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M ay 1 9 6 6

ANK OF ST. LOUIS

FEDERAL RE

eview
Monetary Expansion Continues

CONTENTS
Page

o

M onetary Expansion C on­
tinues ............................
Floors and Ceilings:
G uidelines and U nd er­
standings in Com m er­
cial B anking— Remarks
by G eo rg e W . M itchell
Bank B orrow ing in the
E ighth Federal Reserve
District, 1963-1965 . . . .
M em ber Bank Revenues
and E x p e n s e s ...............

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1

5

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Volume 48

•

Number 5

FEDERAL RESERVE BANK
OF ST. LOUIS
P.O.Box 442, St. Louis, Mo. 63166




KED ER A L

R E SE R V E C R E D IT , member bank reserves, and
the money supply have increased at extremely rapid rates since
last summer. Money supply growth from last June to April was
the most rapid for a ten-month period since World War II.
Notwithstanding the growth of money and reserves, some
observers have concluded that monetary developments have be­
come restrictive. This conclusion has been inferred from move­
ments in several popularly observed monetary variables, partic­
ularly interest rates and borrowings from Federal Reserve Banks.
However, when the nature of these variables is examined and
their recent movements put in perspective, the impression of re­
striction may prove to be an illusion.
The increase in money and credit since last summer has nur­
tured an increase in total dollar demand for goods and services
by augmenting purchasing power in the hands of borrowers. If
borrowers are financed in part by the creation of credit not
related to planned saving, they can add more to the income
stream than savers undertake to withdraw, and total demand
expands.
Ideally, total demand should just match the economy’s poten­
tial to produce, so that both high employment and relative price
stability can be achieved. The increase in money and credit
since last summer, combined with a stimulative fiscal situation,
has fostered a very large expansion of demand. Output and
prices have both risen substantially, and pressures in resource
markets have increased.

M o n eta ry D e v e lo p m e n ts

Money Supply. A strong upward trend in the
m6ney supply (checking accounts plus currency)
which commenced last June has continued in recent
months. To April the money supply expanded at a
12 per cent annual rate from February, an 8.0 per
cent rate from November, and a 6.9 per cent rate
from June. These figyres compare with a 2.6 per
cent rate of growth in money from 1960 to 1964 and
a 1.4 per cent rate from 1953 to 1960.
M o n e y S u p p ly
Billions of Dollars

Dollar Amounts

Billions of Dollars

Annual Rates of Change

Reserves. The rise in the money supply has been
facilitated by a large increase in reserves available
to support private demand deposits, a variable influ­
enced by Federal Reserve actions. To April these
reserves rose at a 19 per cent annual rate from Feb­
ruary, a 10.2 per cent rate from November, and a 6.3
per cent rate from June, compared with a 1.4 per cent
rate from 1960 to 1964.
The growth of reserves available for private de­
mand deposits, the primary determinant of the
money supply, is determined by the growth of total
reserves less change in reserves required against time
deposits, Government demand deposits, and inter­
bank deposits. Total reserves have increased at an 11
per cent annual rate since last fall and at a 5.2 per
cent rate since June 1965 compared with a 3.5 per
cent rate of growth from 1960 to 1964. A large in­
crease in Federal Reserve credit (which includes Fed­
eral Reserve holdings of Government securities, check
collection float, and borrowings of member banks) has
been responsible for the rise in total reserves since
summer. The rise in Federal Reserve credit has more
than offset a decline in the gold stock and increases
in currency in circulation, both of which absorb re­
serves.
A smaller portion of the increase in total reserves
has been required against time deposits and Govern­
ment deposits since the end of last November, and a
larger portion has been available for private demand
deposits. While time deposit growth was substantial
from late November to early March, it was not so
rapid as in recent years. U. S. Government demand
deposits were at low levels in the first four months
of 1966.

P e r c e n t a g e s a r e a n n u a l ra t e s o f c h a n g e b e tw e e n m o n t h s in d ic a t e d .
L a te st d a t a p lo tted : A p r i l p r e l i m i n a r y

Rapid increases in the money supply usually have
been followed by marked increases in spending. As
banks expand their loans and investments, demand
deposits, the major component of the money supply,
rise. Borrowers and sellers of securities spend the
proceeds of their loans or sales, and the income and
money holdings of owners of factors of production
rise. When the money supply increases rapidly,
people find themselves holding greater cash bal­
ances than they desire at prevailing interest rates.
When people have more money than they wish to
hold, they spend money on other financial assets and
goods and services. This places downward pressure
on interest rates and causes a rise in money income,
thus helping to equate desired holdings with actual
money holdings.
Page 2



Bank Credit. Bank credit (bank holdings of loans
and securities) rose at an estimated 9.7 per cent rate
from November to April and at an estimated 8.8 per
cent rate from last June to April. This compares with
a 7.9 per cent growth rate from 1960 to 1964.
In response to strong loan demands in recent
months, banks expanded their holdings of loans rap­
idly while they reduced holdings of Government
securities. For all commercial banks the ratio of
loans to deposits was an estimated 65.6 per cent in
April compared with 64.5 per cent in November, 62.2
per cent last April, and 55.9 per cent in 1960. Many
banks currently find meeting all demands for loans
difficult or impossible. This situation stems from the
intense demand for funds and not from exceptional
restriction of the supply of funds. Meeting all de­
mands for loan funds would facilitate continuation of
excessive demand which makes for inflation.

Illusion of Restraint. Despite the rapid monetary
expansion since summer, some analysts and financial
writers have concluded that monetary action has been
“firmer,” “tighter,” or “more restrictive.” The belief
that there has been a tightening of policy may stem
from recent movements in several well publicized
financial variables, especially net borrowed reserves
(borrowings less excess reserves) and interest rates.
Also, borrowers are finding credit somewhat less
readily available.
The notion that net borrowed reserves have in­
creased and that this amounts to a restriction or
rein on credit is a double illusion. First, net bor­
rowed reserves have been widely criticized as a meas­
ure of monetary policy.1 Briefly the criticism is: if
the Federal Reserve were to conduct its policy by
fixing a target level of net borrowed reserves, it
would lose control over other variables such as money
and bank credit. Whenever member banks attempt­
ed to increase borrowings or reduce excess reserves,
causing net borrowed reserves to be above the target,
the Federal Reserve would inject reserves into the
system, reducing borrowing or increasing excess re­
serves to the level needed to achieve the target net
borrowed reserves. The member banks, in turn, might
desire to expand credit further. Thus, it is possible
for money and credit to increase at any rate with a
given level of net borrowed reserves. In the short
run, the level of free or net borrowed reserves may
reflect swings in credit demand and other market
forces, not monetary policy. The second illusion is
that net borrowed reserves increased in the period
from June 1965 to March 1966. Net borrowed reserves
averaged $129 million in the period from December to
April compared with $144 million in the period from
June to November.
The rise in market interest rates since last July
and the increase in the discount rate and ceiling rates
on time deposits in December have been mentioned
as indications of a tightening of monetary policy. An
interest rate rise may be caused by an increase in
the demand for funds or by a decrease in the supply
of funds. Higher interest rates resulting from grow­
ing demands for funds ration available credit and
1See Harry Brandt, ‘‘Controlling Reserves—The H eart of F ed ­
eral Reserve Policy,” Monthly Review, Federal Reserve Bank
of Atlanta, Septem ber 1963; “The Significance and Lim ita­
tions of F ree Reserves,” M onthly Review, Fed eral Reserve
Bank of New York, November 1958; Jack M. Guttentag, “The
Strategy of Open M arket Operations,” The Quarterly Journal
o f E conom ics, February 1966; Alexander Jam es Meigs, F ree
R eserves and T he M oney Supply (C hicago: University of
Chicago Press, 1 9 6 2 ); “Monetary Policy and Free Reserves,”
Monthly E con om ic L etter, First National City Bank, New
York, July 1965.




encourage saving. Such an interest rate rise is not a
sign that monetary expansion is any less rapid. On
the other hand, a rise in interest rates might indicate
a reduction in the flow of loan funds which has re­
sulted from restrictive actions by the monetary au­
thorities.
The interest rate rise since last July has been caused
by a swelling demand for funds rather than by mon­
etary restriction. The intensity of the demand for
loan funds is witnessed by a very rapid expansion of
bank loans, very large offerings of corporate and
municipal securities, and a substantial increase in
Government debt outstanding as well as by the
increase in interest rates.
The upward adjustments in the discount rate and
ceiling rates on time deposits in early December were
in the direction of keeping up with the tide of rising
market rates. These adjustments were not of a re­
strictive nature.

O th e r P olicy D e v e lo p m e n ts
The economic impact of the Government’s taxing
and spending actions has been, and is expected to
continue to be, stimulative. The high-employment
budget2 was nearly in balance in late 1965, the most
stimulative level in many years. During the four years
of economic expansion from mid-1961 to mid-1965 the
high-employment budget showed a surplus averaging
$8.3 billion a year. Preliminary data indicate that Gov­
ernment actions have continued to be expansionary in
early 1966.
Guidelines policy has undertaken to limit price in­
creases in the past year. Such a policy attempts to
affect wages and prices by persuasion and thus pre­
vent inflation in times of strong demand. Similar to
the guidelines policy are programs of persuasion re­
garding investment plans, export of capital, and oth­
er economic decisions.
The guidelines policy, which resembles the “in­
comes” policies of some other countries, may have
some effect in areas of monopoly power and admin­
istered prices. However, in a major portion of the
economic system it is not practical as a means of
limiting increases in price levels. The policy has not
been applicable, for example, in controlling rapid
rises in agricultural prices in the past 15 months. This
policy can possibly be helpful if accompanied by
adequate limitation of total demand by means of mon­
etary and fiscal policies.
2 For an explanation of the various budgets, see K eith M.
Carlson, “Budget Policy in a High-Employm ent Econom y,”
R eview, Fed eral Reserve Bank of St. Louis, April 1966.

Page 3

B u s in e s s D e v e lo p m e n ts

Preliminary data indicate a further strong rise in
total spending and output in the first quarter of 1966.
Spending has outpaced production, and prices have
increased.
The growth of gross national product (GNP), the
dollar value of the nation’s output of goods and serv­
ices and a measure of total demand, has picked up
since mid-1965. At a $714 billion annual rate in the
first quarter, GNP is up at a rapid 9.8 per cent annual
rate since the third quarter of 1965 and is 8.6 per
cent above a year ago. GNP rose at a 5.7 per cent
rate from 1960 to 1964 and at a 4.9 per cent rate from
1951 to 1960.

and remaining about unchanged from 1958 to mid1964. Prices of farm products and processed foods
climbed at a 10.1 per cent rate from October to
April while industrial prices increased at a 2.9 per
cent rate. The consumer price index rose at a 3.5
per cent rate from October to March, after rising at
a 1.2 per cent rate from 1960 to mid-1964. In the
consumer category, food prices have risen at a 9.4
per cent rate since October while the prices of non­
food commodities have risen at a 0.7 per cent rate and
the prices of services have risen at a 2.9 per cent rate.

Real output of goods and services rose at a 6.2 per
cent annual rate from the fourth quarter of 1965 to
the first quarter of 1966 compared with a 7.7 per cent
rate of expansion from the third to the fourth quarter
of last year. Output grew at a 4.3 per cent annual rate
from 1960 to 1964 and a 2.7 per cent rate from 1951
to 1960.
1959

Expansion of output since mid-1965 has been made
possible by a further reduction of unemployed work­
ers and idle industrial capacity, by growth of labor
force and capacity, and by increased productivity.
The number of persons estimated to be unemployed
has declined from 3.5 million last summer to 2.9
million in April. Unemployment decreased from 4.6
per cent of the labor force last summer to 3.7 per
cent in April. Over the same period the unemploy­
ment rate for experienced wage and salary workers
declined from 4.3 per cent to 3.4 per cent, and the
rate for married men fell from 2.4 per cent to 1.8 per
cent. From last summer to March the average work­
week in manufacturing industries rose from 41.0 to
41.6 hours and in contract construction, from 37.3 to
38.5 hours.
In view of the current low unemployment rate and
the high level of capacity utilization, the 6.9 per cent
annual rate of growth of output prevailing since last
summer may not now be sustainable. If so, total de­
mand should appropriately grow less rapidly.
Some of the surge in demand since last summer
has spilled over into an acceleration of price increases.
The implicit GNP deflator, the broadest of the price
indexes, rose at a 3.6 per cent annual rate from the
fourth quarter of 1965 to the first quarter of 1966.
The deflator rose at a 1.3 per cent rate from 1960 to
1964. The wholesale price index rose at a 4.7 per
cent rate from October to April after increasing at a
2.3 per cent rate from June 1964 to October 1965
Page 4



1960

1961

1962

1963

1964

1965

1966

P e r c e n t a g e s a r e a n n u a l ra t e s of c h a n g e b e t w e e n m o n t h s in d ic a t e d .
L a te st d a t a p lo tted : C o n s u m e r - M a r c h p r e lim in a r y ; W h o l e s a l e - A p r i l p r e l im in a r y
S o u r c e : U .S. D e p a r t m e n t o f L a b o r

I n te r n a tio n a l D e v e lo p m e n ts
The balance-of-payments deficit, on a liquidity ba­
sis,3 is likely to be at as high a rate in the first quarter
of 1966 as during 1965. The trade surplus in the first
quarter of 1966 was somewhat less than the 1965 aver­
age and considerably below the 1961-64 average. This
contraction of our trade surplus results from the addi­
tional foreign exchange costs associated with the Viet­
nam commitment (estimated to be $700 million to
$900 million in 1966) and from the strength of total
demand in the United States. Because of continued
strength in the services balance (largely due to steady
growth in investment income) the current account bal­
ance will probably show little change in the first
quarter.
The rapid growth in domestic demand has caused
an acceleration in imports of both consumer durables
and business investment goods. Imports in the first
quarter were at an annual rate of about $24 billion,
3There are two basic ways in which the U. S. Government
defines the balance of payments, the “liquidity” basis and the
“official settlements” basis. The differences concern the treat­
ment of certain capital account items. The liquidity measure
treats increases in foreign private short-term holdings of dol­
lars as a way of financing the deficit in the balance of pay­
ments. The official settlements basis treats these private hold­
ings of dollars as a demand on the part of foreigners for dollar
balances, and thus they represent a short-term capital inflow.

a substantial 21 per cent annual rate of increase over
the last half of 1965. The annual growth in imports
averaged 7.8 per cent from 1961 to 1965. Exports
increased at an annual rate of 6.5 per cent in the first
quarter over the last half of 1965, which is better
than the 3.9 per cent growth in 1965 and about the
same as the average growth rate from 1961 to 1964.
The simultaneous appearance of boom conditions in
the United States and less expansionary conditions in
the other industrial countries has shrunk our trade
surplus. If further shrinkage of the trade surplus is
to be avoided this year, domestic inflationary pres­
sures will need to be held in check.

government guaranteed bonds during the year, is re­
ported to be revising its plans downward because
of the tight capital markets both here and in Europe.
When these natural market forces plus the voluntary
foreign credit restraint program, introduced in Feb­
ruary 1965, are taken into consideration, it seems
likely that outflows of U. S. private capital were at no
higher a rate in the first quarter of 1966 than in 1965.

C o n c lu s io n
Rapid monetary expansion since last summer has
augmented the volume of spendable funds, and the
aggregate demand for goods and services has expand­
ed at a very rapid rate.

Only scattered data on the capital account of the
balance of payments in the first quarter is available
at the time of publication. On the favorable side,
there was a net decline in outstanding U. S. bank
credit to foreigners at an annual rate of more than
$1 billion. On the adverse side, there was a sharp
increase in American purchases of foreign securities,
dominated by a bunching of new Canadian issues
which had been postponed from the fourth quarter
of 1965.

The surge in demand has been met by a large ex­
pansion of output and imports and by price increases.
The expansion of output since summer has been
accompanied by a substantial decline in unused re­
sources, and consequently the rate of increase in real
output henceforth may not be so rapid as in the past.
The Government deficit, investment, and consumer
borrowing may now appropriately be financed to a
greater extent by saving (i.e. foregoing consumption)
and to a lesser extent by bank credit creation (which
does not require any cutbacks in spending). Total
demand would then probably rise less rapidly than
since last summer. Not only would this be appropriate
for the domestic situation but the restraint on infla­
tion and the higher interest rates which would fol­
low would be helpful in reducing the country’s ad­
verse balance of payments with the rest of the world.

There is some evidence that the recent tightening
in the money and credit markets in the United States
has had a favorable effect on the capital account. As
total loan funds in the United States become scarcer
relative to demand, foreign customers are finding
their credit lines reduced and the terms for floating
new issues in the American capital market less attrac­
tive. For example, the Government of Japan, which
anticipated floating $130 million in government and

F lo o r s a n d C e ilin g s :

Guidelines and Understandings in Commercial Banking1
by

G eo r g e

W.

M

it c h e l l ,

Member, Board of Governors of the Federal Reserve System
OMMERCIAL BANKS are perhaps the oldest
surviving business institutions whose product and
method of manufacture has been relatively unchanged
over the years. They have continuously been a highly
important and integral part of our economic system,
attracting and allocating or reallocating credit re­
sources among a broad spectrum of needs. But com­
1 Remarks made at the Annual Executive Forum of the Amer­
ican Institute of Banking (S t. Louis C h apter), St. Louis,
Missouri, April 13, 1966.




mercial banking has not remained static. In parti­
cular, during our generation banks have had to
change in order to cope with an environment in
which two discordant—
and interrelated—
trends have
been at work.
First, they have found themselves facing more in­
tense competition from new financial institutions—
as
well as from the money and capital markets and nonfinancial businesses. Second, mainly as a heritage from
Page 5

historical experience—
especially, but not solely in the
1930’s—
banks have been subject to detailed regula­
tion by the States and the Federal Government. And,
as competition has come increasingly to substitute
for regulation in promoting and protecting the public
interest in many sectors of our economy, the confin­
ing effect of regulation appears intensified.

previous economic environments still haunt the mod­
ern banker long after the body of the original pro­
blem— it ever truly existed—
if
has turned to dust. And,
what is perhaps even worse, too often it is assumed
that the rule, policy, or regulation is successful in al­
leviating the problem to which it was directed, when
study suggests this is just not so.

It is the inhibitions on competitive behavior of
banks, self-imposed and superimposed, that I should
like to discuss with you today: the rules, the guide­
lines, and the informal understandings that condition
the way banks behave in the market place. These
factors not only influence portfolios and profits of
banks, but also how much and how well banks con­
tribute to the effectiveness and efficiency of our eco­
nomic system.

Present day usury laws are a case in point. These
statutes were established in the late 19th and early
20th centuries to prevent the exploitation of small and
weak borrowers. The direction of these legislative
actions was liberalizing in a degree. The older usury
laws simply had made it impossible for most legiti­
mate lenders to supply funds to certain borrowers,
and many credit demands were diverted to illegal
lenders. But rather than repudiating the usury mores
of the Middle Ages, the thrust of legislative action
was to exempt certain kinds of loans on a regulated
basis. Moreover, there was no recognition of the role
of competition in protecting consumers; instead, reg­
ulation proliferated with separate laws for each type
of lender or borrower.

Banking history for the past decade or so demon­
strates that commercial banks can and have used
competitive methods to grow and to prosper. The
earlier disdain many of them had for small depositors,
consumer instalment credit, and residential mortgages
has disappeared but not before it provided the op­
portunity for specialized financial intermediaries and
other credit>granting institutions to become well
established. Today banks have become large in the
consumer credit field, where they show signs of
spectacular innovation. On occasion they enter the
mortgage market quite vigorously.
The new spirit of competition has not been limited
to the asset side of the balance sheet. Early in this
decade, for example, banks saw the demand for their
deposits declining because consumers and businesses
found other financial assets more attractive. Eventual
awareness of this attrition has caused banks latterly
aggressively seek deposits of all types and sizes by
offering a variety of attractive claims. They—
and the
public— better off, as the new spirit of competition
are
and innovation spreads.
This new competitiveness is, when carried out with
sense, all to the good. But there are still many areas
where custom, practice, and regulation dull the edge
of bank competition, making the life of bankers and
bureaucrats more comfortable, to be sure, but re­
ducing the contribution of banks to the well-being
of society. These factors, it seems, feed on themselves.
The bankers and Government officials who keep say­
ing that banks are different and hence need certain
regulations and policies may really mean that these
regulations and policies have made the banks dif­
ferent. Moreover, the ghosts of past problems and
Page 6



Has the effect of these laws been to protect the
consumer and other borrowers who are the supposed
beneficiaries of usury regulations? The evidence sug­
gests the contrary. Take the case of consumer credit,
an area where the original laws were supposed to
work their protection, and where most of the “con­
trolled” exemption from usury laws has taken place.
The first thing we observe is that in most consumer
instalment credit markets actual rates are below the
ceilings—
which for commercial banks in the various
States range between 12 and 16 per cent simple in­
terest. This seems to suggest that most consumer
credit markets are operating under competitive mar­
ket forces. Only at small loan companies, which face
greater risks and higher costs, do actual rates tend to
be at their ceilings of 24 to 48 per cent.
Despite surface appearances, however, the usury
laws do interfere with competition. And they do so
because widely different ceiling rates for essentially
the same transaction exist between lender groups,
such as banks and sales finance companies. Part of
this difference, of course, reflects the different types
of credit risks that the various lenders face, but the
point is that multiple rate ceilings essentially allow
each lender group to stake out part of the market
for itself free of any competition from a group with
rate ceilings below its own. Thus, the superficial
appearance of competition is just that: appearance.
The public—
and banks, whose rate ceilings are among
the lowest—
would be much better off if there were
either no ceiling or a uniform ceiling for all loans,

both of which would permit lenders to attempt to
penetrate other markets.
Second, what has been called the “6 per cent myth”—
that is, the indoctrination that 6 per cent is a “right” or
“fair” rate—
has been reinforced by rate ceilings. As
a result, legitimate lenders quote rates on a basis that
disguises the true, simple interest rate and the con­
sumer finds it impossible to compare costs among
alternative borrowing sources. I realize fully that
calculating simple interest is not simple, but lenders,
including banks, are clearly muddying the water
when they quote automobile instalment loan rates at
5 per cent when they know full well that they are
charging 10 per cent on the unpaid balance. Perhaps
repeal of usury laws would further efforts to devise
uniform methods of rate quotation—
which would con­
tribute importantly to effective and fair competition.
While consumers are immediately brought to mind
when rate ceilings are discussed, the various State
laws regarding interest rate ceilings also extend to
business borrowing. It has recently been estimated,
you may be surprised to hear, that over 40 per cent
of all business credit, and almost 60 per cent of farm
credit, are subject to some interest rate ceiling. And
here, too, usury laws are hostile to their announced
purpose, for while many States exempt corporate
businesses, most States that have usury laws do not
exempt unincorporated enterprises and this fact may
deny bank credit to the very enterprises that the usury
laws seek to protect.
Consider a bank, which, given today’s credit con­
ditions and demand, charges 5% per cent on loans to
its highest quality customers, but cannot charge in
excess of 6 per cent on a high-cost, high-risk loan to
the corner retailer. Doesn’t it stand to reason that the
bank must recoup a high enough margin over the
rate charged its highest quality customers to compen­
sate for the greater risk and costs of the poorer credit?
If usury laws prevent this, the poorer risk loans will
not be made even though the would-be borrower is
prepared to pay a higher rate rather than forego the
funds. Of course, banks can find ways to overcome
ceilings—
such as requiring relatively larger compen­
sating balances and imposing relatively greater ser­
vice charges on deposit accounts—
but the point is
clearly that such ceilings interfere with the market
process by putting a real constraint on the freedom
of banks to make loan and portfolio decisions in both
the public and private interest.

Ceilings on asset returns are paralleled by ceiling
rates that banks may pay for deposits. As you all




know, banks are prohibited from paying interest on
demand balances—
because of legislation enacted in
the 1930’s on the basis of claims that such payments
had led to destructive competition in the twenties—
and the Federal Reserve, the FDIC, and some States
set maximum rates that banks may pay on time and
savings balances.
The public policy issues raised by ceiling rates on
deposit balances involve difficult practical questions
affecting savings institutions, savers and investors, and
the allocation of credit among the competing demands
for it. Few economists approve ceilings on rates,
especially on time and savings deposits, because they
interfere with the market adjustment mechanism.
Yet the market mechanism, which inevitably invol­
ves financial institutions whose assets have a longer
maturity than their liabilities, can be quite destabiliz­
ing.
If maturities of depositors’ claims matched loan re­
payment schedules, changes in financial market con­
ditions would have roughly comparable effects on
rates for both deposits and loans. Under these condi­
tions the close alignment of ceilings with market
rates would not be disruptive to the liquidity position
of the financial intermediary. But when commitments
on the deposit side are short—
even on demand—
loan
runoff from term loans or mortgages cannot cope
with withdrawals stimulated by higher returns offered
by competitors that are not similarly exposed in their
deposit-loan relationships. Thus, an important advan­
tage of relatively stable rate ceilings is that they per­
mit intermediaries to offer savers liquidity and a
reasonable return from the higher yields of longer
term loans.
But near-instant liquidity of time deposits is a
privilege that cannot be widely shared with those
whose withdrawals are stimulated by rate incentives
when such incentives are pervasive among time de­
positors. A predictable, even though large, turnover
in savings accounts is one thing— mass withdrawal
a
to take advantage of rising yields is quite another. To
meet this problem, many banks are attempting to
stratify their time accounts, according the rate conscious-investment type money a more competitive
yield but on a fixed maturity and with interest penal­
ties for earlier withdrawal. And other types of savings
institutions are beginning to do the same. But the
plans of some institutions only amount to changing
the name of the game, and others are either unwill­
ing or legally constrained from doing anything.
There is also a statutory responsibility involved in
the fixing of rate ceilings. The Federal Reserve Board
and the FDIC have no choice under the spirit of the
Page 7

present law but to establish rate maxima. But, doing
so under the law does not change the fact that such
ceilings are a competitive inhibition, even though
such inhibitions may be justified by the real possi­
bility of serious damage to other financial intermedi­
aries. True, the ceilings may make life easier for
policymakers, banks, and other financial institutions,
but they may also protect the best of all possible
worlds for the small- and medium-sized saver.
Even with ceilings, market pressures are always at
work to narrow or circumvent rate differentials.
Shorter maturities op certificates of deposit and more
frequent compounding, just to mention two examples,
are used in lieu of higher nominal offering rates.
Even the prohibition of interest payments on demand
deposits is partially breached—
quite legally. Com­
peting for balances through additional services, or
reduced service charges, or varying compensating
balances is a kind of substitute for explicit interest
payments.
Not all prohibitions are expressed in terms of rate.
For example, while member banks may absorb the
cost of numerous services to demand depositors, they
do not have the option of absorbing exchange charges
as the result of nonpar remission of checks. This
prohibition denies member banks the use of yet
another competitive tool. Would the loosening of con­
straints here intensify the pressure on nonpar banks
to remit the face value of checks? Would competition
be able to achieve par clearance, something regulation
cannot accomplish, or at least has not accomplished
over the years?
Ceiling rates on loans and deposits are established
by law. But floors on rates are set by the policy of
bankers. The prime rate, for example, establishes the
rate at which loans are made to the “best” customers
of banks—
that is, the large, well established firms,
which have the least risk of default. On the surface,
this policy—
adopted by most banks as an operating
convention—
seems a rational way to differentiate
loan rates on the basis of risk to the lender. However,
the history of this policy suggests that it may be in
the interests of neither the public nor banks.
The establishment of a nationwide prime rate came
in the 1930’s when a very liquid banking system faced
a greatly reduced loan demand. The combination of
banks seeking loans and of customers who were well
aware of the large number of available banking al­
ternatives kept downward pressure on loan rates. In
an effort to protect themselves from erosion of yields
by these competitive forces, banks began to follow
the lead of a few large banks who simply announced
a floor rate below which they would not lend. Rates
Page 8



were scaled up from this minimum for less prime cus­
tomers and stability in yields was thus assured. Bor­
rowers were supposed to be happy because they
knew that they were paying the lowest rate available.
Lenders were supposed to be content since they
knew they competitively could not charge more than
the going rate, and if they charged less they would
simply cause all other banks to join them and, hence,
they would “spoil the market.” The similarities be­
tween the logic of the prime rate and the pricing pro­
cedures suggested under the NRA are clear, but there
is no evidence that banks displayed the blue eagle
when discussing the prime rate.
This anachronistic, inflexible policy is still with us
today. To be sure, banks tend to vary the definition of
a prime customer as supply and demand conditions
change, but the basic inflexibility remains— the
to
detriment of the public and bank stockholders.
A properly functioning market mechanism should
not only foster flexible yields but also permit reason­
ably stable differentials between the cost of funds
and the price of uses. The prime rate convention does
little for either objective. Consider the period from
1961 to 1965. The prime rate was unchanged at 4V
2
per cent, despite two upward changes in the discount
rate, an almost 200 basis point increase in short-term
yields, a 60 basis point increase in long-term yields,
and a 225 basis point rise in the price paid for time
deposits. The fixed prime rate over these years clear­
ly suggests that bank loan rates were in a changing
relationship to market forces.
Since late 1965, two increases in the prime rate have
occurred as market yields have risen sharply and
bank liquidity has declined. But the inflexibility of
the prime rate convention still shines through. And
its rigidity is very much reinforced by the companion
convention that a borrower must pay all his creditor
banks the same interest rate. Banks themselves are
among the most insistent advocates of this latter
rule; but they have sacrificed some of their own free­
dom in the process.
Not all banks experience the same loan demands,
face the same portfolio problems, or have the same
deposit costs. Bank managements ought to have the
flexibility to vary their lending prices accordingly,
if they are to produce optimal results. The way banks
are pricing CDs, for instance, provides an instructive
example. Market competition does create a tendency
for the CD rates within a banking market to move
toward uniformity, but, within that market uniformity,
individual bank CD pricing is freely adjusted to the
circumstances at each bank. This kind of price flexi­

bility has a dynamism in it that can serve the best in­
terests of both the individual bank and its customer,
and the community at large. The kind of price fixing
inherent in the prime rate, on the other hand, contra­
venes some of the key virtues that we associate with
competitive market enterprise.
Furthermore, in the present era of monetary re­
straint the rigidity of the prime rate structure also
hinders the transmission of monetary restraint from
banks to many of the largest users of bank credit.
The best customers, those with the largest balances
over the longest period of time, have a powerful claim
on banks’ loanable resources. Past policies and un­
derstandings make it extremely difficult, if not im­
possible, for those customers to be turned away, or
even scaled down. The only really impersonal inhibi­
tion to their borrowing is price, and the prime rate
convention inhibits the reasonable use of that alter­
native. One could almost say it is downright discrim­
inatory to fight inflation with monetary restraint so
long as the prime rate is holding the credit door in­
vitingly open to the biggest borrowers in the business.
To summarize, my argument is that floors and
ceilings on interest rates set by law and understand­
ings inhibit the competitive stance of banks. So do a

whole host of other laws and agreements—
chartering,
branching, limits on mortgage loans, the voluntary
foreign credit restraint program, correspondent bank
arrangements, etc. Some of these are necessary ad hoc
or long-run compromises with the philosophy of a
free market society. But even the cursory review of
a few of the concessions that I have discussed today
should remind us that too often reconsideration
suggests that the costs of intervention in the market
system outweigh the benefits—
real or imagined. Some­
how, it is always necessary for someone to point out
that the Emperor is now wearing no clothes.
Banking has an old and honorable tradition, and in
recent years has demonstrated anew its ability to
change, innovate, and compete. Competition—
like
progress—
helps some and hurts some, has good and
worrisome implications. Banks in the last five or so
years have learned the benefits of competition and in
their own self-interest, as well as the public interest,
should be intensifying their efforts to widen the scope
within which they can compete. Not all the unfet­
tering called for, however, depends on getting Con­
gress or some regulatory authority to give up the key
to a shackle. Some of those keys are deep in banking’s
own vest or trouser pockets; these keys should be
used too.

B a n k B o r r o w in g
in th e E ig h th F e d e r a l R e s e r v e D is tr ic t,

1963-1965
I n t r o d u c t io n
EMBER BANK BORROWING from the Federal
Reserve Bank of St. Louis edged upward in 1965 and
early 1966 from the level of 1963 and 1964. Average
borrowing was $15.3 million in 1965, up from the $6.3
million level in the 1963-64 period (Chart 1). In the
three months ending in April 1960, just prior to the
1960-61 recession, borrowing averaged $28 million.
In the three months ending in April 1966, member
bank borrowing from the St. Louis Reserve Bank
averaged $26.2 million, down from the $31 million of
the preceding three months but more than three times
greater than a year earlier.
Member bank borrowing from the Federal Reserve
System as a whole has risen similarly since early 1963.




Chart 1
L o a n s to M e m b e r B a n k s
b y the Federal R e se rv e B a n k of St. Louis
M illio n s o f D o lla r s

M illio n s o f D o lla r s

Latest data plotted: April

Page 9

In the three months ending in March 1966, borrowing
from the Federal Reserve System averaged $477
million compared with $142 million in early 1963.
During the period of alleged tight policy over the
past year, borrowing has risen from $431 million in
the three months ending in April 1965 to $552 million
in the comparable period this year. Just prior to the
1960-61 recession member bank borrowing reached
$684 million.
Aggregate borrowing can rise as a result of one or
more factors: First, more banks may find it desirable
to borrow; second, banks may borrow with greater
frequency or for longer duration; third, banks may
borrow larger average amounts.
This note outlines briefly some of the factors which
affect the decision of an individual bank to borrow
from the Federal Reserve and presents some of the
facts relating to varying borrowing patterns among
banks in the Eighth Federal Reserve District.

F a c t o r s L e a d in g to B a n k B o rro w in g
Although commercial banks generally demonstrate
a reluctance to borrow, individual banks do, from
time to time and for a variety of reasons, choose to
borrow. Basically, they do so because it is less costly
to borrow than to turn away customers or make asset
adjustments which would make borrowing unneces­
sary.
A bank may borrow from its Reserve Bank, another
commercial bank, or other sources. The choice de­
pends upon several factors. For some banks there is
less reluctance to borrow from a correspondent or in
the Federal funds market than from its Reserve Bank.
In addition, some bankers may feel that the role of
the Reserve Bank should be confined to that of a
lender of “last resort.” On this premise, banks may
wish to preserve their good credit standing at the dis­
count window of the Federal Reserve.
The relevance from the standpoint of monetary
policy of whether banks borrow from other banks or
from their Reserve Bank depends upon one’s view of
the mechanism by which monetary policy affects the
behavior of the banking system. Borrowing from the
Federal Reserve increases the reserve base of the
banking system and thereby permits a multiple ex­
pansion in bank credit and money. Emphasis on this
line of causation relegates interbank borrowing to a
relatively passive role.
On the other hand, according to some analysts the
influence of the central bank on the banking system
is reflected in increased or decreased bank borrowing,
Page 10



leading to increased or decreased “pressure” on the
banking system to repay indebtedness rather than to
extend credit further. If individual banks feel pres­
sure to repay indebtedness to the central bank, there
is a presumption that they will feel some pressure to
repay indebtedness to other commercial banks. To
the extent that monetary influence is viewed in these
terms, it may be just as important to take account of
borrowing among banks as it is to consider commercial
bank borrowing from the Federal Reserve.
A member bank may borrow from its Reserve
Bank by over-the-counter delivery of an executed
note or by mail. A bank may also borrow by tele­
phone, provided collateral is in the possession of the
Federal Reserve Bank or is being held for the Reserve
Bank by a correspondent of the borrowing bank; such
borrowing involves an understanding that an ex­
ecuted note will follow. Borrowing is not to be un­
dertaken principally for taking advantage of interest
rate differentials or for obtaining a tax advantage.
In considering the length or frequency of the borrow­
ing of an individual bank, a prime factor is that Fed­
eral Reserve credit not become an ordinary part of the
bank’s resources.1

B o rro w in g S in c e 1963
The rise in bank borrowing from the Federal Re­
serve since 1963 appears to be related to the rise in
national and regional business activity and the ac­
companying expansion in the demand for commer­
cial bank credit. In addition, the forces leading to
borrowing are intensified by the fact that the holdings
of readily salable assets are relatively small.
1 Relevant portions of Regulation A are as follows:
“ ( c ) Access to the Federal Reserve discount facilities is
granted as a privilege of membership in the Federal Reserve
System in the light of the following general guiding principles.
“ (d ) Federal Reserve credit is generally extended on a short­
term basis to a member bank in order to enable it to adjust
its asset position when necessary because of developments
such as a sudden withdrawal of deposits or seasonal require­
ments for credit beyond those which can reasonably be met by
use of the bank’s own resources. Federal Reserve credit is also
available for longer periods when necessary in order to assist
member banks in meeting unusual situations, such as may
result from national, regional, or local difficulties or from ex­
ceptional circumstances involving only particular member
banks. Under ordinary conditions, the continuous use of Fed­
eral Reserve credit by a member bank over a considerable
period of time is not regarded as appropriate.
“ (e ) In considering a request for credit accommodation,
each Federal Reserve Bank gives due regard to the purpose
of the credit and to its probable effects upon the maintenance
of sound credit conditions, both as to the individual institution
and the economy generally. It keeps informed of and takes into
account the general character and amount of the loans and
investments of the member bank. It considers whether the
bank is borrowing principally for the purpose of obtaining a
tax advantage or profiting from rate differentials and whether
the bank is extending an undue amount of credit for the spec­
ulative carrying of or trading in securities, real estate, or com­
modities, or otherwise.”

The most striking fact about borrowing from the
Federal Reserve Bank of St. Louis is that very few
banks do it. Of the 483 banks in the Eighth District
which are members of the Federal Reserve System,
420, or 87 per cent of the total, did not borrow from
the Federal Reserve Bank of St. Louis at any time
during the 1963-65 period. Thus, in discussing mem­
ber bank borrowing from the Federal Reserve Bank
of St. Louis, attention is limited to the behavior of
63 banks, 13 per cent of the member banks located in
the Eighth Federal Reserve District.
On the other hand, the 63 banks which borrowed
from the Federal Reserve during the 1963-65 period
hold nearly 60 per cent of the assets of member banks
in the district. Thus, a major portion of the banking
business in the Eighth Federal Reserve District is
conducted by borrowing banks.
Aggregate borrowing from the Federal Reserve
Bank of St. Louis rose during the 1963-65 period.
However, the rise did not reflect an increased inci­
dence of borrowing among banks. During 1965, 33
banks borrowed, 11 fewer than in 1964 and 3 less than
in 1963. The combination of longer or more frequent
borrowing along with greater average borrowing re­
sulted in the substantial rise in aggregate borrowing
during the 1963-65 period.
The frequency or duration of indebtedness increased
successively in the years 1963, 1964, and 1965. Chart 2
shows the banks which borrowed in 1963, 1964, and
1965 arrayed according to their cumulative indebted­
ness. The banks on the extreme left of each figure
were in debt for one day only; the bank in debt for
the greatest number of days appears to the extreme
right of each figure. On the average, those banks
which borrowed were indebted for a total of 51 days
in 1965 compared with 25 days in 1964 and 23 days in
1963 (Table I).

Fewer banks borrowed for short periods, and more
banks borrowed for longer periods in 1965 than
earlier. Of those banks which borrowed in 1965, only
6 borrowed for less than 10 days (Table I and Chart
2).2
Table I

LENGTH OF INDEBTEDNESS
Borrowing Banks in the Eighth Federal Reserve District

Years

Average Number
Days of
Indebtedness

1965
1964
1963

N um ber o f Banks Borrowing for
Less than
10 Days

More than
2 Months

51

6

25

16

23

17

1
1
6
4

During 1965, 11 banks were in debt for more than
two months, cumulatively. In 1964 and 1963 only 6
and 4 banks, respectively, were in debt for more than
two months.
In analyzing borrowing from the perspective of a
bank’s reserve behavior, knowledge of the length of
indebtedness gives only a partial picture. It is also
necessary to take account of the amount of borrow­
ing. For purposes of meeting reserve requirements,
the effects of borrowing $10 million for three days or
$30 million for one day are identical.3
Banks which borrowed in 1965 incurred substantial­
ly larger indebtedness than in 1964 or 1963 (Chart 3).
On the days on which they were in debt to the Fed­
eral Reserve, borrowing banks secured 39 per cent of
their required reserves through the discount window.
2This does not mean that the banks were in debt for consecutive
days; the figures presented are cumulative.
3 Reserve requirements are calculated as an average over a
reserve settlement period. There is a 7-day period for reserve
city banks and a 14-day period for country banks.

Chart 2

D u r a t i o n of I n d e b t e d n e s s

1965
D YS IN D T
A
EB

200

1964

160
D YS IN D T
A
EB

1963

120 120
D YS IN D B
A
ET

80




80 80

40
A Y O 36 BA KS
RRA F
N
ACCORDING TO CU U TIVE IN EB N
M LA
D TED ESS

80
40

40 40
A R YO 4 B N S
RA F 4 AK
ACCORDING TO C M LA E IN EB N
U U TIV D TED ESS

A A OF 3 BAN
RR Y 3 KS
ACCORDING TO CU U TIVE IN EB N
M LA
D TED ESS
Page 11

Chart 3
A v e r a g e B o rro w in g s*

P RCENT O
E
F
D ILY AVERAGE
A
R U ED R VES
EQ IR ESER
1963

P CEN O
ER T F
D ILY AVERAGE
A
R U ED R VES
EQ IR ESER

P CEN O
ER T F
D AVERAGE
AILY
R U EDR VES
EQ IR ESER

P RCEN O
E
T F
D ILY AVERAGE
A
R U ED R V
EQ IR ESER ES

1964

P R CEN O
E
T F
D AVERAGE
AILY
R U EDR VES
EQ IR ESER

P CEN O
ER T F
D AVERAGE
AILY
R U EDR VES
EQ IR ESER

120

120

180

80

40

A Y O 36 BAN
RRA F
KS
ACCORDING TO SIZE O AVERAGE BO W GS
F
RRO IN

1965

A R YO 4 B N S
RA F 4 AK
ACCORDING TO SIZE O AVERAGE BO W GS
F
RRO IN

40

A R Y O 3 BAN
R A F 3 KS
ACCORDING TO SIZE O AVERAGE BO W GS
F
RRO IN

*Com
puted fo days borrow only.
r
ed

In 1964 and 1963 borrowing banks in the Eighth Fed­
eral Reserve District borrowed 31 and 32 per cent,
respectively, of their required reserves (Table II).
Fewer banks borrowed small amounts in 1965 than
in the two preceding years. Only 5 banks borrowed
as little as 20 per cent of their required reserves. In
the preceding year, 8 banks borrowed as little as 20
per cent, and, in 1963, there were 11 “small” borrowers
(Table II and Chart 3).
Table II

AM OUNT OF INDEBTEDNESS IN RELATION
TO REQUIRED RESERVES
Borrowing Banks in the Eighth Federal Reserve District
Number of Banks Borrowing

Years

Average
Indebtedness 1
(Per Cent)

20 Per Cent
or less

1965

39

5

4

31
32

8
1
1

3
4

Borrowing is a more common practice among large
banks than small ones. Of the 60 banks with assets
of less than $2 million, only 1 borrowed from the Fed­
eral Reserve during the 1963-65 period. The largest
number of borrowing banks was from the $5 million
to $10 million size group; however, the 18 banks
which borrowed constituted only 13 per cent of the
banks within that size group. In the $25 million to $50
million group, 36 per cent of the banks borrowed,
and, in the $50 million and over group, 77 per cent
of the banks borrowed (Chart 4).

More than
60 Per Cent

1964

in the district. The median size of Eighth District
member banks during the 1963-65 period was slightly
less than $6 million, with 134 banks falling within the
$5 million to $10 million range (Chart 4).

1963

iMean indebtedness when borrowing.

Although there was no increase in the number of
“large” borrowers4 in 1965, the average size of their
indebtedness was substantially greater than in 1963
or 1964. On the days on which they borrowed, the
four “large” borrowers borrowed 89 per cent of their
daily average required reserves. On borrowing days
in 1964, the three “large” borrowers borrowed 64 per
cent of their daily average required reserves; in 1963,
the four “large” borrowers borrowed 70 per cent.

B a n k S iz e a n d B o rro w in g
There were 483 banks in the Eighth Federal Re­
serve District which were members of the Federal
Reserve System as of December 31, 1965, approx­
imately one-third of the total number of banks located
4Defined

here as those borrowing more than 60 per cent of their
required reserves.

Page 12



Chart 4
B o r r o w i n g b y B a n k Size
N um ber o f Banks

N um ber o f Banks

140
140 I ------------------------------------------------------------ 1
B a n k s w h ic h b o r r o w e d

120

d u r i n g 1 9 6 3 - 6 5 p e r io d .

120

100

100

80

80

60

60

40

40

20

20

0

$50 i
a nd over
$ 5 m il lio n

0

$ 1 0 m illio n $ 2 5

AVERAG E

D E P O S IT S

C o n c lu d in g R e m a rk s
During the 1963-65 period, there was a substantial
rise in member bank borrowing from the Federal
Reserve Bank of St. Louis. However, there was not an
increase in the number of banks which borrowed.

Instead, those banks which found it expedient to
borrow in 1965 borrowed larger amounts and either
borrowed more frequently or remained in debt for
longer periods than in 1964 or 1963. This does not
necessarily mean that borrowing has not become more

M em ber

Bank

widespread. It may be that a portion of the rise in
borrowing from the Federal Reserve is being used to
support interbank borrowing.
W illia m

R evenues

A

FTER-TAX INCOME of all Federal Reserve
member banks in the nation totaled $2.1 billion in
1965, up 9.6 per cent from the previous year. Oper­
ating revenues increased 12 per cent, and operating
expenses climbed 15 per cent. Net income before
taxes was up only 2.4 per cent. Thus, most of the
gain in net income after taxes reflected a reduction in
tax rates.
After-tax income of Eighth District member banks
totaled $75.0 million, up 5.9 per cent from a year
earlier. Operating revenues rose 11 per cent, oper­
ating expenses rose 14 per cent, and net income before
taxes declined 0.5 per cent.

and

R.

B ry a n

E xp en ses

reduced from 22 per cent of assets in 1946 to 17 per
cent in 1965.
In addition to the growth of earning assets, banks
have enhanced operating revenues by adjusting their
portfolios from lower earning to higher earning
types of assets. Holdings of United States Govern­
ment securities dropped from 54 to 15 per cent of
assets during the 1946-65 period (Chart 1). Loans
nearly tripled in relative importance, rising from 18
per cent to 53 per cent of assets. “Other” securities
(mostly tax-exempt state and local government obli­
gations) rose from 5 to 12 per cent of assets.
Chart 1
Distribu tion of Total A s s e t s

R evenues
Since 1946 total operating revenues of member
banks in the nation have risen from $2.4 billion to
$13.9 billion or at an average annual rate of about
10 per cent (Table I). The growth reflected largely
an increase in total assets, a shift from nonearning
assets and relatively low yielding securities to higher
earning assets, and a marked rise in the average level
of interest rates.
From 1946 to 1965 total assets of member banks
grew from $132.3 billion to $298.3 billion, an average
annual rate of increase of 4.4 per cent. The history
of member bank asset growth since 1946 may be
divided into two periods: from 1946 to 1961, when
asset growth was relatively slow, 3.3 per cent per
year, and from 1961 to 1965, when assets grew rap­
idly, at an annual rate of 8.5 per cent.
Earning assets rose 3.4 per cent per year from 1946
to 1961 and 9.1 per cent per year from 1961 to 1965,
slightly higher rates of increase than for total assets.
The slight disparity in rates of growth in total assets
and earning assets reflects the fact that member banks
in the nation, due largely to reductions in reserve re­
quirements, placed an increasing proportion of their
available funds in earning assets. Cash balances were




Per Cent

A ll M e m b e r B anks in th e U n ite d S tate s

Per Cent

Growth in revenue from loans has accounted for
the major portion of total bank revenue growth since
1946. From $772 million in that year or 32 per cent
of the total, revenue from loans rose to $9.3 billion in
1965 or 67 per cent of the total. Revenue from loans
increased at an average annual rate of 14 per cent
from 1946 to 1965.
In contrast to the rising importance of revenue from
loans, revenue from investments has declined sub­
stantially relative to the total since 1946. At that
time, investment revenue was $1.2 billion, 50 per cent
of total revenues, while in 1965 investment revenue
was $2.8 billion, 20 per cent of the total. From 1946
Page 13

Table I

heavy loan demands from a rapid growth in total
funds. Since 1961 most of the growth in bank credit
has been met without reducing holdings of Govern­
ment securities.

REVENUES AN D EXPENSES OF MEMBER BANKS
IN THE UNITED STATES
(Dollar Amounts in Millions)
Per Cent Change

1965

1964-65

Annual
Rate
1946-65

$ 9,317

14.9

14.0

a. U.S. G o v e rn m e n t.......................

1,692

— 2.9

2.5

b. O t h e r ...........................................

1,081

18.7

11.0

Revenue on loans .............................
Interest on s e c u ritie s .........................

A ll other re v e n u e s .............................

1,783

9.9

7.8

$ 1 3 ,8 7 3

T o ta l o p e r a tin g re v e n u e s . . . .

12.0

9 .7

Salaries, wages, and b e n e fits .........

3,478

6.7

8.8

Interest on time de posits..................

4,220
2,524

24.7

17.1

12.1

8.3

O ther expenses ..................................

$ 1 0 ,2 2 2

14 .9

10.8

N e t c u r re n t e a rn in g s ..............

$ 3 ,6 5 1

4 .6

7 .4

Recoveries, transfers from
reserves, and p ro fits .......................

324

Losses, charge-offs, and
transfers to re s e rv e s ....................

983

N e t in c o m e ..................................

$ 2 ,9 9 2

2 .4

5 .7

Taxes on net in c o m e .........................

884

— 11.4

6.1

N e t in c o m e a f t e r t a x e s .........

$ 2 ,1 0 8

9 .6

5 .5

Cash dividends ..................................

1,061

10.4

7.5

T o ta l o p e r a tin g e x p e n s e s

.

to 1965 such revenue rose at an average annual rate
of 4.5 per cent.
The sources of investment revenue have changed
substantially since 1946. At that time, revenue from
U. S. Government securities totaled $1.1 billion, 88
per cent of total investment revenue, and revenue
from other securities amounted to $0.1 billion, only
12 per cent of the total. In contrast, U. S. Govern­
ment securities accounted for 61 per cent of total
investment revenue in 1965. State and municipal ob­
ligations accounted for most of the remaining 39
per cent.
Revenues from sources other than loans and invest­
ments have also grown during the postwar period but
contributed proportionately less to total revenues in
1965 than in earlier years. Service charges on deposit
accounts, trust department earnings, service charges
and fees on bank loans, and other revenue have risen
at an average annual rate of 7.8 per cent since 1946.
These items accounted for 18 per cent of total rev­
enues in 1946 compared with about 13 per cent in
1965.
During the earlier part of the 1946-65 period bank
loans and investments other than U. S. Government
securities grew rapidly; expansion was met largely
by the funds obtained from sales of Government secu­
rities. During the later portion, however, banks met
Page 14



The greater part of the expansion in assets was
made possible by great increases in time and savings
deposits. From 1961 to 1965 these deposits rose at an
average annual rate of 16 per cent. In contrast, they
had risen at a 6.1 per cent rate in the preceding 15
years.
The rise in time and savings deposits has been
accompanied and, in some respects, facilitated by
institutional changes. In early 1961 a secondary mar­
ket for large denomination certificates of deposit de­
veloped. These CD’s have become useful as short­
term investments for corporations, state and local gov­
ernments, and others seeking temporary employment
for large amounts of funds. Also, the development
of the CD market has provided the banking system
with a new means of attracting funds.
The expanded use of negotiable CD’s was only the
first of several new means of attracting funds to the
commercial banks. Since their emergence such addi­
tional debt instruments as short-term unsecured notes
and long-term subordinated debentures have also
been developed. These innovations have helped to
make the commercial banking industry an increas­
ingly dynamic element in the financial system.
Another factor tending to increase revenues of mem­
ber banks in the last two decades has been the up­
ward secular trend of interest rates. The average
return on bank loans increased from about 3.2 per
cent in 1946 to the 5.9 per cent level which prevailed
in the 1960-65 period (Chart 2). The average return
on Government securities rose from 1.5 per cent in
1946 to 3.7 per cent in 1965.
Chart 2
A v e r a g e R e tu rn on E a r n i n g A s s e t s
Per C e n t

M e m b e r B a n k s in th e U n ite d S ta te s

per C ent

In the Eighth District operating revenues of mem­
ber banks have generally followed the national pat­
tern. In 1965 revenues of these banks totaled $435.4
million, up 11 per cent from 1964, slightly below the
gain nationally (Table II). Since 1946 member bank
revenues in the district have risen at an average an­
nual rate of 8.6 per cent, also somewhat less than the
national rate of gain.
Eighth District member bank revenue growth can
be traced to the same sources as for member banks
throughout the nation. Earning assets have increased
rapidly, largely as a result of growth in time and
savings deposits. District banks have also shifted from
lower yielding investments to higher yielding loans.
Since 1946 earning assets of district member banks
have increased at a 4.1 per cent annual rate. As in
the nation, the rate of gain has been much greater in
recent years than in the earlier part of the period.
Such assets rose 2.9 per cent per year from 1946 to
1961 while the rate has been 8.9 per cent annually
since 1961. Time and savings deposits increased some­
what more rapidly than assets, rising at an average
annual rate of 5.3 per cent from 1946 to 1961 and
at a 15 per cent rate since 1961.
As in the nation, growth in loan revenue has ac­
counted for the major portion of total revenue growth
Table II

REVENUES AND EXPENSES OF EIGHTH DISTRICT
MEMBER BANKS
(Dollar Amounts in M illions)
Per Cent Change

1965
Revenue on loans

1964-65

Annual
Rate
1946-65

$284.6

13.6

12.1

69.6

.......................................

— 1.0

3.4

36.9

19.0

9.7

44.3

10.5

6.1

8.6

Interest on s e c u ritie s ......................
a. U.S. G o v e rn m e n t..................
b. O t h e r ...................................... ___
A ll other re v e n u e s ........................... ___

$ 4 3 5 .4

11.1

___

109.0

7.9

7.9

Interest on time deposits............... ___
O ther expenses ............................... ___

114.1

20.7

87.3

12.7

16.0
7.5

T o ta l o p e ra tin g e x p e n s e s . ___

$ 3 1 0 .3

1 3 .7

9 .6

N e t c u r re n t e a rn in g s ...........

$ 1 2 5 .1

5 .0

6.8

0 .5

5 .3

T o ta l o p e r a tin g re v e n u e s .

. .

Salaries, wages, and benefits

Recoveries, transfers from
reserves, and p ro fits ..................

18.1

Losses, charge-offs, and
transfers to re s e rv e s ................ ------

36.9

N e t in c o m e ............................... ___

$ 1 0 6 .3

N e t in c o m e a ft e r ta x e s
Cash dividends ...............................

___

— 13.1

6.0

$ 7 5 .0

5 .9

4 .8

32.3

7.3

7.1

Note: Detail may not add to totals due to rounding.




—

31.3

Taxes on net in c o m e ......................

of district banks since 1946. From $33 million in 1946
or 36 per cent of the total, loan revenue rose to $285
million in 1965 or 65 per cent of the total. Revenue
from loans at district member banks increased at an
average annual rate of 12 per cent from 1946 to 1965.
Revenue from investments at district member banks
totaled $106.5 million in 1965, up 4.9 per cent from
a year earlier. Investment revenue was 48 per cent
of total revenue in 1946, while in 1965 it was only
25 per cent of the total. From 1946 to 1965 such rev­
enue rose at an average annual rate of 4.9 per cent.
Of the $106.5 million of revenue from investments in
1965, U. S. Government securities accounted for $69.6
million or 65 per cent of the total. Revenue from
other securities accounted for the remaining 35 per
cent. In 1946 revenue from Government securities
totaled $36.6 million, 85 per cent of total investment
revenue, while other securities accounted for $6.3
million, only 15 per cent of the total.

E x p en ses
Total operating expenses of member banks in the
nation totaled $10.2 billion in 1965, up about 15 per
cent from the previous year (Table I). Of the major
expense items, interest paid on time and savings de­
posits increased most rapidly, rising about 25 per cent.
Salaries, wages, and benefits increased 6.7 per cent,
and all other expenses, 12 per cent.
Since 1946 operating expenses of member banks in
the nation have risen from $1.5 billion to $10.2 billion,
an average annual rate of 11 per cent. Reflecting the
rapid and prolonged rise in time and savings deposits
and the upward secular trend in interest rates, interest
expense was the major factor in the overall increase.
For the purpose of analyzing the growth in interest
cost the years since 1946 may be divided into two
periods: the years 1946-61, when interest cost rose at
a moderate rate, and 1961-65, when such cost increased
rapidly. During the earlier years banks were able to
meet most of their loan demands through shifts in
portfolio holdings and growth in reserves. They ac­
cepted time and savings deposits at relatively moder­
ate interest rates.
Since 1961, however, with the high demand for loans
and a minimum of other assets available for shifting
into loans, banks have bid aggressively for time and
savings deposits. Both the volume of such deposits and
the average rates paid have increased rapidly. Time
and savings deposits rose at a rate of 6.1 per cent per
vear from 1946 to 1961 compared with a rate of 16
per cent from 1961 to 1965. The average rate of inter­
est paid on time and savings deposits rose from 0.8 per
Page 15

cent in 1946 to 2.73 per cent in 1961 and to 3.74 per
cent in 1965. This combination of increases in volume
of deposits and rates paid has resulted in bank interest
expense rising from an average rate of increase of 15
per cent per year in the years 1946-61 to 25 per cent
per year in the past four years. Such expense now
constitutes 41 per cent of total bank operating ex­
pense, whereas interest cost was only 14 per cent of
bank expense in 1946.

Chart 3
N e t In c o m e after T a x e s a n d D i v i d e n d s
a s a Per C e n t of Total C a p it a l

Other major bank expense items have risen at fairly
constant rates during the past two decades. Salaries,
wages, and benefits increased at an 8.8 per cent rate,
and all other expenses at an 8.3 per cent rate.
Expenses of member banks in the Eighth Federal
Reserve District rose to $310 million in 1965 from $273
million in 1964, an increase of 14 per cent. Interest
on time and savings deposits rose 21 per cent, salaries
and wages, 8 per cent, and other expenses, 13 per cent.
Since 1946 total expenses at district banks have
increased at a slightly lower rate than those in the
nation. Overall expense in the district rose at an an­
nual rate of 9.6 per cent compared with 11 per cent
for the nation. Interest on time and savings deposits
rose at a rate of 16 per cent in the district compared
with 17 per cent for banks in the nation. Salaries and
wages at district banks rose at a rate of 7.9 per cent
compared with 8.8 per cent nationally, and all other
expenses of district member banks rose at a rate of 7.5
per cent compared with an 8.3 per cent rate of gain
nationally.

N et E a r n in g s a n d I n c o m e
Net current earnings of member banks in the nation
rose to $3.7 billion in 1965, an increase of 4.6 per cent
from 1964 (Table 1). The net result of adjustments
for recoveries, losses, and charge-offs was a reduction
in net income before taxes of $659 million in 1965
compared with a reduction of $570 million in 1964.
Member banks have shown a net gain from these trans­
actions in only three postwar years (1946, 1954, and
1958), when profits on security sales more than offset
loan and security losses and charge-offs.
Net income after taxes totaled $2.1 billion in 1965,
an increase of 9.6 per cent from 1964. Net profits rela­
tive to capital accounts in 1965 were 8.8 per cent,
unchanged from a year earlier. During the postwar
period net profits relative to capital accounts at mem­
ber banks have fluctuated between 7 and 10 per cent
( Chart 3).
Since 1946 net income after taxes of member banks
in the nation has risen about 5 to 6 per cent per year.
The average rate of gain for the two decades was
Page 16



5.5 per cent, 5.6 per cent for the years 1946 to 1961
and 5.3 per cent since 1961. Net income before taxes
rose at a rate of 5.7 per cent per year for the two
decades, and net current earnings (net income before
adjustments for recoveries, losses, and charge-offs) rose
7.4 per cent per year.
Member banks in the nation distributed dividends
of about $1.1 billion in 1965, an increase of 10 per cent
from 1964. Capital also increased about 10 per cent;
thus, the ratio of dividends to total capital (4.4 per
cent) was unchanged from the previous year.
Net current earnings of member banks in the Eighth
District totaled $125 million in 1965, about 5.0 per
cent above the previous year. Net losses and chargeoffs absorbed $19 million, 53 per cent more than during
1964. Nearly all of this sizable jump is attributable to
an increase in transfers to loan valuation reserves, re­
flecting changes in Internal Revenue Service rulings
on methods of calculating maximum permissible addi­
tions to bad debt reserves.
Net income before taxes of $106 million was 0.5 per
cent below a year earlier; however, income taxes
decreased, and net income after taxes rose 5.9 per cent
to $75 million.
The growth rate of earnings and income at district
member banks during the past two decades was slight­
ly below that for the nation. Net income after taxes
at district banks grew at a rate of 4.8 per cent per year
compared with 5.5 per cent for the nation. Before-tax
income and current earnings grew at rates of 5.3 and
6.8 per cent, respectively, in the district compared with
rates of 5.7 and 7.4 per cent in the nation.
After distributing cash dividends of $32.3 million in
1965, an increase of 7.3 per cent from the previous
year, district member banks added $42.7 million to
their undivided profits.