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CONTENTS ■■ ’ • 'I l f V 5war The Recent U.S. Trade Deficit —No Cause for Panic GEOFFREY E. WOOD and DOUGLAS R. MUDD _/\_LARM has been mounting about the size of the U.S. trade deficit in 1977 and what seems in prospect for the deficit in 1978. The 1977 deficit has been de scribed as the “largest in the Nation’s history.”1 It has been implied that the trade surpluses of other coun tries, which are the counterpart of the U.S. deficits, are in some way harmful. There is no reason to believe that this pattern of accumulating surpluses for the oil exporters and chronic deficits for the oil importers will be reversed in the near future. The grim conclusion . . . is that the OPEC countries will continue to pile up excess reserves . . . accumulating some $250-$300 billion in financial assets by 1980.2 It has been claimed that the deficit has “produced a loss in jobs.”3 Perhaps as a consequence of these fears, policy has increasingly come to focus on reducing one com ponent of the trade deficit as a means of halting the decline of the dollar. But the balance of trade is only one aspect of a country’s international economic relations, and there are circumstances when a trade deficit is highly de sirable. Further, the fear that a trade deficit will ag gravate national unemployment is erroneous. In terms of national economic policy, the recommendation to reduce one component of the deficit so as to strengthen the dollar would not be helpful. !Youssef M. Ibrahim, “$26.7 Billion Trade Deficit, Fed by Oil Imports, Is Nation’s Biggest,” New York Times, January 31, 1978. The revised figure for the 1977 U.S. merchandise trade deficit is $31.2 billion. 2U.S. Congress, Senate Committee on Foreign Relations, Sub committee on Foreign Economic Policy, “International Debt, the Banks, and U.S. Foreign Policy,” 95th Congress, 1st ses sion, August 1977, p. 33. 3U.S. Congress, Joint Economic Committee, Subcommittee on International Economics, “Living With the Trade Deficit,” 95th Congress, 1st session, November 18, 1977, p. 5. Page 2 The Balance of Merchandise Trade, the Balance of Trade, and the Balance of Payments A country’s exchange rate — that is, the value of its currency in terms of other currencies — will stay unchanged if the quantity of the currency supplied just equals the quantity demanded at the prevailing exchange rate. The exchange rate will rise when the quantity demanded exceeds quantity supplied and will fall when the quantity supplied exceeds quantity demanded. Broadly speaking, the quantity of U.S. dollars sup plied to foreign exchange markets in any year is made up of the dollars spent on imports, plus the amount of funds U.S. residents wish to invest outside the United States.4 The demand for U.S. dollars arises from the reverse of these transactions. Both exports by U.S. residents and the demand by foreigners to invest in the United States require that foreigners acquire dollars to spend in the United States. Exports and imports comprise both goods (tangible items such as automobiles and wheat) and services (such as banking, insurance, transportation, and in vestment income). An export of services generates demand for dollars by foreigners just as does an ex port of goods, and the actual quantities involved in trade in services are very substantial. Net exports of these “invisibles” (as internationally traded services are known) in 1977 were $15.8 billion, having grown fairly steadily from $0.7 billion in 1966. As shown in Table I, net exports of services by the United States have, over the past few years, turned 4U.S. importers supply dollars so as to purchase foreign cur rency to pay for imports, while investment abroad by U.S. residents creates demand for foreign currency because the foreign capital assets purchased — factories, stocks, govern ment bonds, etc. — must be paid for in foreign currency. FEDERAL RESERVE BANK OF ST. LOUIS APRIL 1978 tor demand for dollars; the right hand side is the private sector supply. Table I U.S. BALANCE OF TRADE (M illio n s of Dollars) Merchandise Trade Balance Services Trade Balance Balance on G o od s and Services Equation (1) can be rearranged in a number of ways; the most useful for the present purpose is as follows: Exports — Imports = Capital Outflows — Capital Inflows (2) 1966 $ 3,81 7 $ 697 4,5 1 4 4,395 595 3,8 0 0 1 96 7 $ 1968 635 986 1,621 1 969 607 3 95 1,002 2,912 2,603 309 1971 - 2,260 1,920 - 34 0 1972 - 6,4 1 6 328 - 6,088 911 2,609 - 5 ,3 6 7 7,527 2,160 9,045 7,119 16,164 1 97 6 - 9 ,3 2 0 12,916 3,5 9 6 1 97 7 -3 1 ,2 4 1 15,827 -1 5 ,4 1 4 1970 1973 1974 1975 3,520 Source: U .S. Department of Commerce several deficits in trade in tangible goods into sur pluses on total U.S. trade. Further, discussions of the 1977 trade deficit often are in terms of merchandise trade; when invisible trade is taken into account, the total trade deficit is much smaller. Inflows of foreign funds are required to offset a trade deficit if the foreign exchange value of the dollar is to remain unchanged.5 It is useful to write that out in the form of an equation, where both ex ports and imports refer to total trade — that is, vis ibles plus invisibles — and private sector refers to the private sector in both the United States and abroad. This rearrangement of the equation helps one to see that a trade deficit must, as a matter of arithmetic, be accompanied by a net importation of investment funds, that is, a “capital inflow” in the terminology of balance of payments accounting. There cannot b e one without the other; the United States cannot import funds without running a trade deficit. The balance of payments must always be in balance. In the absence of government transactions under taken with the aim of changing the exchange rate, the exchange rate will adjust until the private sector’s supply of U.S. dollars on the exchange market equals the quantity of dollars demanded by the private sec tor in that market.6 The fact that a trade deficit (with an unchanged exchange rate) implies a net capital inflow is vital in seeing the economic significance of the current trade deficit. Trade Deficits — the Historical Record The United States ran a trade deficit for a sub stantial part of the 19th century. Table II shows tenyear annual averages of U.S. trade deficits, as per centages of Net National Product, for the years 1869 to 1908, and for the years 1967 to 1977 on an annual basis.7 Exports + Capital Inflows = Imports + Capital Outflows (1) The left hand side of equation (1) is the private sec5An inflow of funds into a country for the purpose of invest ing there, whether the funds are for investment in bank de posits, securities, or even land, is described as an inflow of capital. An inflow of capital, to the extent that the capital is invested in financial assets, can be thought of as an export of securities. The term “capital inflow” does not refer to an in flow of capital goods, although the U.S. resident to whom the funds are lent can of course use them to buy capital goods abroad. It may appear surprising that an inflow of funds, which can be spent on either consumption or capital goods, is de scribed as an “inflow of capital.” But an individual’s capital is what can be spent in excess of current income; even if it has been lent to him, the capital is available for current expenditures. An inflow of funds into the United States is the result of foreigners deciding to lend to the United States, and their doing so lets the United States spend more than its current income, just as when an individual is lent funds he has acquired capital which enables him to spend in excess of current income. A noteworthy feature is that, taken as a percentage of Net National Product, last year’s deficit was not markedly large by 19th century standards. Another 6For a discussion of official transactions and a distinction be tween when they are intended to influence the exchange rate and when they are not, see Douglas R. Mudd, “International Reserves and the Role of Special Drawing Rights,” this Review (January 1978), pp. 10-11. 7NNP is used in this comparison as this figure shows much better than GNP (which contains replacement investment) what is happening to national income after maintaining the nation’s stock of real capital. Comparing the deficits to NNP, therefore, relates the deficits to what the nation can spend without depleting its accumulated stock of capital goods. (For the purpose of comparison, it may be useful to note that the 1977 deficit, 0.9 percent of NNP, is 0.8 percent of GNP.) Taking deficits as a percentage of NNP both compensates for inflation and relates the deficit to the income which is avail able to service the change in indebtedness which a deficit implies. Comparisons of deficits as percentages of NNP are therefore the most appropriate form of comparison over long time periods. Page 3 APRIL FEDERAL. RESERVE BANK OF ST. LOUIS Table II U.S. BALANCE OF TRADE RELATIVE TO NET NATIONAL PRODUCT Period 1 8 6 9 -1 8 7 8 Balance on G oods & Services* (M illio n s of Dollars) $- 62 12 1 8 7 9 -1 8 8 8 Net National Product* (N N P ) (M illio n s of Dollars) $ 7,6 6 7 10,601 Balance as Percent of NNP -0 .8 % -0 .1 0.03 1 8 8 9 -1 8 9 8 4 12,049 1 8 9 9 -1 9 0 8 35 3 2 0 ,5 4 0 1.7 1967 4,395 7 2 9 ,3 0 0 0.6 1968 1,621 7 9 4 ,7 0 0 0.2 1 96 9 1,002 8 5 3 ,1 0 0 0.1 2,912 8 9 1 ,6 0 0 0.3 1971 - 3 40 9 6 4 ,7 0 0 -0 .0 4 197 2 - 6,088 1 ,065 ,8 0 0 3 ,5 2 0 1,188 ,9 0 0 0.3 1970 1 97 3 -0 .6 1 97 4 2,160 1 ,2 75,20 0 0.2 197 5 16,164 1 ,366,30 0 1.2 197 6 3,5 9 6 1,527,40 0 0.2 1977 -1 5 ,4 1 4 1,6 93,10 0 -0 .9 •Figures for the years 1869-1908 are ten-year averages. Sources: National Bureau of Economic Research and U .S. Depart ment of Commerce notable feature of the data in Table II is tbe shift to a trade surplus that occurred as the century pro gressed. This implies that the United States was mov ing from being a substantial net importer of invest ment funds to being a net exporter.8 A major reason for this is that in the earlier part of the period, the United States was expanding westwards at a very rapid rate. That created a demand for investment to construct transportation facilities, develop farm lands, and so forth. The rate of return that could be earned on capital in the United States was signi ficantly higher than that which could be earned in the rest of the world. The economy thereby became more industrialized and agriculture more mechanized. Only as the United States became relatively abundant in capital, towards the end of the 19th century, did the situation change and the United States become a capital exporter. T he Deficit and Inflows of Funds As Table II shows, the United States reverted to the position of a net importer of investment funds in 8These investment funds were, it should be noted, actually used in large part to buy capital goods from abroad in the 19th century. Page 4 1978 1977. The large increase in oil prices of recent years has provided some oil exporting countries with enor mous ability to save out of current incomes. Naturally, they wish to invest these savings. That same increase in oil prices reduced spending power in the United States; people had to spend a larger portion of their incomes on oil, and had therefore less left for other purposes. This means that it is quite rational for the United States to import investment funds at the present time; in other words, to attempt to borrow funds to pay for the increased imports. These funds allow U.S. con sumers to adjust their consumption more smoothly — they are not forced to make a sharp change, which is always unpleasant and can be inefficient since it forces cuts in what is easiest, rather than most desir able.9 Further, and ultimately more important, the inflow of funds can make it easier for U.S. firms to invest. The inflow of funds represents an increase in the de mand for U.S. securities. Unless the supply of these securities rises by at least the same amount as the increase in demand, the price of U.S. securities is bolstered by this inflow of investment funds, and U.S. interest rates are lower than they would otherwise have been.10 This increased ease in obtaining funds helps firms to invest, and thus encourages long-run growth in output, which is the only way the decline in U.S. living standards caused by the oil price in crease can ultimately be reversed. Without the in flow of funds from the oil exporting countries, living standards would be lower and prospects of raising them bleaker than with the inflow. The Deficit and Unemployment Imports do not cause unemployment. Many imports into the United States are themselves used in U.S. exports. An example is imported steel. Steel can be obtained more cheaply abroad than in the United States, and the prices of U.S. exports which use steel reflect the lower input price. Restrictions designed to raise import prices would also raise U.S. export (and domestic) prices for those goods, as well as directing 9An example is a family which bought a new automobile just before the oil price increase. The family might want to change to one which used less gas, but initially would be stuck with the car and have to cut back on, say, clothing. 10It should be emphasized that there is not necessarily a net increase in investment as compared to what would have happened without the oil price increase. There is an increased incentive to invest, as compared to the hypothetical situation where oil prices had increased but there had been no inflow o f funds from abroad. FEDERAL RESERVE BANK OF ST. LOUIS to the production of steel resources which would more profitably be used elsewhere. The increase in U.S. export prices relative to world market prices would reduce U.S. exports and, hence, U.S. export produc tion and U.S. employment in some exporting industries. Imports into the United States also create income abroad. If imports were suddenly restricted, U.S. ex porters would experience an associated drop in de mand. Agriculture, an industry currently eager to export so as to boost income, is an example of an industry highly sensitive to foreign demand for its products. Hence, imports create some job opportunities as part of the very process by which they reduce others. But, even if the United States used more labor in producing every good than any other country in the world, it would still be possible for the United States to participate in foreign trade, to gain from that trade, and not to suffer unemployment as a result. That proposition is by no means new. It was demon strated first in 1817 by the economist and stockbroker David Ricardo. Briefly, the reason why trade cannot permanently cause unemployment is that when workers are displaced from one job by competition from else where, they can move on to another job. It does not matter whether the competition is at home or abroad. If some goods are being produced and sold more cheaply than before, consumers, and also producers of these goods, have increased income and thereby increased demand for other products.11 That is not of course to say that engaging in inter national trade cannot cause a temporary fluctuation in unemployment. There can be temporary unemploy ment as workers move around while some industries expand and others decline.12 But if trade is restricted to eliminate that type of unemployment, the economy is frozen in a wasteful pattern of production, just as if, when the automobile started to displace the horse n A more detailed demonstration is contained in the screened insert accompanying this article. The demonstration given there is essentially Ricardo’s. As his proof considers only the labor which is involved in production, it is particularly well-suited to show the effect of trade on employment. See David Ricardo, The Principles of Political Economy and Taxation (London: J. M. Dent & Sons, Ltd., reprinted 1948), pp. 77-93. 12Workers would also have to move around if a country pegged its exchange rate despite having a higher rate of inflation than its trading partners. They would have to do so because pegging the exchange rate would depress both exporting and import-competing industries. Pegging the exchange rate can therefore cause unemployment, but this, too, would be temporary. APRIL 1978 and carriage, automobile production had been made illegal to protect the carriage-making industry.13 Accordingly, a trade deficit cannot permanently cause unemployment, if there are no dom estic restric tions on labor mobility. A trade deficit can be accom panied by temporary unemployment as workers move from one job to another, but protecting the old jobs is both unnecessary and harmful to national prosperity. (It is most certainly understandable that workers re sist having to move from one job to another; such moving can be expensive and inconvenient. But it is in no one’s interest for them not to move.) The Trade Deficit and the Dollar Eliminating any one part of U.S. imports, even one equal to the deficit, would not do much to prevent the fall in the dollar’s foreign exchange value. For example, if the United States suddenly stopped im porting oil, it would lose a nearly equivalent dollar inflow from the oil-producing countries, and there would be little net effect on the balance of supply and demand for dollars on the foreign exchange markets.14 As a further example, if the United States suddenly stopped importing foreign automobiles, there would be increased demand for domestic automobiles. Thus, resources would be diverted from the production of exports, and income would also of course be reduced abroad, thereby reducing the dem and for U.S. exports. Again the overall effect on the foreign exchange mar ket is unlikely to be large. Nor would the United 13There are very special circumstances when it may be ad visable to provide assistance to smooth the decline of an industry; but that assistance should never take the form of trade restriction, and should never aim to actually prevent the decline. The arguments for this can be found in Geoffrey E. Wood, “Senile Industry Protection: Comment,” Southern Economic Journal (January 1975), pp. 535-37. 14At the end of 1977, U.S. banks reported liabilities of about $9 billion to Middle East oil exporting countries. These countries also made net purchases of U.S. corporate stocks and bonds and marketable U.S. Treasury bonds and notes totalling about $7.5 billion during 1977. Further, since these figures omit purchases of land and buildings, they understate the capital inflow. Another large part of OPEC revenue from the United States (some 34 percent) is spent on U.S. goods. (As noted by Clifton B. Luttrell, “Free Trade: A Major Factor in U.S. Farm Income,” this Review (March 1977), p. 23, agricultural exports rose considerably as a result of OPEC price rises.) Total OPEC spending in the United States is also understated by the amount of U.S. net exports of services to the oil exporting countries. There is good reason for thinking this understatement to be substantial in view of the large jump in U.S. net exports of services after the first major oil price increase. Thus, the simple arithmetic does not support the claim that U.S. imports of oil have produced on foreign exchange markets all the excess supply of dollars which has caused the decline of the dollar’s foreign exchange value. Page 5 FEDERAL RESERVE BANK OF ST. LOUIS APRIL 1978 Labor Mobility, The Benefits from Trade, and Employment For the sake of exposition, we can assume that there are only two countries, the United States and the “rest of the world,” and, for simplicity, that there are only two goods, wheat and cloth. In the presence of competition, the price of wheat relative to the price of cloth will be equal to their relative production costs. Suppose that production of a unit of cloth re quires the labor of 120 workers for one year in the United States, and that a unit of cloth can be pro duced in the “rest of the world” with the labor of 80 workers for one year. Production of a given quan tity of wheat in the United States requires the labor of 100 workers for a year, while the same quantity of wheat could be produced in the “rest of the world” with the labor of 90 workers for a year. Thus, the production of both cloth and wheat requires a smaller expenditure of labor in the “rest of the world” than in the United States. With labor being the only cost of production and with competitive markets, in the absence of trade the relative price ratio of wheat to cloth in the United States would be equal to the ratio of labor inputs — that is, it would be 100/120 ( = 5/ 6). The corres ponding price ratio in the “rest of the world” would be 90/80 ( = 9 / 8 ) . If trade between the United States and the “rest of the world” opens up, the United States will import cloth and export wheat. The reason is as follows. At the “rest of the world’s” price ratio, 9/8, the United States could exchange one unit of wheat for 9/8 units of cloth. Hence, the United States could employ 100 workers to produce a unit of wheat and exchange the wheat for a quantity of cloth which would have re quired the labor of 135 workers to produce domes tically. Further, the “rest of the world” could employ 80 workers to produce a unit of cloth and exchange it, States have “gained jobs”. There would be an increase in the number of jobs in automobile production, but reduced job opportunities in those industries where foreign demand had fallen. Further, such trade re strictions will divert U.S. resources to activities more productively carried out abroad. Piecemeal attacks on the trade deficit will not achieve an improvement in the balance of payments on any significant scale. Summary and Conclusions Present concern about the U.S. trade deficit is much greater than the facts justify. When all trade, and not just merchandise trade, is examined, the deficit is, by historical standards, not outstandingly large. Further more, the deficit has a most desirable feature. It allows the United States to import investment funds. At the Page 6 at U.S. prices, for 6/5 units of wheat. Thus, the “rest of the world” could obtain an amount of wheat, which would have required the labor of 108 workers to pro duce domestically, for one unit of cloth which it pro duced by the labor of 80 workers.1 As production of wheat in the United States rises (and production of cloth declines), workers move out of the U.S. cloth industry and into the wheat in dustry. Workers in the “rest of the world” on the other hand, move out of the wheat industry and into the cloth industry. As a result of trade both the United States and the “rest of the world” gain in that both countries obtain a unit of each good for a smaller resource expenditure than would be required to pro duce the same amount of goods in the absence of trade, and can therefore consume (or invest) more. Although the “rest of the world” has been assumed to use less resources in producing every good than does the United States, it still benefits from buying goods produced in the United States. The example shows that in the absence of restric tions on labor moving from one industry to another within a country, all who want to work will find em ployment, even in a country where production costs are higher than those in the rest of the world. Further, it also shows that as a consequence of trade they will be better off than they would be without trade. This arises because they specialize according to whatever they can best do. This, of course, is what individuals who wish to maximize their income do on their own initiative. 1For the sake of brevity, the example speaks of numbers of workers. If wages are higher in one country than in another, this is dealt with by specifying the example in terms of “value-equivalent” labor units. The same result holds. moment this is desirable from the point of view of both the United States and the countries which are supplying those funds. The deficit has at most a transitory effect on the overall level of employment in the United States. Jobs will be lost in some industries, but gained in others. So long as resources, including labor, can move fairly freely, a trade deficit does not reduce the overall level of employment. Analysis which points to particular activities which are eliminated as a result of engaging in foreign trade, and then concludes that trade has led to a loss of jobs, implicitly assumes that once re sources are in place they can never again move. There are instances when artificial barriers restrict these movements, but the problems that arise are due to these barriers and not to the deficit. APRIL FEDERAL RESERVE BANK OF ST. LOUIS Finally, and perhaps m ost im portant, measures aim ed at elim inating some particular com ponent of the trade deficit would produce w asteful uses o f re sources, have little effect on the b alan ce of payments, 1978 and therefore m ake little contribution to arresting the slide in the d o llars foreign exchange value. Panic attacks on individual com ponents of the trade deficit w ill do m uch harm and little good. APPENDIX Merchandise Trade Balance: Goods and Services Balance: Current Account Balance: Capital Account: Capital Account: Exports of goods less imports of goods. Exported agricultural products accounted for about 20 percent of total U.S. merchan dise exports in 1977. Imported petroleum accounted for about 30 percent of total U.S. mer chandise imports in 1977. Merchandise trade balance plus net exports of services. Internation ally “traded” services include banking, insurance, transporta tion, tourism, military purchases and sales, and receipts of earn ings on investments abroad. United States exports of services have exceeded imports for the past 16 years. Goods and services balance less unilateral transfers. Unilateral transfers include private gifts to foreigners and government foreign assistance grants but ex clude military grants. U.S. uni lateral transfers to foreigners have averaged about $4.5 bil lion per year since 1970. Includes changes in U.S. invest ment abroad and changes in for- eign investment in the United States. Purchases of foreign (U .S .) government securities and corporate bonds and stocks are examples of U.S. (foreign) investment abroad (in the United States). An increase in U.S. investment abroad repre sents a capital outflow (entered into balance-of-payments ac counts as a negative item ). An increase in foreign investment in the United States represents a capital inflow (entered as a pos itive item ). Since changes in U.S. investment abroad, and foreign investment in the United States, include changes in offi cial reserve assets (such as pur chases of U.S. Treasury securi ties by foreign central banks), the capital account and current account must offset each other (a balancing category, “statistical discrepancy,” is required to pro duce an exact offset in the re ported data). Thus, with a cur rent account deficit of $20.2 billion in 1977, the United States recorded a net capital in flow of $23.2 billion (and hence a “statistical discrepancy” figure of $—3.0 billion). Page 7 Have Multibank Holding Companies Affected Commercial Bank Performance? NORMAN N. BOWSHER ^ I N C E the late 1960s there has been a rapid ex pansion of multibank holding companies which has had far-reaching impacts on the structure of banking in the nation. These multibank holding companies (MBHCs) were established as alternatives to branch ing systems in a number of states where branch bank ing was prohibited or severely limited.1 The holding company device for controlling and managing banks is not new — having been used since about the turn of the century — but its importance has increased dramatically in the last decade. MBHCs’ control of commercial bank deposits increased from 8 percent at the end of 1965, to 16 percent at the end of 1970, and to 34 percent at yearend 1976. The rapid expansion of MBHCs in recent years and the changes in banking structures and practices brought about by this development have generated much controversy regarding the merits and desirabil ity of holding companies. This article reviews evi dence on some major issues raised by the emergence of MBHCs. COMPETITION AND CONCENTRATION There has been a longstanding public concern in this country over the possibilities for excessive concen tration in banking. Many have feared that increased concentration would place resource allocation in the hands of a relatively small number of banking or ganizations in the financial centers. Reflecting these attitudes and policies based on them, the structure of American banking has been unique in the world, with its numerous independent banking institutions. At the same time, because of limits on bank entry and branching, maximum interest rates on deposits, and other regulations, competition has been limited and individual banks, particularly in some smaller communities, have attained some degree of monopoly power. iMBHCs have been established in various branch banking states. Organization as an MBHC can have advantages over that of a branch banking system. For instance, a holding com pany system can often maintain lower aggregate reserves than the same-sized branch network. Page 8 A chief issue which has emerged with MBHC de velopment has been the effects that these holding companies have had on concentration and competi tion in banking. With entry into banking limited by prevailing government regulations, acquisitions by holding companies could increase concentration by reducing or eliminating competition, and permit the remaining firms in the market to obtain monopolistic profits by raising prices and lowering services. Since there are no widely agreed upon measures of concen tration and competition, and since in some ways in creased concentration could be consistent with more, not less, competition, evaluations have not been uniform.2 Concentration Nationally From a review of banking developments since the mid-1960s, it does not appear that national concentra tion has been a crucial problem. Although numerous acquisitions did affect concentration from what it would likely have been otherwise, given all other fac tors, concentration has changed only slightly during the period of rapid holding company expansion. Concentration, as measured by total domestic de posits held by the 100 largest banking organizations in the country, changed little in the period 1957 to 1968 when holding company activity was relatively dormant. From a level of 48.2 percent in 1957, con centration rose slightly to 49 percent in 1968. How ever, despite an acceleration in holding company acquisitions after 1968, many of which were made by the 100 largest banking organizations, nationwide 2Evidence has been advanced which supports both the hypothe sis that increased market concentration results from efficiency of large organizations and the hypothesis that increased con centration facilitates collusion among firms. The relationship between efficiency and concentration, by itself, implies that customers gain as a result of higher concentration, but the relationship between collusion and concentration, by itself, implies that customers lose as a result of higher concentration. Since fewer restrictions on holding companies are associated with higher concentration, there are both potential benefits and costs for bank customers from such lessened restrictions. Gerald P. Dwyer, Jr. and William C. Niblack, “Branching, Holding Companies, and Banking Concentration in the Eighth District,” this Review (July 1974), pp. 11-18. FEDERAL RESERVE BANK OF ST. LOUIS concentration by these firms decreased from 49 per cent of domestic deposits to 47 percent in 1973.3 More recent calculations find that between 1968 and mid-1977 the 10 largest banking organizations’ share of domestic deposits declined from 20.4 to 18.3 percent while the share of the top 25 dropped from 31.9 to 28 percent. The 100 largest organizations’ share declined from 49.7 to 45 percent over this period.4 The apparent reason for this somewhat surprising result is that growth of domestic deposits (as dis tinct from foreign) was slower at the larger banking offices during the 1968-77 period than deposit growth at smaller banking offices. Also, there was a con straining influence on the larger organizations from antitrust laws and policies. Although over one-half of the 100 largest bank holding companies acquired other banks through the holding company device, a large portion of those acquired were de novo or small “foothold” acquisitions. Nevertheless, acquisitions by the 100 largest bank ing organizations between 1968 and 1973 did maintain nationwide concentration of domestic deposits above what otherwise would have prevailed. If the quanti tative impact of these acquisitions is subtracted from the 1973 actual ratio of concentration, the resultant adjusted nationwide concentration ratio for 1973 would have been 44.7 percent. Since the actual ratio was 47 percent, holding company acquisitions in the 1968-73 period, everything else equal, increased con centration by 2.3 percentage points above the level that would have existed in the absence of such acquisi tions. Thus, the pronounced increase in the share of total deposits of banks in MBHCs, mentioned in the introduction, reflected primarily the largest banks in the nation forming MBHCs and not acquisitions by the large banking organizations. Concentration Statewide There is justification for measuring concentration in an area smaller than the nation since the market for most banks is considerably less than the entire coun try. Since the state is the largest area within which banks can legally branch and form holding companies, 3Samuel H. Talley, “The Impact of Holding Company Acquisi tions on Aggregate Concentration in Banking,” Staff Economic Studies (80), Board of Governors of the Federal Reserve Sys tem, 1974. 4Statement by Philip E. Coldwell, member of the Board of Governors of the Federal Reserve System, before the Com mittee on Banking, Housing and Urban Affairs, United States Senate, March 7, 1978. APRIL 1978 and hence attempt to gain monopoly power, some feel that states are the relevant areas for measuring con centration.5 Also, interbank rivalry may be dependent not only on local market concentration, but also on the degree to which a few large banking organiza tions in a state, each of which has banking offices in several common local markets, agree not to engage in competitive behavior in any such local markets.6 Available evidence indicates that trends in statewide concentration in banking have varied markedly from state to state, with average changes remaining small. Between 1960 and 1976, there was no overall trend toward increased concentration of the three largest banking organizations in each state. Calculations of averages of changes indicate that states which al lowed statewide branching experienced a very small increase in the proportion of domestic deposits held by the three largest banking organizations: 0.2 per centage point. Limited branching states and unit banking states experienced average decreases of 1.7 and 2.9 percentage points, respectively. Among state wide branching states, those with the highest concen tration in 1960 exhibited the greatest decline in con centration, while those with the lowest concentration exhibited the greatest increase.7 Among the five largest banking institutions in each state, an increase in concentration occurred in 28 states, a decline in 22 states, with one unchanged in the 1968-73 period (the District of Columbia was treated as a state). The median increase for all states “It might be noted, however, that the Justice Department has failed to win a banking case on the grounds of statewide con centration alohe or the closely related grounds of potential competition statewide. See Aubrey B. Willacy and Hazel M. Willacy, “Conglomerate Bank Mergers and Clayton 7: Is Potential Competition the Answer?” Banking Law Journal (February 1976), pp. 148-195. Nevertheless, the legal issue of whether states are appropriate areas for administering anti trust policies is not settled since legislatures in a few states prohibit expansion by merger or acquisition beyond some state wide concentration level. See Katharine Gibson and Steven J. Weiss, “State-Imposed Limitations on Multibank Holding Company Growth,” Proceedings of a Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago, 1976, pp. 208-209. Also, Senate Bill S 72, the “Competition in Banking Act of 1977,” would prohibit bank mergers or hold ing company acquisitions if the resulting banking institution would control more than 20 percent of the banking assets within the state. eSee Elinor Harris Solomon, “Bank Merger Policy and Prob lems: A Linkage Theory of Oligopoly,” Journal of Money, Credit and Banking (August 1970), pp. 323-336. 7Statement by Philip E. Coldwell, member of Board of Gov ernors of the Federal Reserve System, before the Committee on Banking, Housing and Urban Affairs, United States Senate, March 7, 1978. See also Manferd O. Peterson, “Aggregate Bank Concentration and the Competition in Banking Act of 1975,” Issues in Bank Regulation (Park Ridge, Illinois: Bank Administration Institute, 1977), pp. 37-41. Page 9 FEDERAL RESERVE BANK OF ST. LOUIS was only 0.7 percentage point. In the 38 states permit ting MBHCs, concentration tended to increase during the period, while in the 13 states which prohibited them, concentration tended to decline. Nevertheless, the impact of MBHC acquisitions on statewide con centration was limited almost entirely to states with low or moderate concentration.8 It might have been expected that holding company activity would have its greatest impact on concentra tion at the state level, since holding companies are prohibited from operating in broader regions and since legal actions designed to prevent monopolistic formations are usually focused on smaller banking markets. Yet, what would appear to represent a sig nificant increase in aggregate concentration in some states sometimes does not, in fact, represent any mean ingful change in structure. The increases in concen tration often involved acquisitions of banks which had formerly operated as members of a banking group unified through common owners and directors and interlocking management.9 Concentration in Local Markets Concentration in local markets is more crucial from a competitive point of view than is concentration na tionally or statewide.10 In a local market, banks and their customers are in sufficiently close proximity for competitive interaction to occur, and both information and transaction costs tend to rise for many types of services as the distance between the bank and cus tomer increases, reducing the threat of effective out side competition.11 Local markets characterized by a structure with relatively few firms and high barriers to entry will facilitate pricing conduct that is aimed at achieving joint profit maximization through collu sion, price leadership, or other tacit pricing arrange ments.12 Nevertheless, greater publicity is given to 8Samuel H. Talley, “The Impact of Holding Company Acquisitions.” 9See Nancy M. Goodman, “Holding Company Developments in Michigan,” Federal Reserve Bank of Chicago Business Condi tions, (October 1975), pp. 10-15. 10This view has been adopted by the U.S. Supreme Court in evaluating competition. See U.S. v. Philadelphia National Bank in 1963; and U.S. v. Marine Bancorporation in 1974. n One study concluded that distance dominates all other factors in determining the selection of a banking office. Lorman L. Lundstein and Lewis Mandell, “Consumer Selection of Bank ing Office — Effects of Distance, Services and Interest Rate Differentials,” Proceedings of a Conference on Bank Struc ture and Competition, Federal Reserve Bank of Chicago, April 1977, pp. 260-286. 12See Stephen A. Rhoades, “Structure-Performance Studies in Banking: A Summary and Evaluation,” Staff Economic Studies (92), Board of Governors of the Federal Reserve System, 1977. Page 10 APRIL 1978 trends in concentration in the nation or at the state level than at the local level. This probably reflects the difficulty of defining a local market, but also reflects a popular misconception that “bigness” alone is a measure of monopoly power. It appears that concentration has remained un changed or has decreased in most local banking mar kets during the period of rapid holding company acquisitions. A study of 213 metropolitan areas and 233 country banking markets over the 1966-75 period concluded that most banking markets became less concentrated in that period. Also, the pro competitive changes in banking market concentration occurred with greatest frequencies and in the largest magni tudes in those markets which had a relatively high concentration ratio in 1966.13 In addition, local areas experiencing MBHC activity generally had lower ini tial concentration than areas where no MBHC acqui sitions occurred.14 Also, MBHCs tend to acquire banks in markets characterized by relatively fast growth in terms of banking offices, and relatively favorable ra tios of deposits per banking office.15 One positive influence on local competition may be stringent standards for approval of holding com pany acquisitions by the Board of Governors of the Federal Reserve System. Before approval is given to a holding company to acquire a bank, the Board ana lyzes the effects of the proposal on competition in the local banking markets. An application is denied if its effects would be to reduce materially competition in a local market, unless there are other strong mitigat ing factors.16 Managements of relatively large hold ing companies generally assume that proposed acqui sitions of relatively large independent banks in an 13Samuel H. Talley, “Recent Trends in Local Banking Market Structure,” Staff Economic Studies (89), Board of Governors of the Federal Reserve System, 1977. 14Jack S. Light, “Bank Holding Companies — Concentration Levels in Three District States,” Federal Reserve Bank of Chicago Business Conditions (June 1975), pp. 10-15. See also, Stephen A. Rhoades, “Characteristics of Banking Mar kets Entered by Foothold Acquisition,” Journal of Monetary Economics (July 1976), pp. 399-408, which concluded that the procompetitive effects of holding companies are less than they might otherwise be. loGregory E. Boczar, “Market Characteristics and Multibank Holding Company Acquisitions,” Journal of Finance (March 1977), pp. 131-146. 16In administering the Bank Holding Company Act, the Board of Governors of the Federal Reserve System has been ada mant not only in denying applications by holding companies to acquire existing banks with which they compete, but in addition, the Board has stood ready to deny applications on the basis of potential competition and probable future com petition. See Harvey Rosenblum, “Bank Holding Companies —-Part II,” Federal Reserve Bank of Chicago Business Con ditions (April 1975), pp. 13-15. FEDERAL RESERVE BANK OF ST. LOUIS area where the MBHC has a subsidiary would be denied, and few such applications are even submitted. In analyzing the growth of MBHC subsidiaries after acquisitions, no significant effects in the market share of affiliated banks vis-a-vis banks remaining inde pendent were found in four studies.17 This probably reflects offsetting effects of MBHC affiliation. On the one hand, subsidiaries of MBHCs enjoy greater fi nancial strength and ability to offer a wider range of services. On the other hand, the independent banks, on balance, can probably give more personalized service and adapt more quickly to changing local conditions. Indeed, the independent bank’s response to MBHCs in their area has probably intensified competition. BANK SERVICES A related issue raised by the MBHC development is the effect of holding company affiliation on the availability and cost of bank services. The evidence available on bank performance is mostly indirect, such as changes in bank operating ratios; hence, most con clusions are tentative. It has been argued that holding companies are able to offer more and better banking services to the cus tomers of their affiliates than are independents be cause of their larger size and superior management. This assertion cannot be tested directly, but a reason able proxy variable for the general quality of banking services is the rate of growth of a bank’s deposits. Presumably, banks providing more and better services grow faster than other banks. However, as noted in the previous section, growth of affiliates has not been significantly different on average than growth of com peting independent institutions. Federal Reserve System application of the Holding Company Act probably has some influence on foster ing better and broadened service by MBHC affiliates. To promote public interest, the Federal Reserve Sys tem evaluates the effects of a bank holding company acquisition on the basis of convenience and needs of 17Lawrence G. Goldberg, “Bank Holding Company Acquisitions and Their Impact on Market Shares,” Journal of Money, Credit and Banking (February 1976), pp. 127-130; Stuart Hoifman, “The Impact of Holding Company Affiliation on Bank Performance: A Case Study of Two Florida Multibank Holding Companies,” Working Paper Series, Federal Reserve Bank of Atlanta, January 1976; David D. Whitehead and B. Frank King, “Multibank Holding Companies and Local Mar ket Concentration,” Federal Reserve Bank of Atlanta Monthly Review, (April 1976), pp. 34-43; and Jerome C. Darnell and Howard Keen, Jr., “Small Bank Survival: Is the Wolf at the Door?” Federal Reserve Bank of Philadelphia Business Review (November 1974), pp. 16-23. APRIL 1978 the community to be served.18 Every MBHC applica tion to acquire a bank must include a description of changes, if any, the holding company plans to initiate in either availability or prices of services and how these changes will benefit the public. Proposals fre quently include establishment of a trust or foreign banking service, raising interest rates on time and savings deposits to Regulation Q maxima, reducing rates on credit insurance premiums, providing data processing services, expanding certain types of loans, and providing more customer facilities, such as park ing lots. Convenience and needs factors alone are sel dom the decisive factor in ruling on a case but these pledges can be crucial in determining whether the proposal is approved when it appears that other fac tors are marginal.19 In one study in which stated in tentions of MBHC applications were compared with actual implementation, no instances were found in which promised actions were not subsequently taken. In a number of cases, however, intentions were not fully realized.20 Even though many MBHCs have implemented promised services and/or reduced prices, the differ ences between services offered by MBHC banks and other banks have been marginal. Statistical analyses show that bank branching and size are stronger de terminants of most bank behavior ratios than MBHC affiliation.21 Affiliated banks tend to reduce cash and low-risk securities and increase loans, suggesting greater credit availability by MBHCs.22 Much of the gain, however, reflects the acquisition of a number of formerly ultraconservative banks. The ratio of time and savings deposit interest to total time and savings 18U.S.C., title 12, section 1843, as amended by Acts of July 1, 1966 (80 Stat. 238) and December 31, 1970 (84 Stat. 1763). 19See Michael A. Jessee and Steven A. Seelig, “An Analysis of the Public Benefits Test of the Bank Holding Company Act,” Federal Reserve Bank of New York Monthly Review (June 1974), pp. 157-167. 20Joseph E. Rossman and B. Frank King, “Multibank Holding Companies: Convenience and Needs,” Federal Reserve Bank of Atlanta Economic Review (July/August 1977), pp. 83-91. This study, however, had basic limitations. For example, the results were based primarily on a survey of MBHCs, taking the company’s word for what was done. 21William Jackson, “Multibank Holding Companies and Bank Behavior,” Working Paper 75-1, Federal Reserve Bank of Richmond, July 1975. -2See Lucille S. Mayne, “A Comparative Study of Bank Hold ing Company Affiliates and Independent Banks, 1969-1972,” Journal of Finance (March 1977), pp. 147-158. Another study, however, found that within county changes in bank structure in Ohio by holding company acquisition did not materially alter the supply of credit. Richard L. Gady, “Per formance of Rural Banks and Changes in Bank Structure in Ohio,” Federal Reserve Bank of Cleveland Economic Review ( November-December 1971), pp. 3-14. Page 11 FEDERAL RESERVE BANK OF ST. LOUIS deposits at MBHC affiliates increased relative to those of independent banks, but the change was not statis tically significant.23 The ratio of trust revenue to total revenue tends to be higher for affiliates than for in dependents, from which some analysts conclude that MBHCs offer more trust services. However, empirical evidence indicates that trust revenue of banks in counties in which one or more banks are affiliated with holding companies was neither higher nor lower than in other counties, holding other factors constant.24 In short, most MBHC banks resemble non-MBHC banks.25 The impact of MBHC management upon the behavior of affiliated banks is best analyzed on an individual bank basis. MBHC acquisition of a “prob lem bank” or an ultraconservative bank could serve the public interest, whereas an MBHC acquisition of a well-managed independent bank would apparently offer few public benefits. A study of the effects of 43 acquisitions of rural community banks in Ohio compared with 101 com parable independent banks in the same communities found several interesting impacts of the MBHCs. The affiliates showed a greater preference for consumer lending, but some lack of interest in real estate and farm lending. Affiliate banks charged higher rates of interest on loans, but they required somewhat lower downpayments and extended credit over slightly longer periods. Independent banks generally provided more auxiliary services with special emphasis on farm management consulting and general tax and financial advice. Holding companies introduced a number of services for the acquired banks, such as data process ing, marketing, and loan participation arrangements. Some independent banks responded by joining con sortia and relying heavily on correspondents in order to obtain comparable services.26 The available evidence suggests that MBHC affili ation has produced a slight enlargement in the avail ability of banking services. Holding companies have -^Samuel H. Talley, “The Effect of Holding Company Acquisi tions on Bank Performance,” Staff Economic Studies (69), Board of Governors of the Federal Reserve System, 1972. 24R. Alton Gilbert, “Trust Revenue of Commercial Banks: The Influence of Bank Holding Companies,” this Review (June 1974), pp. 8-15. 25See Robert F. Ware, “Characteristics of Banks Acquired by Multibank Holding Companies in Ohio,” Federal Reserve Bank of Cleveland Economic Review (August 1971), pp. 19-27. 2''Warren F. Lee and Alan K. Reichert, “Effects of Multibank Holding Company Acquisitions of Rural Community Banks,” Proceedings of a Conference on Bank Structure and Compe tition, Federal Reserve Bank of Chicago, May 1-2, 1975, pp. 217-225. Page 12 APRIL 1978 had only a slight net effect on prices of affiliated banks relative to those of the remaining independents. In short, as one might expect in a competitive environ ment, availability and prices of services have been little different at banks, regardless of corporate form. OPERATING EFFICIENCY AND PROFITABILITY Although it has frequently been contended that one advantage of joining an MBHC is improved op erating efficiency for the acquired bank, empirical evidence does not indicate any such clear improve ment of efficiency of affiliates over independents. The impact of affiliation on operating efficiency and profits is difficult to assess from financial statements since MBHCs may attempt to shift reported profits to the consolidated holding company rather than report them for each affiliate. This may be particularly true where the holding company does not completely own the affiliate. One study found no significant change in operating costs when an MBHC acquired a unit bank and an increase in such costs when it acquired a bank with branches.27 MBHC affiliates, as components of banking organi zations larger than most independent banks, probably experience some economies of scale.28 MBHCs are able to consolidate risks by generally having a larger asset base and serving a wider geographical area than most independent banks, reducing cash and capital re quirements. Other operating efficiencies for affiliates include better access to capital markets,29 advertising, data processing, specialized lending, and trust and foreign banking services. Although ratios of total revenues to total assets have been higher for affiliates than for independent banks, total operating expenses to total assets have also been higher.30 In particular, MBHCs incur larger employee 27Donald J. Mullineaux, “Branch Versus Unit Banking: An Anal ysis of Relative Costs,” Changing Pennsylvania’s Branching Laws: An Economic Analysis, Technical Paper, Federal Re serve Bank of Philadelphia, 1973, pp. 175-227. 28See Ernst Baltensperger, "Economies of Scale, Firm Size, and Concentration in Banking,” Journal of Money, Credit and Banking (August 1972), pp. 467-88; and Ernst Balten sperger, “Costs of Banking Activities — Interactions Between Risks and Operating Costs,” Journal of Money, Credit and Banking (August 1972), pp. 595-611. 29Cost of raising capital tends to be lower for large firms than for smaller enterprise. See Roger D. Blair and Yoram Peles, “The Advantage of Size in the Capital Market: Emperical Evidence and Policy Implications,” Working Paper 24, Cen ter for the Study of American Business, Washington Univer sity, St. Louis, December 1977. ■i°See Rodney D. Johnson and David R. Meinster, “The Per formance of Bank Holding Company Acquisitions: A Multi FEDERAL RESERVE BANK OF ST. LOUIS benefit costs and greater “other expenses” than inde pendent banks.31 Because MBHCs are usually the larger banking organizations, one would intuitively expect them to have employee benefit plans which would tend to be extended to subsidiaries. The “other expenses” category includes many diverse bank ex penses, and the actual reasons for the higher “other expenses” for holding company banks is not known. One could speculate that costs relating to the holding company structure and included in this category, such as management or legal fees, could conceivably drain some “profits” from the subsidiary banks. Nevertheless, holding company acquisitions have probably had only moderate effects on prices, ex penses, profitability, or performance of acquired banks.32 Since MBHCs have slightly higher operating costs than independent banks, it has been contended that affiliation with a holding company entails net diseconom ies of scale rather than economies.33 Using a different fine of reasoning, a study of Alabama banks over the period 1968 to 1973 found that, on balance, technical and operational efficiency improved for both independent and affiliate banks. Since this was a period in which the dominant change in the state’s banking industry was the emergence of an aggressive MBHC movement, the findings were tentatively at tributed to that activity.34 Since there are significant differences between in dividual holding companies, it is probably misleading to group them in some average. Many of the perform ance measures indicate that operations of banks affil iated with particular holding companies differed sig nificantly from both independent banks and banks variate Analysis,” Journal of Business (April 1975), pp. 204-212, and Robert J. Lawrence, The Performance of Bank Holding Companies, Board of Governors of the Federal Re serve System, 1967. 31Jack S. Light, “Effects of Holding Company Affiliation on De Novo Banks,” Proceedings of a Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago, 1976, pp. 83-106. 32Samuel H. Talley, “The Effect of Holding Company Acquisi tion on Bank Performance,” Staff Economic Studies (69), Board of Governors of the Federal Reserve System, 1972. Also, Lucille S. Mayne, “Management Policies of Bank Hold ing Companies and Bank Performance,” Journal of Bank Re search (Spring 1976), pp. 37-48. APRIL 1978 affiliated with other holding companies. It was possi ble in a number of instances to reject the hypothesis that holding-company-affiliated banks can be treated as elements of a single group as far as performance is concerned.35 Examining the profitability of MBHC banks com pared with independent banks through the use of performance ratios has not produced uniform results. In one study, MBHC affiliation was found to have a negative impact on the ratios of net income to total assets and on net income to equity.36 Another inquiry found no significant difference in holding company performance on net income to equity from that of independent banks.37 Two studies by John Mingo, taken together, hint at a third view of the profitability of MBHC affiliates. The first study found that holding companies tend to purchase banks with earnings to capital ratios below those of other banks.38 The second found that holding company banks, after acquisition, tend to have higher net earnings to capital ratios than do independent banks.39 A conclusion that MBHCs improved the prof itability of acquired banks, however, may not be war ranted in view of the changed samples. The evidence on the profitability of MBHC affiliates is mixed, and the issue is not likely to be settled soon. In a number of cases, subsidiaries have been less prof itable than independents of similar size in the same general area. However, the holding company may be attempting to maximize profits of the system rather than for each subsidiary. Also, many acquisitions have been of banks with below average profitability, and it may take more time to get a fair evaluation of their performance within the holding company. To date, only a few MBHC affiliates have been liquidated, sold, or spun off, indicating that any drag on the system’s profitability has not been intolerable. 36Arthur G. Fraas, “The Performance of Individual Bank Hold ing Companies,” Staff Economic Study (84), Board of Gov ernors of the Federal Reserve System, 1974. 36Jack S. Light, “Effects of Holding Company Affiliation on De Novb Banks,” Proceedings of a Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago, May 1976, pp. 83-106. 33Dale S. Drum, “MBHCs: Evidence After Two Decades of Regulation,” Federal Reserve Bank of Chicago Business Con ditions, (December 1976), pp. 3-15. See also, George J. Benston and Gerald A. Hanweck, “A Summary Report on Bank Holding Company Affiliation and Economies of Scale,” Conference on Bank Structure and Competition, Federal Re serve Bank of Chicago (April 1977) pp. 158-168. 38John J. Mingo, “Capital Management and Profitability of Prospective Holding Company Banks,” Journal of Financial and Quantitative Analysis (June 1975), pp. 191-203. 34Terrence F. Martell and Donald L. Hooks, “Holding Com pany Affiliation and Economies of Scale,” Journal o f the Mid west Finance Association (1975), pp. 59-71. 39John J. Mingo, “Managerial Motives, Market Structure and the Performance of Holding Company Banks,” Economic Inquiry (September 1976), pp. 411-424. 7William Jackson, “Multibank Holding Companies and Bank Behavior,” Working Paper 75-1, Federal Reserve Bank of Richmond, July 1975. Page 13 FEDERAL RESERVE BANK OF ST. LOUIS BANK SOUNDNESS Holding companies claim that they strengthen ac quired banks in a number of ways. At times, they pro vide additional capital, personnel training, or skilled management. They diversify risks and lower the costs of providing certain specialized services. Resources of the entire system can be mobilized to solve a local bank’s problems. Yet, most analyses have indicated that the alleged benefits of MBHCs on bank sound ness are exaggerated. It is still not clear whether the holding company movement has, on balance, in creased or reduced the soundness of banks. The Board of Governors of the Federal Reserve System denies applications of proposed holding com pany acquisitions if the payments necessary to retire debt incurred in buying the bank’s stock would be likely to drain its retained earnings. In addition, cap ital has been supplied by the parent holding com panies to a number of subsidiaries. Nevertheless, the capital positions of a number of acquired banks have been relatively low. The average ratio of capital to total assets or deposits is generally lower for affili ated banks than for independent counterparts.40 How ever, it has been found that holding company affilia tion caused only a small decline in the capital to deposits ratio, one which was not statistically significant.41 MBHC banks, on average, are leveraged to a greater extent than independent banks (as measured by lower capital/asset ratios), and hold greater proportions of higher-yielding (presumably more risky) assets than do comparable independents. Also, as market concen tration increases, capital to asset ratios rise for inde pendent banks as a class but decline for holding company banks. Such observations suggest that inde pendent banks take most benefits of greater market power in the form of reduced risk, while MBHC banks are less risk-averse.42 Although affiliation tends to increase the payout ratio (dividends to net income) for affiliated banks,43 the funds may still be retained within the MBHC organization. 40See Arthur G. Fraas, “The Performance of Individual Bank Holding Companies,” Staff Economic Study (84), Board of Governors of the Federal Beserve System, 1974, and William Jackson, “Multibank Holding Companies and Bank Behav ior,” Working Paper 75-1, Federal Beserve Bank of Bichmond, July 1975. 41Talley, “The Effect of Holding Company Acquisitions on Bank Performance.” 42John J. Mingo, “Managerial Motives, Market Structures, and the Performance of Holding Company Banks.” 43Jackson, “Multibank Holding Companies and Bank Behavior.” Page 14 APRIL 1978 Through the use of the holding company, some or ganizations have engaged in “double leveraging” — that is, raising funds through parent debt issues and “downstreaming” equity capital to bank subsidiaries. This practice allows the subsidiaries to increase re ported capital ratios, while increasing the leverage of the holding company as a whole.44 A conclusion that affiliated companies hold less cap ital to assets or deposits than their independent counterparts does not necessarily indicate that they are undercapitalized or less stable.45 The risks of banking are usually more diversified by having a larger asset base, by engaging in more activities and by operating over a wider region in an MBHC ar rangement than for an individual bank. Since such diversification reduces the lead bank’s risk, the MBHC might assume a somewhat greater risk in each of its subsidiaries than otherwise without increasing the exposure of the system.40 Hence, even though an in dividual affiliate has less capital cushion, this might be matched by help it could reasonably expect from its parent should aversity arise.47 SUMMARY AND CONCLUSIONS Despite a tremendous expansion of MBHCs during the last decade, commercial banking has changed only moderately as a result of these activities.48 Recogniz ing that it is too early to appraise adequately all the ramifications, the weight of the evidence so far seems to indicate that the net effects of the holding company 44See Federal Beserve Bulletin (February 1976), p. 115. 45See “Bank Holding Company Financial Developments in 1976,” Federal Beserve Bulletin, Board of Governors of the Federal Beserve System (April 1977), pp. 337-340. 40Leverage was found to be statistically significant in explaining market risk premium on long-term debt when bank issues alone were examined, but was statistically insignificant when issues of bank holding companies alone were analyzed. Anne S. Weaver and Chayim Herzig-Marx, “A Comparative Study of the Effect of Leverage on Bisk Premiums for Debt Issues of Banks and Bank Holding Companies,” Staff Memoranda, Federal Beserve Bank of Chicago, 1978. 47Nevertheless, the potential benefits from diversification in MBHC organizations has been found to be limited due to the relatively homogeneous nature of holding company acquisi tions of banks. See Peter S. Bose, “The Pattern of Bank Holding Company Acquisitions,” Journal of Bank Research (Autumn 1976), pp. 236-240. 48See Stephen A. Bhoades, “Structure and Performance Studies in Banking: A Summary and Evaluation,” Staff Economic Studies (92), Board of Governors of the Federal Beserve Sys tem, December 1977, p. 45.Based on a review of 39 studies of market structure and performance published since 1959, it was concluded that the changed market structure has had only a small quantitative effect on price or profit performance in banking. FEDERAL RESERVE BANK OF ST. LOUIS movement have been favorable for the general public. The fear that commercial banking would become less competitive if holding companies were permitted has not been substantiated. In many local markets, affili ates of MBHCs have increased competition, and the independent bank’s response to the introduction of a holding company competitor has frequently also been to intensify competition. On balance, MBHCs have offered a slightly wider range of banking services and have increased credit extended to consumers and small businesses over what APRIL 1978 otherwise would have been likely. As a result, reve nues of affiliates have been higher than at independent banks, but costs have also been greater. Affiliates of MBHCs are not as well capitalized as their independent counterparts, but risk is reduced through greater diversification. Independent banks do not seem to have been harmed by the introduction of a holding company operation in their market area, having grown at roughly the same rate as similar-sized MBHC affiliates. Evidence on profitability of affiliates versus independent banks is still mixed. Page 15 Operations of the Federal Reserve Bank of St. Louis —1977 PAUL A. WATKINS, JR. _A lS the central bank of the United States, the Fed eral Reserve perforins three basic functions. It con ducts monetary policy, supervises and regulates member banks, and provides various services to the public, the Treasury, and commerical banks. These functions are performed by the Federal Re serve System’s Board of Governors in Washington, the 12 regional Reserve Banks located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco, and the 25 branches of the regional banks. Although they have authority to examine all mem ber banks, Federal Reserve Banks generally do not examine national banks, all of which are required to be members of the Federal Reserve System. Pri mary responsibility for examination and supervision of national banks, which number 340 in the Eighth District, lies with the office of the Comptroller of the Currency. The Federal Deposit Insurance Corpo ration (F D IC ), along with respective state banking authorities, examines state nonmember banks that are insured by the FD IC. Noninsured banks are ex amined only by state authorities. The Federal Reserve Bank of St. Louis, together with the state banking authorities, has responsibility for the supervision of the 79 state chartered banks in the Eighth District which have elected to become members of the Federal Reserve System. An annual examination is made of state member banks in order to evaluate their assets, liabilities, capital accounts, liquidity, operations, and management. Attention is also focused on compliance with applicable laws and regulations. Federal Reserve Banks also supervise bank holding companies. At the end of 1977, the Federal Reserve Bank of St. Louis had jurisdiction over 20 multibank and 88 one-bank holding companies. Prior approval must be obtained from the Federal Reserve System for bank holding company formations and for acqui sitions of additional banks and permissible nonbank subsidiaries. Applications for holding company for mations and for acquisitions of additional subsidiaries are analyzed by the Bank Supervision and Regulation Department along with the Legal and Research De partments. These departments consider the history, financial condition, and prospects of the institutions, and evaluate the quality of management. They also assess the legal aspects of the proposal and its likely effects on banking and nonbanking competition. Dur ing 1977, the Federal Reserve Bank of St. Louis re ceived 14 applications to form one-bank or multibank holding companies and 24 applications from holding companies to acquire additional subsidiaries, engage de novo in nonbank activities, or establish new locations. Information gathered from such examinations is utilized by banking authorities to direct attention to potential problems or unsatisfactory conditions of the banks. Supervision seeks to foster an effective bank ing system in which the public interest is safeguarded. After formation, bank holding companies are re quired to register and file annual reports with Federal Reserve Banks. These annual reports are analyzed by the staff of the Bank Supervision and Regulation De partment to verify accuracy and completeness, to The Eighth Federal Reserve District is served by the head office in St. Louis and branches in Little Rock, Louisville and Memphis. The district encom passes Arkansas and parts of Illinois, Indiana, Ken tucky, Mississippi, Missouri, and Tennessee. This article reviews the operations of the Federal Reserve Bank of St. Louis during 1977. Bank Supervision and Regulation Page 16 APRIL FEDERAL RESERVE BANK OF ST. LOUIS ascertain the current financial condition of the hold ing company and its subsidiaries, and to determine compliance with applicable laws and regulations. Examination reports prepared by the primary Fed eral supervisory agency of the respective bank sub sidiaries are also analyzed by the Federal Reserve Bank to determine the overall condition of such sub sidiaries. In addition, discretionary on-site inspections of bank holding companies and their nonbank sub sidiaries are conducted by Supervision and Regula tion personnel. The purpose of these inspections is similar to that of examinations of banks. C heck Collection The collection and clearing of checks drawn on member and nonmember banks is a service provided by the Federal Reserve System and is a major activ ity at this Bank. Payment for the items cleared is ac complished on the day of presentment by a charge to the reserve account of the member bank or to the reserve account of a member correspondent. Checks drawn on nonmember banks are also paid for on the day of presentment by a charge to the account of a specified member correspondent. During 1977 the four Federal Reserve offices in the Eighth District cleared 693 million checks totaling $289 billion. This reflects increases of almost 4 per cent in the number of checks cleared and more than 14 percent in dollar value when compared with 1976 check clearing activity. Although growth in the vol ume of items cleared has slowed somewhat over the past year, the dollar value of these items continued to increase at about the same rate as in past years. A major goal of the Federal Reserve System is to provide a speedy check payments mechanism. To this end a Regional Check Processing Center (RCPC) program was implemented during the early 1970s to 1978 increase the speed of the check payment process and to facilitate the return of dishonored items. The RCPCs that have been in operation in the Eighth Federal Reserve District since 1972 continue to enable the overnight collection of items drawn on banks in the RCPC area, thereby permitting prompt credit and payment for these checks. Electronic Transfer of Funds Wire transfers have been used for many years to facilitate transfers of balances between banks. The Federal Reserve and its member banks utilize a com puter network for transferring funds nationwide. Us ing this system, many member banks are able to render more efficient service to their customers and effect payment for the purchase and sale of Fed funds. Nonmember banks benefit from this service indirectly through correspondent member banks. Settlement for such transfers is made by debits and credits to reserve accounts. Generally, transfers through this network are for large amounts, with no charge levied for transfers of $1,000 or more. Mem ber banks also utilize these facilities to transfer mar ketable government securities. All four Federal Re serve offices and 22 commercial banks in the Eighth District with a significant volume of transfers are currently on-line. Several other banks are considering the installation of terminals. Over 360 member banks nationwide have installed on-line terminals connected to their Federal Reserve District computers. Member banks not having on-line terminals may telephone their transfers to their local Federal Reserve office where the transfers are entered into the wire transfer system over Federal Reserve Bank terminals. Terminal installations at the banks are connected to the computer at the St. Louis Federal Reserve office which is the switching center for the Eighth Table I VOLUME OF OPERATIONS* Number Dollar Amount (millions) - - (thousond,)----- Percent 1977 1976 Change Checks handled2 ................................................ 6 9 2 ,7 2 3 Transfers of f u n d s ................................................ 1,141 Currency received and counted ................... 3 1 8 ,0 0 0 Government securities issued, serviced, and redeemed . 13,300 U.S. Government coupons p a i d ............................. 400 Food Stamps received and c o u n te d ........................ 1 2 0 ,0 0 0 6 6 7 ,6 7 8 974 2 8 1 ,0 0 0 3 .8 % 17.1 592 $ 2 8 8 ,9 2 9 $ 2 5 4 ,3 5 7 1,035,00 0 8 7 1 ,0 0 0 Percent Change 13 .6 % 18.8 13.2 2,9 0 0 2,800 3.6 .6 36,388 6 9 ,0 5 0 -4 7 .3 185 266 -3 0 .5 —10.5 504 556 - 9.5 1 3 ,226 1 3 3 ,0 0 0 1976 1977 -3 2 .4 ■Total for the St. Louis, Little Rock, Louisville and Memphis offices. 2Excludes U.S. Government checks and postal money orders. Page 17 APRIL FEDERAL RESERVE BANK OF ST. LOUIS District. Operators of the terminals in the commercial banks can initiate transfers directly from their banks, at which time the transfers are processed automat ically through the computer at the St. Louis office and directed through a central switching computer at Culpeper, Virginia, to another Federal Reserve Dis trict for the account of the receiving commercial bank. Transfers of funds may also be made between mem ber banks in the same District. If the receiving bank is on-line, transfers are switched automatically to that bank’s terminal through its Federal Reserve District computer. By transferring funds electronically, all necessary information for completing the transfer is obtained. Third-party information may be entered to identify the originator and/or the recipient of the funds. Member bank reserve accounts are debited and cred ited automatically, and banks with on-fine terminals receive an immediate record of each transaction at its conclusion. The use of electronic equipment for transfers of funds has reduced the time required for completion of a typical transaction from almost an hour to a matter of only a few minutes. With the installation of on-line terminals at the 22 District commercial banks, about 3,900 transactions per day are sent and received by electronic means, and thus do not require manual processing by Eighth District personnel. This represents 82 percent of total transfers processed. Volume and dollar amounts of transfers processed by the Eighth District continues to increase. During 1977, more than 1.1 million transfers amounting to $1,035 billion were completed by the Federal Reserve Bank of St. Louis and its branches. This is an 18 per cent increase in number and a 13 percent increase in value over the previous year. Federal Recurring Payments The Bank has been processing the payroll for Air Force installations in the Eighth Federal Reserve District by electronic means since August 1975. A number of other Federal recurring payments are also settled through the electronic funds transfer system (E F T S ). Social Security payments comprise the largest category with a monthly volume of 280,000 payments. Monthly volumes for other categories are 11,700 Civil Service Annuity payments, 8,500 railroad retirement payments, 12,000 Veterans Administration payments, and 5 CIA retirement payments. In addi tion, 2,000 revenue sharing payments are processed quarterly. Page 18 1978 Automated Clearing Houses An automated clearing house (ACH) provides for the exchange of payments on magnetic tape. Tradi tional clearing houses, by contrast, provide for the exchange of payments with batches of paper checks. The St. Louis Reserve Bank and each of its branches operate automated clearing houses. The Arkansas Automated Clearing House, operated by the Little Rock Branch, began operations in October 1977. The Kentuckiana Automated Clearing House, operated by the Louisville Branch, began operating in April 1976. The Mid-America Payments Exchange, operated by the Bank’s head office in St. Louis, has been opera tional since July 1976. In addition, the Mid-South Automated Clearing House, operated by the Memphis Branch, began operations in February 1977. The Dis trict’s four ACH’s process about 42,000 commercial debit and credit items monthly. Coin and Currency Coin and currency, comprising approximately 26.1 percent of the money stock, are more widely used than demand deposits in consummating small transac tions, primarily because of convenience. Personal checks generally are used for transactions of larger amounts. The Federal Reserve Banks supply, through the commercial banking system, virtually all of the coin and currency in circulation, and excess coin and currency is returned to Federal Reserve Banks through the commercial banking system. Approximately 318 million pieces of currency valued at $2.9 billion were received and verified at the four Federal Reserve offices in the Eighth District during 1977. This was an increase of about 13 percent in num ber of pieces, and a 4 percent increase in dollar vol ume from 1976. The number and value of coins re ceived and verified showed a decline from 1976 levels. Combined sorting, counting, and wrapping of coin and currency at the four offices averaged almost 6.4 mil lion pieces per working day in 1977, up slightly from 1976. In sorting currency at the Reserve Banks, that which is no longer usable is removed from circulation and destroyed. During 1977, the Federal Reserve Bank of St. Louis and its branches verified and destroyed cur rency totaling $771 million. Lending Three types of credit are made available to member banks in the Eighth Federal Reserve District: short FEDERAL RESERVE BANK OF ST. LOUIS term adjustment, seasonal, and emergency credit. Mem ber banks may make temporary adjustments in their reserve positions due to deposit losses, unexpected or unusual requests for loans, or other changes they en counter. Member banks which have highly seasonal loan demands may apply to this Bank for seasonal credit. Such loan demands are due primarily to a re curring pattern of change in deposits and loans. Un der seasonal credit, member banks are permitted to maintain a portion of their liquid assets in the form of Federal funds (loans of excess reserves to other banks), so long as such holdings conform to the bank’s normal operating experience. Arrangements for this type of credit should be made in advance. Credit for longer periods is also available to member banks to meet emergency conditions which may result from un usual local, regional, or national financial situations, or adverse circumstances where member banks are involved. The discount rate is the rate of interest charged by the Federal Reserve Bank on loans to member banks. The level of the discount rate, in relation to other short-term market rates, has an influence on the volume of credit extended by the Federal Reserve Bank. When the discount rate is higher than other market interest rates, member banks usually choose to obtain funds from other sources to make tempo rary reserve adjustments. When the discount rate is low in relation to other market rates, member banks tend to rely more heavily on the Federal Reserve for funds. At the start of 1977, the discount rate was 5.25 percent. The rate was increased twice during the year, and at yearend it was 6 percent. However, throughout the last half of 1977, the discount rate was below other short-term interest rates. As a result of this difference in rates, member bank borrowings in the Eighth District were relatively high. The daily average of loans outstanding amounted to $23.7 mil lion in 1977, more than ten times the $2.2 million for 1976. There were 860 loans amounting to $5.0 billion made to 63 Eighth District member banks by the Federal Reserve Bank of St. Louis during 1977. This is an increase from 1976 when 231 loans totaling $428.9 millon were made to 32 member banks. APRIL 1978 in the System. Funds received by the Treasury are deposited into its account at the Federal Reserve Banks or into tax and loan accounts at designated commercial banks. These funds represent mainly re ceipts from payment of taxes and collections from the sale of Government securities to the public. Balances in the tax and loan accounts are transferred upon call to the account of the Treasury of the United States at Federal Reserve Banks in order for the Treasury De partment to have use of the funds. The Federal Reserve Banks also act on behalf of the Government in marketing Treasury securities. When the Treasury offers new securities, the Reserve Banks prepare and distribute applications and official offering circulars, receive subscriptions from those who wish to buy, allot the securities among the sub scribers according to the terms of the offering, collect payment, and make delivery to the purchasers. With funds from the Treasury’s account, Federal Reserve Banks pay interest on securities and redeem them at maturity. Reserve Banks also pay interest on and redeem securities of most Government-sponsored corporations. The Federal Reserve Banks will, as fiscal agents, hold in safekeeping securities pledged to secure Gov ernment deposits in tax and loan accounts at com mercial banks. Federal Reserve Banks will also hold securities of member banks in safekeeping. U.S. Treas ury and most government agency securities are held in book-entry form by the Reserve Banks. Securities of the U.S. Government and various gov ernment agencies are issued, serviced, and redeemed by Federal Reserve Banks. In 1977, 13.3 million se curities totaling $36.4 billion were handled by the Federal Reserve Bank of St. Louis and its branches. Also during 1977, coupons of U.S. Treasury and agency securities totaling 400,000 pieces amounting to $185 million were paid by Eighth District offices. U.S. Government food stamps are also redeemed by Federal Reserve Banks. A total of 120 million food stamps amounting to $504 million were received and counted by the Federal Reserve Bank of St. Louis and branch offices during 1977. Research Fiscal Agency As a fiscal agent of the Federal Government, the Federal Reserve Bank performs many services. The U.S. Treasury makes payments for various types of Government spending through accounts maintained The Federal Reserve System, while working closely with other policymaking agencies in the Government, has the primary responsibility for the formulation and implementation of monetary policy. Through repre sentation on the Federal Open Market Committee, Page 19 As of March 2, 1978 DIRECTORS St. Louis Chairman o f the Board and Federal Reserve Agent A r m a n d C. S t a l n a k e r , Chairman and President General American Life Insurance Company, St. Louis, Missouri T o m K. S m i t h , J r ., Senior Vice President, Monsanto V i r g in ia M. B a i l e y , Owner, Eldo Properties, Little Rock, Company, St. Louis, Missouri Arkansas W i l l i a m H. S t r o u b e , Associate Dean, College of Science R a l p h C. B a in , Vice President, Wabash Plastics, Inc., and Technology, Western Kentucky University, Bowl Evansville, Indiana ing Green, Kentucky D o n a l d N. B r a n d in , Chairman of the Board and Pres ident, The Boatmen’s National Bank of St. Louis, W i l l i a m B. W a l t o n , Vice Chairman of the Board, Hol St. Louis, Missouri iday Inns, Inc., Memphis, Tennessee R a y m o n d C. B u r r o u g h s , President and Chief Executive W m . E. W e i g e l , Executive Vice President and Chief Exec Officer, The City National Bank of Murphysboro, utive Officer. First National Bank and Trust Company, Murphysboro, Illinois Centralia, Illinois Little Rock Branch Chairman of the Board G. L a r r y K e l l e y , President Pickens-Bond Construction Co., Little Rock, Arkansas R o n a l d W . B a i l e y , Executive Vice President and General B. F i n l e y V in s o n , Chairman of the Board, The First Manager, Producers Rice Mill, Inc., Stuttgart, National Bank in Little Rock, Little Rock, Arkansas Arkansas T h o m a s E. H a y s , J r ., President and Chief Executive T. G. V in s o n , President, The Citizens Bank, Batesville, Officer, The First National Bank of Hope, Hope, Arkansas Arkansas E. R a y K e m p , J r ., Vice Chairman of the Board and Chief Administrative Officer, Dillard Department Stores, F i e l d W a s s o n , President, First National Bank, Siloam Inc., Little Rock, Arkansas Springs, Arkansas Louisville Branch Chairman o f the Board Chairman and Chief Executive Officer Porter Paint Co., Louisville, Kentucky H o w a r d B r e n n e r , Vice Chairman of the Board, Tell F r e d B. O n e y , President, The First National Bank of City National Bank, Tell City, Indiana Carrollton, Carrollton, Kentucky R ic h a r d 0 . D o n e g a n , Vice President and Group Execu J a m e s F. T h o m p s o n , Professor of Economics, Murray tive, General Electric Company, Louisville, Kentucky State University, Murray, Kentucky J . D a v id G r i s s o m , Chairman and Chief Executive Offi cer, Citizens Fidelity Bank and Trust Company, T o m G . V o s s , President, The Seymour National Bank, Louisville, Kentucky Seymour, Indiana J a m e s H . D a v is , Memphis Branch Chairman o f the Board J e a n n e L . H o l l e y , Associate Professor of Business Education and Office Administration, University of Mississippi, University, Mississippi W. M. C a m p b e l l , Chairman of the Board and Chief S t a l l in g s L i p f o r d , President, First-Citizens National Executive Officer, First National Bank of Eastern Bank of Dyersburg, Dyersburg, Tennessee Arkansas, Forrest City, Arkansas W i l l i a m W o o t e n M i t c h e l l , Chairman, First Tennessee R o b e r t E. H e a l y , Partner-In-Charge, Price Waterhouse Bank N.A., Memphis, Tennessee & Co., Memphis, Tennessee C h a r l e s S . Y o u n g b l o o d , President and Chief Executive F r a n k A. J o n e s , J r ., President, Cook Industries, Inc., Officer, First Columbus National Bank, Columbus, Memphis, Tennessee Mississippi Member, Federal Advisory Council Chairman of the Board and Chief Executive Officer First National Bank in St. Louis, St. Louis, Missouri Cla ren ce C. B a r k sd a le, Page 20 OFFICERS St. Louis L aw ren ce D on ald W. A natol B . B a lba c h , Senior Vice President J Senior Vice President P . G a r b a r in i, o seph K. M o r ia r t y , J D e n is S . K a rn o sky, J am es R . K en n ed y, O t t in g , Vice President A . M e l v in C a r r , Assistant Vice President ohn R ic h a r d 0 . K W. a ley, Assistant Vice President Assistant Vice President M ic h a e l L in d h o r s t , C l if t o n B . L u t t r e l l , Assistant Vice President F. ea , Assistant General Auditor F. L e s l ie S Assistant Vice President Special Adviser Orf, Assistant Vice President P aul S alzm an , Assistant General Counsel & Assistant W . D r u e l in g e r , Vice President Harry L. R Assistant Vice President Secretary J C h arles D. Zet t le r , E ug en e Assistant Vice President Vice President Vice President e is z , A rth ur L. O er tel, Assistant Vice President Carol B . Cla ypo o l, h o m a s, D elm er D. W Assistant Vice President M . Ca r lso n , J o a n P . C r o n in , R obert W . T General Auditor Vice President W a rren T . S n o v er, Vice President A l b e r t E . B urger, e it h Senior Vice President B e r n h a r d t J . S a r t o r iu s , Vice President N orm an N . B o w sh e r , K Economic Adviser Vice President R uth A . B ryan t, F. r ., Senior Vice President, General Counsel, and Secretary G arlan d R u s s e l l , J H a rold E . U t h o f f , L eo n a ll C. A n d ersen , ohn President First Vice President r ., F. & Controller J R o o s, Assistant Vice President c h m e d in g , Assistant Vice President E dw ard R . S c h o t t , Assistant Vice President W Assistant Vice President J . S n eed, il l ia m A la n C . W h eeler, Assistant Vice President Little Rock Branch J ohn F. B reen , M ic h a e l T . M o r ia r t y , T homas R . Ca l l a w a y , Vice President and Manager Assistant Vice President and Assistant Manager Assistant Vice President D a v id T . R e n n ie , Assistant Vice President Louisville Branch D on ald L . H e n r y , J a m e s E . C onrad, G eo r g e E . R e it e r , J r ., Senior Vice President and Manager Assistant Vice President and Assistant Manager Assistant Vice President T homas J. W il s o n , Assistant Vice President Memphis Branch L. T erry P a u l I . B l a c k , J r ., A . C . Cr e m e r iu s , J r ., B r it t , Vice President and Manager Assistant Vice President and Assistant Manager Assistant Vice President C. L . E pper so n , J r ., Assistant Vice President Page 21 FEDERAL RESERVE BANK OF ST. LOUIS APRIL Table III Table II COMBINED COMPARATIVE STATEMENT OF CO NDITION COMPARATIVE PROFIT AND LOSS STATEMENT (Dollar Amounts in Thousands) (in thousands of dollars) December 3 1 ,1 9 7 7 U.S. Government Securities: B i l l s ...........................................$ 1 ,7 6 3 ,6 6 7 C e r t if ic a t e s ................................. ........ — N o t e s ........................................... 2,148,021 B o n d s ...................................... December 3 1 ,1 9 7 6 $ 1 ,5 7 2 ,6 4 9 — 1,955,85 9 3 7 0 ,9 3 0 TOTAL U.S. G O V E R N M E N T S E C U R I T I E S ........................$ 4 ,2 8 2 ,618 274 ,19 2 $ 3 ,8 0 2 ,7 0 0 $ 4 6 6 ,3 6 4 1 97 6 Total e a r n i n g s ................... $ 2 8 4 ,8 8 8 $ 2 5 6 ,7 9 5 Net e x p e n s e s ................... 33 ,619 35,041 $2 5 1 ,2 6 9 $ 2 2 1 ,7 5 4 -5 ,8 2 9 + 460 -1 ,5 6 3 -1 ,4 0 3 1 1 .4 % $ 2 4 3 ,8 7 7 $220,81 1 1 0 .4 % 1,963 1,915 2 .5 % 2 4 2 ,3 2 9 2 17 ,58 2 Current net earnings Net additions ( + ) or deductions (—) . . . . Assessm ents for expenses of Board of Governors . Net earnings before payments to U.S. Treasury . G old Certificate Reserves................... $ 4 6 8 ,9 1 4 Special D raw ing Rights Certificate A c c o u n t ...................................... 5 3 ,0 0 0 5 0 ,0 0 0 D iv i d e n d s ........................ C o i n ............................................... 19,869 26,661 Interest on Federal Reserve Notes . Loans and Securities: Discounts and Advances Secured by U.S. Government and Agency O b l i g a t i o n s ............................ ...... 6 ,6 0 0 Other Discounts and Advances . 30 0 — Federal Agency O bligations Bought O u t r i g h t ........................ 3 3 9 ,6 5 4 2 7 6 ,9 8 7 Cash Items in Process of Collection . 565,391 321,441 . Bank Premises ( n e t ) ........................ 12,833 12,668 Other A s s e t s ................................. 75,2 9 2 6 3 ,4 5 6 Interdistrict Settlement Account . . . — TOTAL A S S E T S ........................$5,824 ,1 71 2 70 ,47 8 $ 5 ,2 9 1 ,0 5 5 LIABILITIES Deposits: M em ber B a n k — Reserve Accounts U.S. Treasurer — General Account . $ 8 1 7 ,4 4 7 $ 474,331 F o r e i g n ............................................ 9,098 Other D e p o s i t s ............................ 7,778 2 2 ,2 6 0 TOTAL D E P O S I T S ................... $ 1 ,3 2 3 ,1 3 6 Federal Reserve Notes (N ET) . $ 3 ,9 1 2 ,1 2 6 Deferred A vailability Cash Items 58,1 5 3 $ 1 ,4 0 4 ,8 4 2 $ 3 ,5 3 5 ,9 9 2 3 6 2 ,6 3 2 Interdistrict Settlement Account . 7 6 5 ,3 7 4 5 7 3 ,5 3 7 2 49 ,10 8 . 11 4 ,54 5 — Other L i a b i l i t i e s ............................. 4 7 ,4 5 8 3 6 ,0 0 9 TOTAL L IA B IL IT IE S ........................$ 5 ,7 5 9 ,8 9 7 $5,225 ,9 51 CAPITAL A C C O U N T S Capital Paid I n .............................$ . ........................ 3 2 ,1 3 7 TOTAL CAPITAL A C C O U N T S . . $ TOTAL LIABILITIES A N D CAPITAL A C C O U N T S . . $5,824 ,1 71 . $ 3 2 ,1 3 7 64,2 7 4 32,552 32,552 $ 13 .3 % _ -4 1 5 T O T A L ........................ $ 2 4 3 ,8 7 7 1 1.4 1,314 - 1 3 1 . 6 $220,81 1 1 0 .4 % Reserve Banks contribute to System awareness of local and regional business conditions through the collection of business, monetary, and financial data. Information gathered is used by the President of this Bank in policy discussions during meetings of the Federal Open Market Committee. Economic data and analysis of regional, national, and international conditions are made available to the public by the Research Department through its vari ous releases. Comprehensive analysis of economic problems and conditions provide the basis of articles appearing in this Review . The Review , which is published monthly, has a circulation of about 43,000 copies and is distributed both nationally and internationally. As mentioned above, the Research Department also assists in the bank regulatory function by reviewing the impact of bank mergers and holding company acquisitions on the communities to be served. 6 5 ,1 0 4 $ 5 ,2 9 1 ,0 5 5 Federal Reserve Banks play an important role in formulating System policy.1 Also, the 12 Federal xThe Federal Open Market Committee (FOMC) consists of the seven members of the Federal Reserve’s Board of Governors and the President of the Federal Beserve Bank of New York as permanent members, with four of the remaining eleven Beserve Bank Presidents serving on a rotating basis. The FOMC directs the purchase and sale of Treasury and Govern ment agency securities on the open market. Page 22 1 0 .9 % -4.1 Distribution of Net Earnings: Transferred to Surplus — Percent C hange 1977 ASSETS Surplus 1978 Bank Relations and Public Information The Bank Relations and Public Information Depart ment endeavors to establish and maintain personal contact with all banks located in the Eighth Federal Reserve District through a structured visitation pro gram and attendance at various banking functions. An effort is also made to increase public understand ing of the functions, responsibilities, and policies of the Federal Reserve System by distributing films and publications, providing in-house tours, delivering FEDERAL RESERVE BANK OF ST. LOUIS speeches, and conducting seminars. Emphasis is placed on maintaining contact with schools and colleges in this District. The Functional Cost Analysis Program offered to member banks is administered by this department. This program provides participating member banks with bank operating costs by function and permits comparison with banks of similar size. Technical as sistance is furnished during the first year to banks de siring to participate in the program. Last year, 50 Eighth District member banks participated in the program. In maintaining contact with the banking industry and the general public during 1977, the officers and staff members of the Federal Reserve Bank of St. Louis and its branches delivered 208 addresses before bankers, business groups, and educators. The Bank APRIL 1978 was represented at 223 banker, 491 professional, and 200 miscellaneous meetings. Under the bank visitation program, 837 banks in the District were visited. Dur ing 1977, 355 groups requested films and 5,291 visitors toured the four Federal Reserve offices in the Eighth District. Financial Statements The Bank’s net expenses for 1977 were 4 percent lower than net expenses for 1976. While expenses de clined, the Bank’s payments to the Treasury increased by more than 11 percent, from $218 million in 1976 to $242 million in 1977. The $242 million paid to the Treasury was 85.1 percent of total earnings. In 1976, by comparison, 84.7 percent of total earnings was paid to the Treasury. Page 23
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