in short supply now in the American economy.
If applying the pricing system is an effective discipline for encouraging the
economic use of resources, it should be fully applicable to those financial
resources used as reserves on deposit at the Federal Reserve Banks. Others
must, of course, speak to the legal aspects of this issue. If there is uncertainty
about the scope of the Federal Reserve's present authority on this matter, it
would seem desirable for the Congress itself to act. I would, in short, share
the position of the Committee's Democratic Caucus in its resolution of June 26.
On the substance of the proposal for the Federal Reserve to pay interest on
reserve balances the decision to pay interest should be clean cut. If these bttlances
are economic resources which the Federal Reserve needs to use, the Federal Reserve should pay the full economic cost, and a good proxy for that cost or price
is the Treasury bill rate (though a case could actually be made that these are
iong-term commitments and should carry a higher rate more pertinent to longterm obligations). The proposal to pay interest equal to some segment of Federal Reserve earnings, or equal to some percentage of total earnings, markedly
weakens the case for any action here at all. It is no longer consistent with the
logic of using the pricing system, since such limitations would be a form of price
control. Moreover, the economic incentive to keeping reserve balances at the
Federal Reserve Banks would be sharply reduced since owners of these bttlances
would be paid uncertain returns with no necessary relationhip to market conditions.
The incremental cost of adopting the clear-cut policy of paying market rates
on these reserve balances, this additional cost being the major rationale for the
awkward limits suggested for these payments, is probably over-stated. If the
market works toward equilibrating rates of return on capital employed in different enterprises and industries, with due regard for differences in such factors
as risks and rates of growth, the additional earnings on their reserve balances
could be expected to be offset by lower earnings on other assets as financial markets become fully adjusted to the altered situation. The net increase in cost to
the Treasury would thereby be correspondingly limited.
Procedures to phase in these new arrangements gradually, of course, make
sense. If the cost is there, however, it should in the interest of efficiency and
also inter-institutional equity be made explicit.
Users of economic resources, including Government, should pay the going
price. If the resulting gain in economic efficiency were as much as 0.02 percent,
there would be a net gain for the economy.
In summary, these matters are important. Your Chairman is correct that the
orderly conduct of monetary policy and the efficiency of our financial systems do
warrant appropriate attention by the Congress. If these proposals deal with matters of that importance, and I believe that they do, then the Congress would be
well advised to carry through fully on the logic of their premises.

Mr. MITCHELL. Thank you very much, Mr. McCracken.
Mr.Mayer.

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STATEMENT OF THOMAS MAYER, PROFESSOR OF ECONOMICS,
UNIVERSITY OF CALIFORNIA AT DAVIS

Mr. MAYER. Thank you, Mr. Chairman. I appreciate being allowed
to testify on these important issues.
The information requirement in the new bill strikes me as very
good and useful and I would like to associate myself with Mr.
Jordan's comment that it ought to be able to handle nonmember
banks.
The definition of reservablc liabilities to include overnight funds is
also very desirable.
The exemption for small banks from the reserve requirement and
the imposition of the Fed reserve requirements on large nonmember
banks seems to be a very good compromise between the Fed's fear of
losing banks and the fear of other people that the Fed is engaged in
trying to extend its power too much. The exemption of small banks
does not create any serious problem.
With regard to the level of the reserve requirement, there are several aspects to this.
First, there is the reduction in the existing tax which now falls on
banks and their customers, and it seems reasonable to cut this excise
tax. With regard to controlling the money supply and monetary policy, a new reserve requirement may create some difficulty. The difficulty arises in the following way: If we think of banks as wanting to
keep very low reserves for their own purposes, say 2 percent, then
cutting the reserve requirement to 6 percent doesn't really create a
problem. But there is now some evidence in an unpublished paper by
Professor Kane of Ohio State University which suggests it may be the
case that banks want to keep more reserves than that. He :feels that on
the whole banks would want to keep approximately the reserve require•
ments they have from the Fed on demand deposits, but want lower
reserve requirements on time deposits.
If this is due to pressure :from correspondent banks, it wouldn't
create a problem.
But suppose it is due to the fa·ct that banks, :for their own business
purposes, want to keep, say 8-percent reserves and have a 6-percent re~
serve requirement. This is essentially the same thing as repealing the
reserve requirement. This is a very major change. Insofar as banks
want to keep a steady 8 percent for their own business purposes, there
is again no problem, but it is possible that what banks want to keep
as reserves would vary from time to time in a way difficult to predict,
so that sometimes they may want to hold 6 percent, sometimes 10 per~
cent. That would then greatly complicate the task of the Federal Reserve. It could turn out to be a serious problem, particularly in the
beginning when the Fed does not really know what reserves banks
are ~oing to be keeping because they mav be keeping more than intended. Consequently, we should ask the FDIC to do a quick study of
this, if necessary, only by making a :few phone calls to banks to find out
what their own policy would be.
Turning to the same reserve requirement for the demand deposits
and time deposits, thi8 is in line with the tendency now to merge demand deposits and time deposits. Perhaps we should go :further, how-

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ever, and allow the payment of interest on demand deposits too. The
market in any case will eventually bring this about.
Having equal reserve requirements on time deposits and demand deposits probably makes M 2 more predictable thun it is now. One can't
be sure of this, but probably it does. Again, the Fed could probably
very quickly run a simulation on that. M 1 is probably made less
predictable.
As :far as the impact on the economy is concerned, it depends on the
extent to which the public raises its expenditures by as much for a
dollar of demand deposits as for a dollar of time deposits in its
portfolio.
In any case, the Federal Reserve is now planning to allow banks to
transfer automatically from time deposits to demand deposits, which
largely eliminates the distinction between the two. Professor Hart has
submitted to the committee a memorandum where he points out what a
major change this would be and the serious problems that it could
create.
One final aspect on the equal reserve requirement : If Professor
Kane is right, and banks want to keep high reserves against demand
deposits, but not ,against time deposits, they will be unhappy with
having to keep 6 percent against both, which roughly doubles their
reserve i:equirement on time deposits.
Furthermore, if we are to have reserve requirements on time deposits
in commercial banks, it is hard to justify not having reserve requirements for transaction accounts in nonbank institutions, things like
NOW accounts, etc. These things are money much more than time deposits are. I would strongly urge the committee to consider including
these things. If they are to be included eventually, this should surely
be done now before various institutions get into the business of h aving NOW accounts, and then say later on, "Well, we started our activities in this area on the assumption that there would be no reserve
requirements." That would probably be a problem.
We have in this bill a solution to the problem of nonmember banh,
at a time when the real problem for monetary control mav not be the
absence of reserve requirements on nonmember hanks, butthe absence
of reserve requirements. Federal Reserve requirements that is, on savings and loans and mutual savings banks, etc.
Turning to reducing the discretion the Fed has to change the reserve
requirement to half a point either way, that is a very good thing. The
Fed does not need this power. It is a power to tax. The Treasury does
not have the right to change taxes on its own. Why should the Federal
Reservei
I am sorry to see the automatic adjustment of the discount rate go
out. It is not in the new bill. I presume that is done to leave the Federal Reserve flexibility, but actually the Fed does not have much
flexibility with the discount rate in any case, because it is under great
pressure not to raise it and if you can't raise it you also can't lower it.
What may be a good compromise, therefore, is perhaps telling the
Federal Reserve that it should keep the discount rate in line with, or
somewhat above, open market rates, so that the Fed would still have
some flexibility here and would be able to use the flexibility to raise
the rates by saying, "We will have to raise the rate because the law

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tells us to keep it in line with market rates and not to subsidize banks
by a lower rate."
Access to the discount window for all institutions seems highly
desirable to me. Thank you.
[Mr. Mayer's prepared statement follows:]
STATEMEN'.I OF THOMAS MAYER, PROFESSOR OF ECONOMICS,
UNIVERSITY OF CALIFORNIA AT DAVIS

The Committee is considering three sets of related proposals: a bill by CongreSSIIIlan Stanton, some proposals made by the Federal Reserve, and certain
amendments to the Stanton bill introduced by Chairman Reuss. I welcome and
appreciate the opportunity to be allowed to testify on these important issues.
Congressman Stanton's bill consists of three parts: the payment of interest on
member bank reserves, the pricing of Federal Reserve services, and the initiation
of a Federal Reserve study on the feasibility of allowing banks to keep their
reserves in the form of government securities. I will discuss Congressman Stanton's bill first, then the Federal Reserve's proposals to impose additional reporting
requirements, and to turn over to the Treasury some funds out of its surplus, and
to impose reserve requirements on transaction accounts, and then Chairman
Reuss' proposals to eliminate the Federal Reserve's control over the discount rate
and the reserve requirement.
GOVERNMENT SECURITIES AS RESERVES

The idea of having banks hold their reserves as government securities instead
of Federal Reserve deposits and currency is interesting, but it might be useful
to make it more specific. There is an immense difference between allowing banks
to hold as reserves mainly regular government securities which they could buy
on the open market, and allowing them to hold only special government securities
issued specifically for this purpose. In the latter case, if banks could count as
reserves, only these securities, and not deposits with the Federal Reserve and
currency, monetary control might well be enhanced since it would immunize the
reserve base against market factors that can now change it, such as fluctuations
in currency in circulation, or in Treasury deposits with the Federal Reserve. But
in the former case-if the security reserves are supposed to be the binding part
of the reserve requirement-monetary control would be weakened since banks
could then readily obtain any reserves they want by buying government securities
on the open market. The Federal Reserve should therefore be told to not exclude
from its study the use of special issues of government securities as reserves.
THE PRICING OF FED SERVICES

Another part of the Stanton bill would require the Fed to price its services
to member banks explicitly. This is also one •of the Federal Reserve's proposals,
Since there is also no reason why the Fed should have a monopoly in providing
these services, pricing them separately from Fed membership is highly desirable
since pri,ate firms can then enter the market, and try to offer these services at a
lower price. 1 Of the two proposals I prefer the Stanton version to the Federal
Reserve's. The latter does not have an explicit provision to include in the price
of the services an allowance for the cost of the required capital and the taxes
that a private firm would pay. Hence the Ifed could price its services lower than
a private firm could, even if the private firm is more efficient. Another way in
which the FE'd proposal, unlike the Stanton bill, would discourage the entry of
private firms is that it leaves the Federal Reserve the flexibility "to alter charges
or service policies in order to meet its responsibilities to maintain satisfactory,
basic levels of services for the nation as a whole and to encourage innovations."•
The possibility that the Fed would on this basis suddenly lower its service
charges below cost could well discourage private firms from undertaking the investment that is required to enter this market. The Stanton hill is therefore much
more likely to encourage competition in providing these services, and is preferable
on this score. And if there is a real need for the Fed to lower its service/ charges
below costs, legislation to permit this could always be passed.
1 Moreover, Beryl Sprinkel bas pointed out in bis testimony that if the Federal Reserve
services nre. nt the margin. free to banks, hanks will use them excesAively.
• Board of Governors, Federal Reserve System, Press Release, July 10, 1978, p. 5.

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INTEREST ON REQUIBED RESERVES

But the most important part of the Stanton bill is the payment of interest on
reserve balances. This is also provided for in the Fed's bill, and would be
reduced below the level of the Fed's proposal by the Reuss amendment. As long
as the reserve requirements are the same, and apply to the same set of institutions, the payment of interest on required reserves can have, at most, a trivial
effect on the efficacy of monetary policy.
Whether or not to pay interest on required reserves is an issue of fiscal policy
rather than monetary policy. Requiring banks to hold reserves that do not pay interest is equivalent to forcing banks to make an interest-free loan to the government. This is brought out by considering what would happen if instead of facing a
reserve requirement the banks would be required to hold Treasury securities that
pay no interest. Clearly, apart from the fact that banks would then have to hold
other reserves, both the banks' income and the Treasury's income would be the
same as it is now when banks hold required reserves, but do not obtain a piece
of paper, called a bond, in exchange for their reserves. Another way of seeing this
is to consider what happens when a new bank deposits, say, $1 million as reserves
with the Federal Reserve. The Fed uses these $1 million to buy a government
security earning, say, $50,000 which then, at the end of the year, it turns over
to the U.S. Treasury. Hence, the bank is, in effect, taxed $50,000.
Since the reserve requirement is, in effect, an excise tax, it should be evaluated
by the criteria that are used to judge excise taxes. One major criterion is the
incidence of the tax. In the first instance the reserve requirement is a tax on
banks, and initially bank stockholders would gain if this tax were removed. But
most, though certainly not all, member banks operate in a more or less competitive market. Hence, in the long run competition would force banks to distribute
these gains to their depositors, borrowers and employees. As far as depositors are
concerned, some admittedly old (1962) data suggest that that part of the reserve
requirement that is an implicit tax directly on household deposits is progressively distributed. On the other hand, since firms that borrow from banks presumably in large part pass forward in their prices the interest rate they have to
pay, that part of the tax that banks pass on to their borrowers is probably distributed more or less proportional to disposable income or is only moderately
progressive. All in all, the distributional effects of the implicit excise tax on bank
deposits does not provide a persuasive argument for this tax, though in this
respect it probably does not differ much from some of our other excise taxes.
Like practically all taxes the implicit excise tax on bank customers has distorting effects on the way resources are allocated. Specifically, it lowers the de facto
interest payments that banks make to their depositors by providing them with
free services. As a result, depositors reduce the amount of deposits they hold, and
hold currency and other liquid assets instead.• This is inefficient. For example,
suppose that a bank, in the absence of the implicit tax on deposits, would pay
the depositor, say, $50 interest, but that because of the tax it pays the depositor
only $45. If the depositor gains, say, $48 in terms of convenience by holding currency rather than a deposit, he or she will not keep a deposit. But had the bank
been able to pay the full $50, he or she would have opened the deposit and been
better off by $2. Since there is some empirical evidence suggesting that deposit
holdings are responsive to interest rates, the reserve requirement does, in this
way, impose some welfare loss on the economy. And a similar argument applies
to a potential borrower deciding whether to borrow from a member bank or some
other institution, such as a nonmember bank or a savings and loan association.
Moreover, large American banks compete with foreign banks, both in the United
States and abroad, and the existence of a reserve requirement puts them at a
comparative disadvantage vis-a-vis these competitors. Specifically, it provides an
incentive to large depositors and borrowers to shift their transactions outside the
United States into the Eurodollar market. The interest rate paid on Eurodollar
deposits is higher than the interest rate paid on large domestic CD's, primarily
because banks escape the reserve requirement on Eurodollar transactions. At the
same time, U.S. branches of foreign banks can pay somewhat more on their CD's,
• However, a reduction of one free service, free clearing of checks, may induce some
depositors to hold larger deposits so that they avoid service charges. This results from
the fact that previously they earned nothing on their marginal deposit because they old
not have a sufficient volume of activity In their accounts to use up all the free services
earned. But even In this case resource allocation Is distorted.

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or lend at a lower interest rate because they too escape the Federal Reserve
requirement.
And beyond these economic considerations there is another way in which the
implicit ,tax imposed by the reserve requirement is a very bad tax. Taxes should
be out in the open where people can see them. But it is he.rd to imagine a tax that
is more hidden than the tax that results from the reserve requiremen,t.
Thus, the standard considerations by which an excise tax is evaluated suggest
that the Federal Reserve should pay interest on required reserves, rather than
taxing banks and their customers in this way. And this is powerfully reinforced
by ,the fact that the Federal Reserve System is losing mem'ber banks because of
the 1burden of ·the reserve requirement. It may lose them •at a much more rapid
rate in the future, both because the spread of items like NOW accounts may
cause banks to try to protect their profits by leaving the System, and also 'because
of a demonstmtion effect. One major advantage of Federal Reserve mem'bership
is prestige because the large ·banks usually belong. But some relatively large
banks have ,been leaving •the System in recent years, and this may indicate ,to
other large banks that they can leave too without losing prestige. This sort of
thing could. easily snowball. And if banks leave the Federal Reserve System this
may affect the Fed's control over the money stock, and, of course, also the revenue
the Treasury obtains from the implicit tax on banks. I will take both of these
issues up later on.
On the other hand, ,there are a number of factors that suggest that the implicit
tax should perhaps be kept. One is that in the short run the ~kholders of
member banks would receive a windfall gain if the implicit tax were removed.
One could well argue that since ,they mostly bought their bank stock at a price
that reflected the existence of this tax there is no reason why they should now
be benefited by removing the tax. On the other hand, the price at which •they
bought their stock should have reflected, at least to some extent, the possibility
that at some future time interest will be paid on reserves. This might lead one
to argue that there is nothing inequitable about stockholders succeeding in their
galll'ble, and now receiving such a windfall gain. U is not clear to me which of
these two arguments is the better.
Second, as long as banks are prohibited from paying explicit interest on their
demand deposits, and limited by Regulation Q on the interest they can pay on
time deposits, competition among them is relatively inefiicienit. Suppose, for
example, that the implicit ,tax is removed, and that banks now compete for deposits by offering more free services and gifts, more convenient 'bran~hes, etc.
An efiicien:t bank would already previously have offered its customers all the
"free" services and conveniences they are willing to pay for. If they are now
driven by competition to offer even more free services these-services will be worth
less to the depositors than their cost to the bank.• In other words, since banks
cannot compete by price (interest on deposits) •some value gets lost if banks
transfer to their customers some of the inicome they obtain from the Federal
Reserve ,paying them interest on their reserves. However, this is much more of a
problem with household deposits than with business deposits. Business fi-rms
require many bank services, and, in addition, borrow frequently enO'llgh from
banks so that banks can pay them implicit interest on their deposits by charging
them a lower interest rate on ,their loans. The case for paying such interest
would therefore be substantially strengthened if the regulations that prohibit
banks from paying in•terest on demand deposits, and limit the interest they can
pay on time deposits, were removed.
Also, as far as households are concerned, the implicit excise tax on deposits
is a,t least partly offi!et by another tax consideration. This is that the imputed
inrome a household obtains by holding a deposit is not taxed." For example, consider a ·person who has a choice between obtaining $5 of interest income by opening a savings and loan deposit, or no explicit, and hence ,taxable, income but a lot
of convenience by holding a demand deposit in a member bank instead. If ,this
peJ.'ISon is in the 40 percent tax bracket, the $5 of interest income is worth only
$3, and hence he or she mny hold ·the demand deposit instead, even if ,the added
• This Is so because the utility someone receives from one additional unit of the bank's
free service declines as he or sbe obtains more and more units of this service. On the other
hand, the bank's cost of providing these services Is not likely to decline as It provides more
of them.
• The free services received by a firm are taxed Indirectly because they raise the firm's
profits, and hence Its taxes.

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convenience of a demand deposit is worth only $4. The reserve requirement, by
imposing a cost on the bank, and hence ultimately on the depositor, helps to offset
some of this tax-induced lJias towards holding demand deposits, and causes
depositors and nondepositors to be treated more equally.
A more important consideration is, however, that if the imputed tax on bank
customers is reduced or elimina,ted -some other tax will have to be raised, or some
government expenditures cut, or else the deficit will increase. While, as discussed
above, the imputed excise tax on bank customers is undesirable, both on grounds
of equity and resource alloca.tion, the same is true of other ,taxes.
Hence, to a large extent, the question of paying interest on required reserves
should be decided by comparing the benefits of elimination or cutting this tax
with the benefits of cutting some other tax or the loss from cutting government
expenditures or raising the deficit. I will not even attempt to make such a comparison in the general case, but I would like to suggest that if, realistically, the
only way a reserve requirement can be imposed on transactions balances in nonbanks and on deposits in nonmember banks, is to pay interest on reserves, then
I believe such interest should be paid. The case for paying interest is also greatly
strengthened if the prohibition of interest payments on demand deposits and the
Regulation Q ceiling on time deposits are removed.
If interest is to be paid on reserves, how high should the ra,te be? In part, the
answer depends on how one evaluates the above arguments, for and against;
paying any interest on reserves. But it also depends on two other considerations.
One is the impact of the implicit tax rate on Trea·sury revenue. As the Federal
Reserve has pointed out, the fact that this tax is causing banks to leave the Federal Reserve System means a continual reduction in Treasury revenue. And if
the tax were lowered fewer 'banks would leave. Hence, there is some implicit
tax rate that maximizes Treasury revenue, and it may be the case that by paying
some interest on reserves Treasury revenue is 'actually enhanced in the long run.
Unfortuna·tely, there is no way of determining empirically whether payment of
some interest on reserves would raise long run Treasury revenue in actuality,
and if so, what rate of intere·st would maximize it. But the possibility that paying
some interest on reserves would ·be beneficial to the Treasury cannot be dismissed
as unlikely.
A related consideration is that the higher the rate of interest that is paid, the
greater will be the proportion of total lJank deposits that remain subject to the
Fed's reserve requirement. The extent to which this is desirable is discussed below. But again, no data exist that would allow one to estimate the impact of a, say
2 percent interest rate on reserves on the proportion of total bank deposits that
are in the Federal Reserve's member banks.
Second, equity suggests that banks be paid interest only to the extent that
the legal reserve requirement actually imposes a cost on them. But a considerable proportion of the reserves that member banks hold are reserves that they
would want to hold in any case. Estimates of this proportion vary substantially;
while one study sets it at one third, another suggests that it is close to 100 percent for demand deposits, though not for time deposits.• But the Fed's reserve
requirement imposes a burden on member banks even if it actually happens to
be the case that member banks want to keep a reserve ratio as high as the one
required by the Fed's regulations, because of the form in which the reserves
have to be held. Most banks prefer to hold their reserves mainly as balances
with their correspondent banks to obtain the free services correspondent banks
provide as a quid pro quo. But since member banks must keep their reserves with
the Federal Reserve, or as vault cash, they lose this potential benefit from holding reserves. The extent of the loss depends upon how useful these free services
are to the banks; that is, the extent to which hanks can get around the prohibition of interest payments on demand deposits. Unfortunately, no data are
available on this, and I do n0t know any estimates of even the order of magnitude.
But presumably, at the margin, the free services that banks obtain from their
city correspondent banks are worth at least slightly less to the bank than the
prevailing rate of interest. Hence, even if it is decided to repeal the imputed tax
on banks and bank customers entirely, the interest rate paid on required reserves should be at least somewhat less than the rate on Treasury bills or other
high'ly liquid instruments.
• For a discussion of some estimates see John Paulus. "Burden of Federal Reserve Memhership, NOW Accounts. and the Payment of Interest on Reserves." unnuhllsJwd paper,
Boar<l of Governors. Federal Reserve System. See also EilwRril KRne. "'l'hi> Fe,leral Reserve's Membership Problem: A Study in Voluntary Association," unpublished manuscript.

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THE REPORTING REQUIREMENT

The Federal Reserve proposes that all depository institutions be required to
provide it with information on their deposits and reserves. Chairman Reuss
vroposes an amendment that would have the Fed obtain this information
through other regulatory agencies to reduce duplication. In either the Fed's or
Chairman Reuss' version such a requirement is highly desirable. Given the importance that the money supply has for employment and prices it is almost
scandalous that, as shown by the substantial subsequent revisions, our early
estimates of the money supply are so inaccurate. While much of this inaccuracy
is due to difficulties in seasonal adjustment and hence unavoidable, a significant
part of the error is due to insufficient reporting by nonmember banks. And as
transactions accounts in nonbank institutions continue to grow the infrequent
reporting of nonbanks will become a more serious problem. Hence, despite
the fact that many Federal reporting requirements are an undesirable and frequently unnecessary burden on business, I believe that the Federal Reserve
should be given the power to obtain, either directly or indirectly, reports on
deposits and reserves.
In fact, I believe that the Federal Reserve's proposal does not go far enough,
that apart from deposits and reserves the Fed should also have the right to obtain, perhaps through the FDIC, information on something else. This is Transaction in Immediately Available Funds.' In recent years banks have found a
way of avoiding the prohibition of interest payments on the demand deposits of
their large customers. One way they do this is that the bank and the customer
have the following agreement: at the end of the business day the bank will take
all the funds in the customer's account above an agreed-upon minimum, and
invest them by having the customer automatically buy securities held by the
bank, with the bank agreeing to buy these securities back the next morning.•
By such repurchase agreements, the customer's deposit is wiped out overnight.,
but restored the next morning in time to meet any checks that come in. Thus, these
funds, although invested overnight, still effectively function as part of the money
supply. But when the banks report their deposits to the Federal Reserve, these
funds that are invested overnight are excluded, since deposits subject to reserve
requirements are defined as deposits at the close of the business day. No reliable
estimates are available of the extent to which the money supply is thus understated. Estimates of Transactions in Immediately Available Funds vary from
between .$24.6 billion to $36.5 billion as of June 1976.0 However, not all of these
Transaction in Immediately Available Funds represent an understatement of
the money supply since some are not just overnight funds, and some are invested
before the close of the business day. Hence, the Federal Reserve should be given
the right to obtain, either directly or indirectly, reports on the total volume
of Transactions in Immediately Available Funds, their maturity distribution
and on what time during the day they were undertaken. Since most banks do not
have such transactions this reporting requirement would affect onl:t a relatively
small number of banks.
FEDERAL RESERVE PAYMENTS TO THE TREASURY

The Federal Reserve has proposed turning over to the Treasury for the next
three years a sum out of its surplus that would offset any net reduction due to
its payment of interest on reserves. But this proposal is merely a bookkeeping
adjustment that purports to benefit the Treasury. In effect, it is devoid of any
significance. This is so, because to measure the government's impact on the
economy we should consolidate the Treasury's and Federal Reserve's balance
sheets. This becomes apparent when one considers the reason why we impose
taxes at all, instead of financing all government expenditures by deficit spending.
We use taxes to reduce the public's income, and hence its demand, thus releasing
resources for the government's use. Now private demand is reduced whenever the
public gives up income to either the Treasury or any other government agency,
such as the Federal Reserve. But if the Federal Reserve makes a payment out
• Professor Albert Hart, In the statement he submitted to this Committee, has suggesteo
some other Items on which the Fed should collect data.
• For a detailed discussion, see Glllian Garcia and Simon Pak, "Some Clues In the Case
of the Missing Money," Finance Workshop Papei; 67, Graduate School of Business, University of California, Berkeley.
• Ibid., pp. 11-12.

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of its capital or surplus to the Treasury nothing happens to private demand.
Hence, while the government's budget document looks better because the deficit
is smaller, the budget is actually just as inflationary as before since private
incomes and demand are not reduced. Speciffcally, if the Fed pays as interest
on reserves a dollar to member banks this will increase their expenditures and
therefore be inflationary. And when the Fed then compensates the Treasury for
the one dollar decline in its income by turning over a dollar out of its reserves
nothing at all happens to ofl'set the inflationary impact of the banks receiving
an extra dollar of income and spending most of it.
To avoid giving a false appearance to the budget document the Federal Reserve
should therefore be told not to turn over any of its surplus to the Treasury.
BESEBVES ON TRANSAOTIONS ACCOUNTS

Both the Federal Reserve bill and Chairman Reuss' amendments would impose
reserve requirements on all transactions accounts. I believe that this is desirable.
The purpose of the reserve requirement is to aid in controlling the quantity
of money, and any deposit that can be readily transferred to a third party, is
money regardless of whether it is called a demand deposit, a NOW account or
whatever. Hence, there is a strong case for imposing reserve requirements in
transactions accounts and nonmember bank deposits unless it can be shown that
either (1) they are so small that they do not signficantly interfere with Federal
Reserve control, (2) their inclusion in the reserve requirements system would
make it harder to control the money stock, (3) they behave countercyclically, or
( 4) there should not be any reserve requirements on member bank deposits either.
Let us look at each of these arguments in turn. There is considerable empirical
evidence that the fact that nonmember banks do not have to meet the Fed's
reserve requirements has not done any damage so far. 10 However, as nonmember
bank deposits and transactions accounts in nonbanks grow relative to demand
deposits in member banks this may no longer be the case. The imposition of a
reserve requirement on nonmember banks and on institutions ofl'ering transactions accounts need not necessarily in all cases improve the Fed's control over
the money stock, but it should improve the Fed's control over the money stock
plus transactions balances, and this is likely to become the relevant total. 11
It is hard to predict whether in the absence of a reserve requirement the
growth of transactions accounts in nonbanks will have a procyclical or countercyclical effect. If the public shifts deposits out of banks and into these institutions as interest rates rise during an expansion, this would have a procyclical
effect ; while if the public shifts deposits out of these institutions lnto demand deposits this would have a countercyclical efl'ect. In this case the absence of a
reserve requirement on transactions balances is desirable. This case could occur
only if only households are allowed to hold transactions balances, or if the interest rate paid on transactions balances were subject to a ceiling, while there
would be no equally binding ceiling on demand .deposit interest rates. On this
general issue of the impact of reserve requirements on transactions balances on
economic stability, I would like to refer the Committee to the material submitted
by Professor Albert Hart. Professor Hart has also pointed out in the statement
submitted to this Committee that the automatic transfer between time deposits
and demand deposits which the Federal Reserve plans to permit in a few months
is a step that could do a great deal of damage to the stability of the economy.
H.R. 12706, by imposing demand deposit reserve requirements on these "savings
deposits" would substantially reduce this danger. Hart also points out that
monetary control will be greatly weakened by some recent changes in the way
banks function, and he points out the need for a comprehensive examination of
these changes.
The fourth possible justification for not imposing reserve requirements on
transactions accounts is that there should not be any reserve requirements on
demand deposits either. One can try to justify this by arguing that even without
a legal reserve requirement banks would keep a certain ratio of reserves against
deposits. And as long as this ratio is stable and predictable it can operate as the
fulcrum for open market operations just as well as a legal resel/Ve requirement
1 •For a review of the evidence, see George Benston. "Federal Reserve Membership: Consequences, Costs, Benefits and Alternatives,"' forthcoming.
n Cf. J. A. Cacy, "Reserve Requirements and Monetary Control," Federal Reserve :Qank
of Kansas City, MonthJ11 Review, May 1976, pp. 3-13.

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does, The crucial question is therefore whether the reserve ratio that banks
and other depository institutions would keep in the absence of a legal requirement
would be stable and predictable. Unfortunately, almost no information is available on this, but there is a presumption that a voluntary reserve ratio would be
at least somewhat less stable than is the legally required one we have now.12
The upshot of all of this is that, while a system with no reserve requirements
against transactions accounts and nonmember demand deposits may work well
even if these items are a substantial component of the money stock, it would be
unwise to expect that this will necessarily happen. There is a substantial risk
that such a system would significantly increase fluctuations in output as well as
the inflation rate.
So far I have discussed the imposition of a legal reserve requirement only from
the point of view of economic stability. But there is also another aspect. If
member banks have to keep a certain reserve ratio, then both equity and considerations of efficient resource allocation suggest that their close competitors,
nonmember banks and institutions offering transactions accounts, should have the
same reserve requirement. However, this would put transactions balances at a
disadvantage relative to near-monies, such as certificates of deposits.
One possible solution is to pay interest on reserve balances, despite its costs
to the Treasury. If the institutons are fully compensated for the cost of keeping
required reserves then it is hard to see what the social cost of imposing a reserve requirement on their transactions balances would be.
If a reserve requirement is imposed on transactions balances how high should
it be? Stabilization policy suggests that the relative reserve requirements should
be proportional to the relative effects that a dollar of demand deposits and a
dollar of transactions deposits have on spending ; since the function of the
reserve requirement is to control spending. Unfortunately, the relative effects
on expenditures are hard to quantify. My own guess, but it is just a guess, is that
a dollar of transactions balances raises expenditures by a bit less than a dollar
of demand deposits does, so that transactions balances should have a somewhat
lower reserve requirement than do demand deposits.
Finally, it is worth noting that if a reserve requirement is to be imposed on
transactions balances this should be done now before these balances become very
large. Once they have expanded the depository institul!ions may reasonably object that they undertook a large investment in setting up such -accounts in the
belief that they would not be subject to the implicit tax of a reserve requiremJent.
THE DISCOUNT RA.TE

One of Chairman Reuss' amendments would eliminate the Federal Reserve's
authority to change the discount rate and would ilnstead peg it to the avera~
yield on Treasury bills auctioned on the primary market during the last two
weeks. I like this propo!jal very much in principle, but would like to suggest modifying the details. Pegging the discount rate to an open market interest rate
has been supported by many economists over the years. It has the great advantage
of eliminating .the subsidy that member banks obtain by borrowing at a time
when, as frequently happens, the discount rate is below the Federal funds rate.
It would also eliminate the "announcement effect" of discount rate changes. At
present, whenever the Fed raises the discount rate to bring it into the line with
rising market rates this is, despite Federal Reserve disclaimers, widely interpreted as an attempt by the Fed to raise interest rates. To avoid criticism on thts
score the Fed is often under pressure to let the discount rate remain for some
time below the Federal funds rate. Although it can offset by open market sales,
the impact on bank reserves of the resulting rise in borrowing the subsidy to
borrowing banks is undesirable. Pegging the discount rate to the Federal funds
rate would eliminate this problem, and is therefore desirable. The Federal Reserve's argument that discretion dn setting the discount rate is sometimes useful
is probably correct, but it appears that there are more times when the discretionary discount rate is a source of trouble rather than a help.
12 However, while with no legal reserve requirement the reserve ratio actually held may
be unstable 1t may stm be predictable, particularly If the Federal Reserve obtains, say,
weekly reports on reserves and deposits. Nonmember banks In Illinois do not face a reserve
requirement. If the proposed reporting requirement for nonmember banks becomes law,
this should generate data from these banks that may allow us to determine whether a
reserve requirement ls needed, or whether banks keep a stable reserve ratio on their own.

32-972 0 • 78 • 30
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What interest rate should the discount rate be pegged to? Setting it equal to
the Treasury bill rate at the last two bill auctions would create serious problems.
One is that at a time when the Treasury bill rate is rising, banks could make a
profit by borrowing from the Fed at the average of the last two weeks' rates,
and hold bills at the higher current rate. And more generally, in recent times,
the Treasury bill rate has been below the Federal funds rate at which banks
lend reserves to each other. In 1977, the average yield on Treasury bills was
5.26 percent, while the average Federal funds rate was 5.54 percent, that is,
0.28 percent higher. For the first five months of 1978 the difference was 0.51
percent. Moreover, while some years ago the Treasury bill rate was a pivotal
rate because banks would obtain additional reserves by selling Treasury
bills this is no longer the case. Apparently, many banks no longer have a large
volume of Treasury bills available for this, but are using their holdings of
Treasury bills largely as collateral for governmental deposits.
Hence, the discount rate should not be tied to the Treasury bill rate. A
much better' pivot for the dis.count rate would be the Federal funds rate.
However, the discount rate should not be set equal to the Federal funds rate.
That would give banks an incentive to borrow from the Fed if the transaction
cost of doing so is less than the transaction costs of buying Federal funds. As
a result the Federal funds market may shrink. And there is no reason why
the Fed should do what the private market in Federal funds already does.
The discount rate should therefore be set at least somewhat above the Federal
funds rate. Some years ago this would have worked a hardship on many
small banks that did not have access to the Federal funds market. But this
market has grown substantially, and now the great majority of all banks do
have access to it, either directly, or through their correspondent banks. If the
discount rate is set above the Federal funds rate only those banks that still
do not have access to the Federal funds market would then borrow from the
Fed· in normal times, but the discount mechanism would still be available for
special situations and emergencics.13 (Admittedly, turning the discount rate into
a penalty rate would reduce the attractions of Fed membership. Hence,
this should be balanced either by paying some interest on reserves or by making
the Fed reserve requirement lower, or else applying it also to nonmember banks.)
Since the only reasoB for setting the discount rate higher than the Federal
funds rate is to get banks to go first to the Federal funds market, the differential
need not be large. One eighth of one percent should be sufficient for this purpose.
and this should not be too much of a burden on any bank that does not have
ready acc