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For Release on Delivery Friday, November 10, 1972 11:00 a.m. E.S.T. INTEREST RATES AND CREDIT DEMANDS IN THE UNITED STATES Remarks By Andrew F. Brimmer Member Board of Governors of the Federal Reserve System Before the 79th Annual Convention of the Savings Banks Association of New York State Boca Raton Hotel and Club Boca Raton, Florida November 10, 1972 INTEREST RATES AND CREDIT DEMANDS IN THE UNITED STATES By Andrew F. Brimmer* I. Introduction In considering the range of subjects on which I might comment at this meeting, I concluded early that I would not attempt to lecture to you about your own business. After all, you know far more about your own affairs than I do. On the other hand, it would not be appropriate for m e — a Member of the Federal Reserve Board--to discuss the future course of monetary policy. Given these constraints, I decided to focus on an area in which our mutual concerns intersect: the area of interest rates and credit demands in the months ahead. In pursuing this topic, several boundaries must be identified clearly. In the first place, the views and attitudes expressed here are my own and should not be attributed to my colleagues on the Federal Reserve Board. Secondly, as already indicated, the ground to be covered—by necessity—cannot be extended to include a forecast of * Member, Board of Governors of the Federal Reserve System. I am grateful to a number of Board staff members for assistance in the preparation of this paper. Several of these were especially helpful in supplying information and should be mentioned specifically. Mr. Stephen P. Taylor made a special effort to obtain preliminary flow of funds statistics for the third quarter of 1972. The following persons provided information on recent and prospective demands for credit in particular markets: Messrs. Fred Taylor and Bernard N. Freedman (residential mortgages); Mr. Richard Petersen (consumer credit); -Eleanor Pruitt and Helen S. Tice (State and local governments and corporations), and Mr. Helmut F. Wendel (Federal Government). Mr. Edward C. Ettin provided data on income and operating expenses of commercial banks. Mrs. Mary F. Weaver helped to trace changes in commercial banks1 prime lending rate. Finally, Mr. John Austin and Mrs. Ruth Robinson (my assistants) helped with the statistical analysis underlying several parts of the paper. However, the views expressed here are my own and should not be attributed to the Board's staff nor to my colleagues on the Board. - 2interest rate levels. In addition, there is no intention here to get into the affairs of the Committee on Interest and Dividends. Although the Chairman of that unit of the Administration's Cost of Living Council is also Chairman of the Federal Reserve Board, the responsibilities of the two bodies remain separate and distinct. But within these constraints, there remains considerable scope to discuss a number of issues relating to interest rates and credit demands. Most of us are so preoccupied with our daily routines that we seldom have the opportunity to stand aside to identify and assess some of the fundamental trends that are reshaping the financial environment in which we work. I personally try to do that occasionally and most recently I have attempted to broaden my understanding of some of the long-run developments with respect to interest rates. I have the impression that many observers--when they reflect on interest rates at all—are likely to be more concerned about the level and trend of rates than about their structure and economic impact. Whether interest rates are "high11 or "low11 or whether they are "rising11 or "falling" are certainly questions of economic significance. Yet, they certainly do not exhaust the range of issues with respect to interest rates which ought to be explored from time to time. For example, we should also be concerned with the extent to which a given structure of interest rates is commensurate with the actual risks incurred by lenders. In a similar vein, we should ask whether borrowers in different segments of the money and capital - 3markets get as much benefit from interest rate competition among lenders as the overall supply of funds might indicate. In the same context, we ought to be curious as to whether interest rates on the volume of debt outstanding are becoming more subject or less subject to market determination as opposed to being set on an administered basis. For those of us with particular concerns about the role of financial institutions, we ought to be especially curious about the evolving behavior of commercial banks in setting interest rates. Of course, our curiosity should extend to the practice adopted a year ago by a few large banks under which their prime lending rate is linked to key money market variables. But it should not stop there. We should be equally concerned with the growing tendency of commercial banks to take on commitments to make business loans with the expectation of being able (under all circumstances) to offer interest rates on large denomination certificates of deposits (CD's) high enough to obtain the funds needed to meet the commitments. These are some of the issues relating to interest rates which are examined below. In addition, a summary of information on recent developments in credit flow is presented. The latter is intended primarily as background for an assessment of the main factors which might have a bearing on credit demands in the months ahead. These main issues can now be examined more fully. In the final section of the paper, the principal conclusions emerging from the analysis are summarized, and some of their implications are indicated. -4II. Long-Run Perspectives on Interest Rates Anyone with even a casual awareness of interest rates in the United States knows that the current levels are well above those prevailing before the mid-19601s. Table I (Attached) shows interest rates in numerous segments of the credit markets since 1961, Even a brief analysis of these data points up the extent to which interest rates have mirrored developments in money and capital markets over the last decade. To help sharpen the focus, the course of several key interest rates shown in Table 1 has been traced by converting them into an index—using the 1961 level as a base (i.e., 1961 = 100): Interest Rate 3-mo. Treasury bills (market yield) 4-6 mo. commercial paper Long-Term U.S. Gov't, bonds Long-Term State & local bonds (Aaa) Long-Term corp. bonds (Aaa) Home mortgages (new, FHA) (New conventional) Prime rate, commercial bank 1965 1966 1969 1970 1971 167 147 108 97 103 98 96 111 206 187 119 112 118 107 102 133 283 264 156 167 162 134 128 189 271 260 169 187 185 143 139 150 183 172 147 160 170 130 127 117 1972 It might be recalled that, during much of the period 1961-65, a basic objective of national economic policy was the stimulation of output and the reduction of unemployment. The Federal Reserve System shared in the pursuit of that objective by following 201 178 146 154 166 129 129 128 - 5a generally accommodating monetary policy. At the same time, however, the Federal Reserve was also concerned with the deficit in the country's balance of payments—and especially with the heavy volume of capital outflows. Partly in an effort to reconcile those competing aims, the System—during part of the period—adapted its monetary policy to some extent to moderate any tendency for longterm rates to increase while permitting a rise in short-term rates. The legacy of that course was still evident in 1965. For example, short-term interest rates were one-half to two-thirds higher in that year than they had been in 1961. In contrast, yields on long-term U.S. Government and corporate bonds rose very little, and interest rates on home mortgages declined slightly. The prime lending rate of commercial banks climbed only moderately. The impact of severe credit restraint on interest rates in 1966 can also be identified. In that year, short-term rates were roughly twice as high as they were in 1961 and about one-quarter higher than in 1965. On the other hand, the fact that long-term bond yields advanced by only half as much during 1966--while mortgage interest rates climbed by even less—may come as a surprise to some. But on closer analysis, the pattern of rate changes in that year appears not so surprising after all. In its effort to help check the inflation generated by the acceleration of military activity in Vietnam, the Federal Reserve eventually exerted a substantial - 6degree of monetary restraint in 1966. However, the peak of restraint was attained only in late Summer, and it was not held very long. Moreover, the System—on balance—did make net additions to bank reserves during the course of the year. Under those circumstances, overall pressures in the capital markets were considerable but far short of those which developed three years later. In the case of home mortgages, the modest increases in interest rates recorded in 1966 are by no means an index of pressures in that segment of the credit markets. To a considerable extent, mortage rates were subject to administrative ceilings (FHA and VA rates) or to State usury laws (conventional rates). Most of the principal mortgage lenders were also severely circumscribed by the lag in earnings on long-term mortgages in their ability to offer competitive interest rates to savers. As a consequence, ceilings were imposed by Government on the interest rates that these institutions could pay depositors. But even so, the non-bank institutions (especially savings and loan associations) experienced a sharp moderation in the inflow of funds and were forced to reduce drastically the volume of funds supplied to the housing market. But in one sense, the 1966 experience was a rehearsal for the drama that was to unfold three years later. In 1969, as the fight against inflation intensified, the Federal Reserve pursued a particularly stringent monetary policy. In this instance, the volume of bank reserves and the money supply expanded very little. - 7As market yields again climbed to—and exceeded--the maximum interest rates which commercial banks, S&L f s, and mutual savings banks could offer savers, these institutions experienced severe strains on deposit inflows. To counter these, some of the institutions (particularly commercial banks) made a frantic effort to tap new sources of funds—including Euro-dollars and sales of commercial paper by affiliates of bank holding companies. Reflecting mounting pressures on the supply of funds in the face of continued strong demands for credit, all types of market interest rates climbed to historic heights in 1969. fact, the actual peak in rates extended in 1970; In and for the latter year as a whole, only short-term market yields and the commercial bank prime rate were below the levels reached in 1969. During the recession of 1970-71, the Federal Reserve again pursued an accommodating policy and greatly expanded the volume of bank reserves supplied to the banking system. In response to this policy and the declining demand for certain types of credit (e.g., business loans at banks), interest rates declined on a broad front. However, the decreases were much more noticeable in the case of short-term than in the case of long-term rates. The adoption of wage and price controls by the Administration in August last year reinforced the downtrend in interest rates. While the currently prevailing levels of short-term rates (i.e., in October) are above the averages for 1971, the differences are rather small. Moreover, the level of long-term rates is essentially unchanged for the year-ago average. These long-term trends in interest rates should be kept in mind. They will contribute perspective to the subsequent discussion of long-run credit flows. III. Lending Risks, Operating Costs, and Rates of Return Another issue that has concerned me is the extent to which interest rates received by lenders are reflective of the risks they take and the costs of doing business. I am personally convinced that these may not be as closely linked as first impressions might suggest. All of us are familiar with the differences in interest rates associated with loans of different quality and maturity. We understand why those loans entailing higher credit risks or extending for longer periods of time generally carry higher interest rates. Moreover, because the different segments of the credit markets are not completely isolated from each other, movements in interest rates in one sector ordinarily generate repercussions in the same direction in adjacent sectors. But, since lenders and borrowers cannot switch freely among the different sectors, interest arbitrage is far from perfect, and money and capital markets are segmented to a considerable degree. - 9 We also recognize that, in assessing the interest rate on a particular loan, we must be conscious of the particular types of risk a lender incurrs. For example, he must cover his credit risk—i.e., the risk of default; and in the case of marketable loans, he must cover the market risk as well—i.e., the risk that he might have to liquidate the asset at a price below what he paid for it. Moreover, in the case of long-term loans, we must also expect lenders to hedge against future inflation by seeking a premium to compensate—at least in part—for anticipated price increases and the consequent erosion of the purchasing power of his future income. In recent years, this premium has undoubtedly been quite high—although we cannot quantify it. In addition to risks, interest rates must also cover the costs of doing business. These costs also vary considerably with respect to different types of loans. Undoubtedly, it costs more to book and maintain small consumer loans than it does to handle large loans to business. On the average, the risk of losses on the former taken in the aggregate is greater than the loss exposure on the latter. Nevertheless, one ought to ask whether the large differences in interest rates associated with different types of loans can be explained fully by such factors. - 10 A general idea of the richness of rate variations can be seen in Table 2, showing interest rates on selected types of loans to households and businesses. Several features stand out. In the case of loans to consumers, the widely-known fact that commercial banks charge interest rates well below those charged by finance companies is clearly evident. To some extent, of course, finance companies generally deal with borrowers among whom the risk of loss is higher than it is among bank customers. Yet, one might reasonably doubt that the differential in favor of finance companies of about one-quarter in the rate on new automobile loans and of one-seventh on mobile home loans can be fully explained by this factor. Similarly, the spread in favor of finance companies of over two-thirds on personal loans may not be fully attributable to the greater loss exposure which they face. I am personally convinced that at least some of the margin enjoyed by finance companies can be traced to segmentation of the market for personal loans and the dampening of interest rate competition which this implies. In my judgment, if commercial banks were more aggressive in pursuing customers who now depend mainly on finance companies, the cost of credit to consumers would decline somewhat. In fact, it was with this expectation in mind that I personally supported the entry of bank holding companies into the finance company field—as permitted under the 1970 amendments to the - 11 - Bank Holding Company Act. Already a number of bank holding companies have acquired finance company subsidiaries. But the extent to which such acquisitions have resulted in increased interest rate competition is still uncertain. Yet, I have the impression that no significant downward pressure has been exerted. Instead, it seems that the entering bank holding companies typically accept the prevailing structure of finance charges and seek to obtain as large a share of the market as possible. Hopefully, as more bank holding companies expand into the finance company field, more interest rate competition will result. With respect to loans to business, the figures in Table 2 show clearly the expected tendency for interest rates to decline as the size of loan increases. For example, in the case of short-term commercial bank loans (maturing in one year or less), the average interest rate on loans in the $1,000-9,000 size range was about one-quarter above that on all such loans in August of this year. But in the $100,000-499,000 loan size class, the rate was only 6 per cent about the average; and on loans of $1,000,000 and over the rate was 5 per cent below the average. The same general pattern existed with respect to revolving credit and long-term loans to business. Also, as one would expect, the interest rates on only the largest loans (and then only in the case of short-term credits) were close to the prevailing prime lending rate. An even clearer perspective on the relationship among risks, operating costs, and interest rates is provided by the figures in Table 3. These data are based on the average experience in 1971 of 994 member banks in 12 districts of the Federal Reserve System which participate (on a voluntary basis) in a functional cost analysis program. The banks are grouped by size of total deposits (i.e., up to $50 million, 684 banks; $50 million to $200 million, 231 banks; and over $200 million, 79 banks). The banks1 operating experience is shown with respect to total loans; consumer instalment loans; investments combined. real estate mortgage loans; credit card loans; commercial loans and Calculations were made to show for each asset category—as a percentage of outstanding volume: gross yield; related operating expenses; loan losses; and the cost of money. In combination, these variables provide measures of the rate of return to the banks on each category of asset—net of risk and operating costs. Here also several features of the data stand out. First, it will be noted that, for each class of commercial bank loans, operating costs absorb a significant share of the gross yield. all loans, the proportion was about one-quarter. For The highest proportion shows up with respect to credit card loans (four-fifths), followed by consumer loans (one-third), commercial loans (one-sixth), - 13 and real estate mortgages (one-tenth). For investments alone, the proportion was smallest of all (less than 2 per cent). For the banks1 entire portfolio of earning assets (loans and investments combined), the proportion was about one-sixth. Secondly (except in the case of credit cards), loan losses absorbed relatively small proportions of the gross yield. Perhaps an even clearer way to get an appreciation of the relationship among operating costs, loan losses, and interest rates is to relate them to the volume of loans outstanding. To illustrate the results, the experience of the banks in the middle size class (i.e., those with deposits of $50 to $200 million) might be examined. In 1971, the average bank in this class had a gross yield of 8.082 per cent on its total loans outstanding. Operating expenses were 1.907 per cent of total loan volume—providing a net yield before losses of 6.175 per cent. Since loan losses were 0.120 per cent of outstanding loans, the net yield was reduced to 6.055 per cent. However, the cost of money employed (which was 3.438 per cent of loan volume) also had to be subtracted, and this reduced the net yield further to 2.617 per cent. This latter figure is the final measure of the banks1 net return on loans. The same calculations were made for each category of loans taken separately and for each size class of bank. Those calculations are shown in detail in Table 3, and there is no need to list them here. - 14 - However, a few key points should be made. For each size of bank, the net rate of return on consumer instalment loans is clearly higher than that on commercial and other business loans. While operating costs and loan losses in relation to loan volume are higher for consumer instalment loans than for business loans, the cost of money does not differ appreciably between them. Thus, when all the adjustments are made, the banks are left with a margin on consumer instalment loans that appears ftot to be directly related to risk and operating costs incurred in making such loans. In my personal judgment, some part of that residual probably should be attributed to a lesser degree of interest rate competition in consumer credit extension than is found in the case of bank lending to businesses. IV. Administered vs. Market Determined Interest Rates As I indicated above, I personally believe that economic welfare is improved when interest rates are subject more to market 1/ influences than to administrative decisions."" Underlying this belief is a conviction that price competition—when it can be made to w o r k — i s a better guide to credit and resource allocation than actions taken on the basis of conventional practices or other nonmarket standards. Of course, I realize that in numerous circumstances price competition cannot be made to work or other public policy objectives may require overt intervention by Government to moderate 1/ Earlier this year, I examined the same issue at some length with respect to interest rates offered on consumer-type time deposits. See "Interest Rate Discrimination, Savings Flows, and New Priorities in Home Financing," presented before the University of Washington Alumni Association, Seattle, Washington, June 9, 1972. - 15 the workings of the market. But I believe such occasions should be exceptional, and wherever possible our goal should be to encourage price determination on the basis of market forces over as wide a range of economic decisions that we can reasonably have. In passing, I should say that it is in that framework that I have viewed bank merger and bank holding company acquisition applications that come before the Federal Reserve Board for decision. I have been concerned not only with the effects of a proposed merger or acquisition on existing competition but also on potential competition in a given market. The common thread in all my comments on such cases (particularly in those rare instances in which I differ from the Board majority) is a persistent quest for ways to increase rather than diminish the effects of market competition on interest rates and other costs of providing banking services. Against that background, I recently tried to classify the volume of outstanding debt, by major sectors and credit instruments, according to the extent to which the related interest rates are determined on the basis of administrative decisions or are substantially subject to market forces. Table 4. The results of that effort are shown in Data are presented for 1961 and 1971, so broad changes—if any—can be traced over the decade. Before commenting on the results, however, let me say immediately that some of the classifications are matters of judgment and are necessarily arbitrary. Some of the debt categories (such - 16 as U.S. Government obligations) are officially identified in marketable or non-marketable terms. The status of other classifications (such as open market commercial paper and publicly offered bonds) is widely recognized in the money and capital markets. Interest rates on still other debt obligations are subject to a mixture of market and nonmarket factors, and it was necessary to record them in one category or the other for the present analysis. Commercial bank loans to business are an outstanding example in this class of credit instruments. The recently adopted practice whereby some banks link their prime lending rate to market variables makes it even more difficult to classify business loans with respect to administered vs. market determined interest rates. But on balance, the vast majority of banks have not adopted floating prime rates, so bank loans to businesses Turning evident. were classified in the administered rate category. to the figures in Table 4, a clear pattern is In both 1961 and 1971, the total outstanding debt in the United States was about equally divided between market and administered interest rate classes. But among major sectors of the economy, the division varied widely. For instance, virtually all of the household debt was subject to administered rates. At the opposite extreme, all of the State and local government debt was subject to market determined interest rates. the division was about half-and-half. In the business sector, As mentioned above, interest rates on bank loans to business are classified as determined by - 17 administrative decisions, and the volume of these loans heavily weights the total volume of business debt in that direction. About four-fifths of the Federal Government debt is in the market rate category. Over the last decade, no dramatic changes occurred in the distribution of debt in the major economic sectors between market and administered rate classes. However, a few differences are observable, and these might be noted. In the case of the Federal Government, the proportion of debt subject to administered rates declined somewhat (from 21 per cent to 17 per cent of the total). This was due mainly to the relatively slow expansion in the volume of savings bonds outstanding. In the data presented here it will be noted that special issues of Federal Government debt (whether held by trust funds or foreign official institutions) are classified as "nonmarketable11 but recorded in the market determined interest rate class. While these issues cannot be transferred in the market, the interest rates on them are linked explicitly to yields on U.S. Government marketable securities. Because both trust fund and foreign-held special issues rose enormously in the last decade—while the volume of savings bonds rose only moderately--the proportion of nonmarketable outstandings subject to market interest rates climbed from 45 per cent in 1961 to 65 per cent in 1971. - 18 When the situation is viewed in terms of the share of major economic sectors in the volume of debt classified in each category—i.e. , subject to market vs. administered interest rates—several other changes are put into sharper focus. Thus, in 1961 and 1971, the household sector accounted for about the same proportion of all administered rate debt outstanding (56 per cent and 58 per cent, respectively). However, in the share of the business sector the proportion in the administered rate class rose somewhat (from 30 per cent to 35 per cent). This was mainly a reflection of the high rate of growth of bank loans reinforced by the expansion in trade credit. On the other hand, the level of total U.S. Government debt rose more slowly over the decade than total debt outstanding, although its composition shifted more toward the marketable component. As a consequence, the Federal Government's share of all debt subject to market determined interest rates declined from 50 per cent in 1961 to 37 per cent in 1971. Yet, that segment of the Federal debt that expanded most rapidly (special issues) carries interest rates determined in the market rather than by administrative decision. In contrast, savings bonds—which carry administrative rates (which were well below comparable market yields during much of the last decade) — experienced a decline from 12 per cent of all administered rate debt in 1961 to 7 per cent in 1971. - 19 v# Market Factors in the Determination of Commercial Bank Lending Rates At this point I would like to discuss the growing influence of market factors on interest rate determination by commercial banks. In the last year—during which roughly a half dozen large banks have followed the practice of linking their prime lending rates to money market variables—observers have become increasingly aware of the impact of market forces on rates set by commercial banks. Yet, the tying of the prime rate to short-term market yields is essentially an overt (and highly visable) manifestation of a tendency that has been evident for some time--if one looked carefully at the changing sources and uses of commercial bank funds. In essence, commercial banks have become increasingly willing to commit themselves to lend to their regular corporate customers, for which commitment the latter have shown a growing readiness to pay a fee. The banks, in turn, have made such commitments on the expectation that they could obtain funds as needed by offering competitive rates on CD's. In other words, the banks have become increasingly prepared to buy resources to be rechanneled to their best customers. The extent to which banks have come to rely on interestbearing sources of funds can be seen in Table 5, showing liabilities of all insured commercial banks in the United States for the 1961 and 1971. years For present purposes, the key figure in the table - 20 is the proportion of total resources on which the banks paid 2/ interest. In 1961, that proportion was 32 per cent, and by 1971 it had risen to 50 per cent. The most significant change in the composition of these interest-bearing deposits was the dramatic rise in the volume of large negotiable CD's. In 1961, the amount outstanding (while not reported separately) was known to be fairly small. By 1971, the volume had risen to $34 billion and accounted for 10-1/2 per cent of the $320 billion of the banks1 total interest bearing liabilities. The second significant change centered in the expansion of federal funds purchased and securities sold under repurchase agreements. This category was not reported separately in 1961; but last year such liabilities (primarily federal funds) amounted to $24 billion--or 7-1/2 per cent of all interest-bearing liabilities. In 1961, savings deposits on the banks1 books amounted to $64 billion and represented 73 per cent of the $88 billion of interest-bearing liabilities. Time deposits (of which the CD component was negligible) amounted to $19 billion--or 22 per cent of interest-bearing resources. So, in combination, these two categories accounted for 95 per cent of the total liabilities on which the 2/ ~ These interest-bearing resources are defined here as total liabilities and capital minus demand deposits, bankers1 acceptances outstanding, minority interest in consolidated subsidiaries, total reserves, and equity capital. - 21 banks paid interest. By 1971, while savings deposits had expanded to $111 billion, their share of total interest bearing liabilities had shrunk to 34 per cent. Total time deposits had risen to $163 billion (51 per cent of interest-bearing liabilities). But if the volume of CD's is subtracted, the share is reduced to 40 per cent. Another source of interest-bearing funds not shown separately in Table 5 is the Euro-dollar market. As is generally known, about a dozen and a half large banks systematically bid 3/ for Euro-dollars- when the differential cost of short-term money at home and abroad favors greater reliance on such funds compared with federal funds and CD's to provide additional liquidity. The extent to which banks made use of Euro-dollars in 1961 is unknown. However, at the end of 1971, the indebtedness of U.S. banks to their foreign branches amounted to $0,9 billion. in 1969, the volume was $15.4 billion. At the high point reached As I have stressed on 4/ several occasions," I believe firmly that these Euro-dollar inflows greatly aggravated the task of monetary policy in this country in 1969 and 1970. 3/ The bidding for Euro-dollars is done primarily through these banks' London branches, but other banks also participate in the Euro-dollar market through correspondents, brokers, and other arrangements. 4/ For example, see "Commercial Bank Lending and Monetary Management," remarks before the 57th Annual Fall Conference of the Robert Morris Associates, Los Angeles, California, October 25, 1971. - 22 Of course, the counterpart of banks1 increased reliance on interest-bearing resources is the erosion of the relative 5/ importance of interest-free demand deposits.~~ In 1961, the latter amounted to $165 billion and accounted for three-fifths of the banks1 total liabilities and capital. By 1971, the volume of demand deposits had risen to $261 billion, but their share of resources had fallen to two-fifths. demand deposits expanded by only In fact, over the decade, 58 per cent--while time and savings deposits rose by 233 per cent and total liabilities by 130 per cent. The relative decline of demand deposits available to banks and their increased dependence on interest-bearing funds were by no means wholly voluntary on the banks1 part. Instead, the growing sophistication of liquidity management by corporate treasurers and others with control over large cash balances has meant a sharp decrease in their willingness to keep idle funds with banks. The high rates of return available on money market instruments during much of the last decade have added to their incentive to economize on cash holdings. In response, the commercial banks have found it increasingly necessary to bid for interest-bearing funds in the money market—both at home and abroad. 5/ Although demand deposits earn no interest, they are by no means "free" of costs to the banks. The operating costs of handling such deposits must be covered—but this is also true of other deposits. - 23 The impact of such bidding can be seen clearly in the banks1 operating results. Figures which help in assessing this impact are given in Table 6, showing income, expenses, and dividends for insured commercial banks in 1961 and 1971. It will be recalled that, from the banks1 point of view, interest paid is an operating expense. In 1961, the banks1 total operating expenses amounted to $7.4 billion, and these had climbed to $29.7 billion by 1971. Included in these expenses were $2.1 billion of interest payments in 1961 and $12.2 billion last year. The interest on federal funds pruchased amounted to $1.1 billion in 1971. The banks also paid $38 million of interest on other borrowed money in 1961 and $139 million in 1971. In addition, in 1971, they paid out $142 million in 6/ interest on capital notes and debentures. So .the combined interest payments made by the banks represented about 30 per cent of their operating expenses in 1961. By 1971, the proportion had risen to 46 per cent. For deposits alone, the figures were 28 per cent and 41 per cent, respectively. These payments on deposits were equivalent to an effective rate of interest on deposits of 2.7 per cent in 1961 and 4.8 per cent ten years later. The intensified market pressures faced by commercial banks in the competition for funds have induced them to search for 6/ No figures were available separately showing interest payments on federal funds and capital notes and debentures in 1961. - 24 ways to adapt the methods they use to establish the rates they charge to make the latter more responsive to market forces. The most widely noted development in this regard was the practice adopted in November, 1971, under which several large banks tie their prime lending rate to money market variables. banks in this group are: Principal (1) First National Bank of Boston, (2) Bankers Trust, New York, (3) First National City Bank, New York, (4) Irving Trust, New York, (5) Mellon National Bank, Pittsburgh, (6) Michigan National Bank, Detroit, and (7) Exchange National Bank, Chicago. A variety of explanations of their actions were given by these banks when they shifted from a fixed to a floating lending rate to be charged on loans to their best business customers. Moreover, the specific money market variables employed and the techniques used to link the prime rate to them also differed. But the common theme in the banks1 comments was a desire to make their lending rates more responsive to market forces. ^^ To this end, most of the banks adopting the floating rate approach linked their own rates in some way to market yields on such short-term market instruments as commercial paper and CD's. Most of them also announced that they would post changes in the rate on a weekly basis. 7/ ~~ In passing, it might be noted that some observers thought the move to floating rates was also partially motivated by the desire to make changes in the prime rate less subject to political criticism. - 25 The emergence of floating prime rates has been commented on many times, and on the surface there appears to be little more to say about the matter. The decision of one bank (Bankers Trust) made a week or so ago to suspend its floating rate renewed the discussion briefly. However, most of the public comments which followed seemed to have been generated by the bank's explanation that it made the move in order to cooperate with the Administration in pursuit of its economic policy objectives. Thus, one might still ask whether the experience of these half dozen banks with a floating prime rate cast any light on the general responsiveness of commercial banks1 basic lending rate to money market forces. in the affirmative. I believe that question should be answered This conclusion is based on considerations regarding the nature of competition among large banks as well as on the statistical record. The following figures as of December 31, 1971, will put the issue in perspective (amounts in millions of dollars): Category Total Deposits Total Loans Business Loans 535,703 345,386 117,603 30,878 21,222 11,385 All insured commercial banks Floating rate banks Per cent of Total 5.74 6.14 9.66 - 26 These figures suggest that the floating prime rate banks1 impact on the market for business loans is likely to be considerably greater than their impact in the economy as a whole. At the end of last year, their share of total loans was only slightly larger than their share of total deposits. However, their share of business loans was significantly larger. Data from another part of the statistical record also supports the conclusion that floating rate banks are able to exert considerable influence on the prime rates charged by other banks. These data shown in Table 7 relate to the pattern and timing of changes in prime lending rates during the last year. In this table the prevailing rates are divided into two classes: fixed rates for the majority of banks and a range of rates charged by banks with floating rates. The rate data are further analyzed to see whether any judgment can be made with respect to any leadership role which floating rate banks might seek to play. The amount of time elapsed before the majority of fixed rate banks brought their own rates into line once a floating rate had been changed is also shown. Several points should be kept in mind when focusing on these rate statistics. The floating rate banks change their rates in varying units such as 1/8 and 1/4 per cent. changes weekly while others do so less often. Some post Consequently, on a given date, two or more floating rates may be in effect at different - 27 banks. The range of floating rates indicated in Table 7 is designed to encompass that situation. The leadership role of floating prime rate banks in determination of the prevailing rate is judged on the basis of the extent to which the majority of fixed rate banks adjust their own rates. The floating rate banks are assumed to be "successful" leaders when a rate change by one or more of the floaters establishes a trend to a new rate level which is subsequently joined by the majority of fixed rate banks. A "failure" of leadership is assumed to occur when one or more of the floaters makes a rate change but the majority of fixed rate banks do not follow the move 8/ to confirm the change as a new, generally accepted rate.— The time lag in adjustment is the amount of time it took the fixed rate banks to change to a new rate after such change has been successfully led by the floating rate banks. From an analysis of the rate data, several conclusions were reached. Beginning in November last year, the floating rate banks did play a leadership role in the establishment of the prime lending rate charged by the majority of banks. From a prevailing rate of 5-3/4 per cent set on October 20, 1971, the floating rate 8/ It will be noted that as used here successful "leadership" requires that a rate move must establish a trend--e.g., mark a change in level that was sustained. An alternative view of leadership may apply to those cases where the move is from one level to another but in the same direction as previous leading moves. The latter view is not the one considered here - 28 banks led a successful move on November 1 to reduce it by 1/4 to 5-1/2 per cent. It took only 3 days for the majority of banks to make the adjustment. When a floating rate bank subsequently reduced its rate to 5-3/8 on November 22, another floater not only moved in the same direction a week later--but went down even futher to 5-1/4 per cent. However, in this instance, the majority of banks kept their rate fixed at 5-1/2 per cent. In fact, 39 days elapsed before the fixed rate banks again changed their rate—bringing it down to 5-1/4 per cent on December 31. In the interval, the floating rate banks had moved in four steps to reach the 5-1/4 per cent level. In two subsequent actions, the floating rate banks cut their prime rate to 4-3/4 per cent--the latter rate being posted for the first time on January 17, 1972. Yet, it required another week for the fixed rate banks to give up their 5-1/4 per cent rate-and even then they moved only to 5 per cent. The time lag involved in this move from 5-1/4 to 5 per cent required 21 days. On the other hand, it took only 7 days for the fixed rate banks to drop their rate to 4-3/4 per cent. This was the low point by the fixed rate banks in the downard rate movement. At least one of the floating rate banks got down as low as 4-3/8 per cent--set the same day the fixed rate banks adopted a 4-1/2 per cent rate. However, this 4-3/8 per cent floating rate lasted only two weeks, and by March 20, all of the banks--floating and fixed rate—were together at 4-3/4 per cent. - 29 But a week later, on March 27, the floating rate banks launched an upward rate movement that continued until after October 16. On that March date, one floating rate bank posted a rate of 4-7/8 per cent, and another set it at 5 per cent. But no fixed rate banks made a change at that time. However, on April 5, the fixed rate banks adopted a 5 per cent rate (which at least one floating rate bank had charged since March 27), and all the floaters posted the same rate. But this situation was short-lived, for on April 17 a floating rate bank moved up to 5-1/4 per cent, and another moved up to 5-1/8 per cent two weeks later. However, this latest phase of the upward movement in the prime rate led by the floaters could not be sustained. On May 30, all of the floating rate banks moved back down to 5 per cent--the level at which the fixed rate banks had remained. On June 12, the climb in the prime rate resumed as one floater posted a rate of 5-1/8 per cent. On June 26 a 5-1/4 per cent floating rate was adopted, and the fixed rate banks moved to the same level. This upward trend continued until August 7. In the interval, the floating rate had risen to 5-1/2 per cent--a rate that was actually first posted by one bank on July 10. However, even some of floating rate banks lingered behind at 5-1/4 and 5-3/8 per cent, and all fixed rate banks kept their rate at 5-1/4 per cent. So on August 7, the floating rate bank quoting 5-1/2 per cent gave up and moved down to 5-3/8 per cent. cut their rates further to 5-1/4 per cent. A week later, all floaters - 30 The last segment of the upward movement in the prime rate (which ended at least temporarily on October 16) got underway on August 21--when a 5-3/8 per cent floating rate was posted. Subsequently, in four moves, the floating prime rate was advanced to 5-7/8. However, the fixed rate banks remained at 5-1/4 per cent until August 29—when they adopted 5-1/2 per cent. The latter rate was in place until October 4 — w h e n 5-3/4 per cent was established, a rate that is still in effect. On November 6, the floating prime rate was moved back to 5-3/4 per cent from 5-7/8 per cent. As already indicated, that move was said to have reflected a desire of the bank involved to cooperate with the Administration's economic objective. What should we have learned from this review of the statistical record? We should have learned that the floating rate banks can—and did—exert a leadership influence on the determination of the prime rate. But we should have also learned that their role is far from dominant. By the criteria employed here, they were successful leaders in eight rate changes and failures in four cases. Moreover, in only three of the successful cases did the fixed rate banks adjust their rates in less than two weeks. Beyond the statistics presented here, the nature of competition among large banks for business customers also suggests that the floating rate banks can play a leading role—but not a dominant one. As is generally known, the large banks service a - 31 substantial number of the same customers. In fact, some corporations systematically rotate their borrowing among their principal banks on a fairly fixed schedule. Thus, these firms are highly conscious of differences in the prime rate and can be expected to tailor the pattern of borrowing with an eye to minimizing the cost of money to them. Consequently, a bank which sets its rate well above its competitors will experience some loss in demand for loans. opposite is also true: The if its rate is well below its competitors, it will be faced with an expansion in loan demand—and with the discomforting knowledge that it is providing funds at a rate below what other lenders are gettingThus, the ability of corporate borrowers to shift among lenders serves to dampen the extent to which large floating rate banks can influence the establishment of the prime rate. On the other hand, the need for the banks themselves to bid for funds in the money market means that market factors must necessarily have a considerable impact on the interest rates they must charge their customers. VI. Recent Developments in Capital Market Borrowing At this juncture, we can review briefly the broad outlines of capital market borrowing by major sectors during the last year. For this purpose, preliminary data for the third quarter from the Federal Reserve Board T s flow of funds accounts can be used. are presented in Table 8. The figures - 32 The volume of funds raised in the capital market by major sectors during the third quarter of 1972 was about the same as a year earlier ($147•9 billion in 1971 and $151.8 billion this year). However, the amount of borrowing by households rose sharply; the amount raised by the nonfinancial business sector recorded a sizable decline, and borrowing by the Federal and State and local governments also eased off somewhat. On the other hand, the Federal Government ran down its cash balances by a sizable amount last quarter in contrast to a large build-up a year earlier. In terms of capital market instruments, the volume of State and local government securities and corporate and foreign bonds declined moderately on a year-over-year basis. In contrast, all types of real estate mortgages rose--with home and commercial mortgages registering particularly noticeable increases. Corporate equity shares showed quite a large decline. Private credit raised without the use of market instruments dropped by about one-fourth between the third quarter of 1971 and the third quarter of this year. The relative decrease centered in commercial bank loans and open market commercial paper. actual attrition in the latter of about $5-1/2 billion.) (There was On the other hand, consumer credit registered a fairly large gain. These summary credit flows are examined somewhat more closely in the next section in connection with an assessment of the outlook for credit demands in the months ahead. - 33 VII. Outlook: Factors Affecting Prospective Credit Demands In general, it appears that we might see a noticeable moderation in the demands for funds registered in the capital markets during the first part of the coming year. This anticipation is independent of any market impact that might result from the recent national election or which might follow as the peace moves regarding the Vietnam War continue. The easing in credit market demands is expected to be particularly noticeable in the case of State and local governments, and demands by corporations are likely to remain moderate. On the other hand, the volume of borrowing by the Federal Government in the first half of 1973 may be well above that recorded in the same period this year. Corporate long-term credit demands. As corporations sought to restructure their balance sheets after the liquidity crisis of 1969-70, total corporate security offerings rose to historical highs in the last 3 years. Even with long-term bond rates rising to new peaks in the first half of 1970, public bond volume started tp increase sharply as a large communications system began a sizable external financing campaign. The capital needs of public utility and communications firms have provided a high base of long-term credit demand in the capital markets in the early 1970's, and the restructuring needs of many large industrial corporations resulted in a peak public bond volume of over $8 billion in the first quarter of 1971. Although the continued needs of the utlities and an unusual volume of debt offerings by banks - 34 and other financial firms kept public bond offerings at historically high levels well into the first half of 1972, public bond volume has moderated significantly this year. Total corporate security volume in 1972 has not declined as sharply as public bond offerings. In general, it appears that the liquidity needs of many industrial firms—especially the large, highgrade firms—have been satisfied for now. However, a number of smaller, less prestigious corporations were still in the process of balance sheet restructuring in late 1971 and 1972, and utility needs for long-term capital remained high. However, these borrowers have often found it necessary or desirable to issue equity or privatelyplaced debt. In the case of the utlities, concern about debt/equity ratios, interest coverage ratios, and maintenance of high bond ratings has stimulated a trend toward issuance of stock rather than bonds. Many medium-sized and small industrial firms have also utilized the stock market, and gross new equity volume has been averaging about $1 billion a month for almost 2 years. The high cash flows enjoyed by insurance companies in recent years have made available an abundant supply of funds in the private placement market and stimulated a sharply increased volume of such offerings in 1971 and 1972. Given the good cash flow and liquidity position of corporations in the aggregates, one may expect long-term credit demand from industrial corporations to remain moderate over the next few months. We may see some seasonal increase in public bond volume in the first quarter of - 35 1973 and a continued high level of offerings in the private placement and equity markets. According to most underwriters, relatively few firms now plan to offer bonds either this year or in early 1973. Only the energy, communications, and transportation industries appear to have pressing needs for capital funds, and it is probable that firms in these industries will continue to meet some of these needs in the equity and private placement markets rather than by issuance of public bonds. Long-term credit demands of State and local governments. Long-term debt offerings by State and local governments also peaked in the early 1970fs as a result of inflation, increased social needs, and an almost inevitable catch-up process after the sharp drop in tax-exempt financing which occurred during the period of severe monetary restraint in 1969. As in the corporate market, bond volume set a new record in 1971 and then moderated in 1972 as the revenue flows and liquidity position of most State and local governments improved significantly. Thus far in 1972, the pace at which general obligation issues have been offered has slowed relatively more than that of revenue bonds. It appears that one still ought to expect further tapering in municipal bond volume, with less than the usual seasonal rise in the first quarter of 1972. The favorable liquidity position that many governments find themselves in, plus expectations of revenue sharing funds which will be distributed in the near future, will - 36 probably exert some downward pressure on long-term borrowing, especially in the general obligation area. Underwriters report a large backlog of industrial pollution bonds, which will offset this to some extent, but marketing of pollution bonds will probably rise slowly because of the long market lead time required for such issues. Home mortgage debt. Net 1- to 4-family mortgage debt formation reached a record seasonally adjusted annual rate of $39.5 billion in the third quarter of 1972. However, the rate of increase slowed moderately in that period—mainly as a lagged response to a slowing of the quarterly increase in outlays for 1- to 4-family construction. We should expect 1- to 4-family mortgage debt formation to rise moderately further in the fourth quarter of this year and then level off in the first quarter of 1973. The anticipated further slowing in the uptrend in 1- to 4-family mortgage debt formation reflects an expected leveling off in 1- to 4-family construction activity as well as some moderation in activity in the existing home market. Because of seasonal factors, net mortgage debt formation tends to be lowest in the first quarter of a year. Allowing for this factor, net mortgage debt formation may be about one-third less in next year's first quarter than in this year's third quarter—which amounted to $10.6 billion, the record high on a seasonally unadjusted basis. - 37 Consumer credit growth to mid-1973. Consumer credit outstanding should continue to grow at a substantial rate throughout 1972 and into early 1973. Extensions of consumer credit have been strong throughout most of 1972 and should continue to be strong through 1973. The chief reason for this is that consumer credit extensions are related to the level of economic activity and the level of consumer optimism. Both consumer optimism and level of economic activity should be strong into the early part of 1973. In addition, due to the combination of high consumer incomes and enforced price restraint, domestic automobile demand should be very strong into early 1973. Not only are basic demand factors favorable but the relative price of automobiles is probably more favorable now than it would be in the absence of price restraint. Furthermore, due to the recent strong level of housing starts consumer demand for household furnishings and durable goods will tend to be strong for the next several years. Yet, due to the inclusion of more durables in the purchase price of housing, the lagged demand effect of housing starts on consumer credit demand now may be weaker than formerly. Finally, consumer optimism as measured by sentiment indexes has recently risen substantially due to the decline in unemployment and the slackening in the rate of inflation. Since unemployment is expected to continue to decline and the rate of inflation is not likely to return - 38 to its former levels, consumer optimism should continue to be strong. Thus, the main forces which account for consumer credit demand are strong and are likely to remain strong for the near future. In addition, monetary conditions have recently been sufficiently expansive that there should be no serious limitation in the supply of consumer credit in the near future. Net cash borrowing by the Federal Government. As mentioned above, the Federal Government is the principal sector that is expected to expand appreciably the volume of funds raised in the capital markets in the early months of next year. This prospect seems in store whether or not the Administration is successful in keeping Federal outlays within the $250 billion target set for fiscal year 1973. It will be recalled that, even with expenditures held at that ceiling, the Government would probably run a deficit of about $23.5 billion. Of course, cash borrowing could be well below the size of the deficit because the Treasury's cash balance can be drawn down. In the July-December period this year, Federal Government net cash borrowing may be in the neighborhood of $15.0 billion—considerably below the $21.6 billion registered in the same period a year ago. About two-thirds of the $15.0 billion of new cash may be raised in the fourth quarter. Looking ahead, Federal Government net cash borrowing may amount to about $5.0 in the first half of calendar 1973. In the same period last year, about $2.1 billion of borrowing was repaid. - 39 In fact, because of the typical pattern of Federal Government receipts and expenditures, one might usually expect net repayment of debt in the first half of each calendar year. However, the experience over the last five years has been far from usual. In both 1968 and 1971, the Government had to undertake net cash borrowing in the January-June months ($4.2 billion and $3.2 billion, respectively). Even so, if net cash borrowing reaches $5.0 billion in the first half of 1973, the Federal Government will be a major force in the capital markets next year. VIII. Summary and Conclusions The main conclusions reached in this discussion have been presented in each section. However, it may be helpful to summarize them here: --The detailed analysis of the operating experience of commercial banks in 1971 shows that a major share of the fairly high interest rates charged on consumer instalment loans is needed to cover high operating costs and the risks of credit losses. However, even after allowing for the cost of money to banks, a fraction of the interest charge remains that cannot be explained readily by the above factors. --Instead, the relative absence of interest rate competition among consumer credit lenders may account for the remaining component. A similar situation exists in the case of consumer loans extended by finance companies—only more so. --The proportion of debt outstanding in some sectors of the United States that is subject to market-related interest rates—rather than to rates set on an administered basis—appears to be rising. The big exception is the debt incurred by consumers. - 40 --Commercial banks are finding it increasingly necessary to bid for funds needed to carry on their business. As a consequence, interest payments on borrowed money have become a major element in their operating costs. Given this impact of market forces on their sources of funds, banks have sought increasingly to introduce market considerations in determining the interest rates which they charge large borrowers. In fact, the practice adopted a year ago by several large banks whereby their prime lending rate is linked to money market variables is an overt manifestation of this concern. — I n the early months of 1973, credit demands registered in the capital markets are likely to moderate considerably. The demand for funds by the Federal Government may be the only major exception to this outlook. Having explored the above terrain, I am left with several impressions. With respect to interest rates paid by consumers, I am personally convinced that we need much more competition among lenders. It is for this reason that I have supported the entry of bank holding companies into the finance company field. While bank charges on consumer loans are well above those on loans to businesses, they are considerably below those charged by finance companies. Of course, the latter typically deal with less credit-worthy borrowers, and their higher rates undoubtedly need to reflect this fact. However, there still seems to be scope for seeking a better balance between risks and interest rates on consumer loans. I am conscious of the rising cost pressures encountered by commercial banks as they find it increasingly necessary to bid for funds in the money market. Clearly at least some part of their own - 41 higher cost of money must be passed on to their own customers. However, I am also concerned by the other side of the coin: the largest banks in the country are also becoming increasingly willing to commit themselves to lend money to their best customers at some unspecified future date. They are making such commitments with the expectation of being able to raise the funds wken needed by competing for them in the money market. It seems clear to me that—if this becomes the prevailing practice over wide segments of the banking system--the effectiveness of monetary policy as an instrument of national stabilization policy will be severely weakened. - 0 - ^^ile 1. Interest Rates in Selected Category 1961 1965 Cr CD Market 1966 ' 1961 1969 *"1972 1970 1971 1972 (October) Money Market Rates Federal funds 1.96 4.07 5.11 8.22 7.17 4.66 5.00 Prime commercial paper 4 to 6 months 2.97 4.38 5.55 7.83 7.72 5.11 5.30 Finance co. paper, placed directly 3 to 6 months 2.68 4.27 5.42 7.16 7.23 4.91 5.13 Prime, 90-day bankers accpt. 2.81 4.22 5.36 7.61 7.31 4.85 5.05 2.38 2.36 3.95 3.95 4.88 4.86 6.68 6.67 6.46 6.39 4.35 4.33 4.72 4.74 U.S. Government Securities 3-month bills New issue Market yield 6-month bills New issue Market yield 9 to 12 month issues 1 yr. bill (market yield) Other 3- to 5-year issues Long-term bonds 2.60 2.59 4.06 4.05 5.08 5.06 6.85 6.86 6.56 6.51 4.51 4.52 5.12 5.13 2.81 2.91 3.60 3.90 4.06 4.09 4.22 4.21 5.20 5.17 5.16 4.66 6.79 7.06 6.85 6.10 6.49 6.90 7.37 6.59 4.67 4.75 5.77 5.74 5.39 5.41 6.11 5.69 State and local Govft. sec. Total Aaa Baa 3.60 3.27 4.01 3.34 3.16 3.57 3.90 3.67 4.21 5.73 5.45 6.07 6.42 6.12 6.75 5.62 5.22 5.89 5.24 5.03 5.45 4.35 4.50 5.43 7.71 8.68 7.62 7.38p 4.66 4.64 5.34 7.36 8.51 7.94 7.59p 4.35 5.08 4.49 4.87 5.13 5.67 7.03 7.81 8.04 9.11 7.39 8.56 7. 21p 8.06p 4.54 4.82 4.57 4.61 4.72 4.60 5.30 5.37 5.36 7.22 7.46 7.49 8.26 8.77 8.68 7.57 8.38 8.13 7.36p 7.97p 7.63p 5.97 6.04 5.74 5.87 6.14 6.30 7.66 7.68 8.27 8.20 7.60 7.54 7.70* 7.75* - - - 5.76 5.89 6.11 6.24 7.81 7.82 8.44 8.35 7.74 7.54 7.56* 7.53* FHA series (New) 5.97 5.83 6.40 7.99 8.52 7.75 7.70* Secondary market FHA insured (New) 5.69 5.47 6.38 8.26 9.05 7.70 7.56* 4.5 5.0 6.0 8.5 6.75 5.25 5-3/4 5-7/8 Corporate bonds New Issue (Aaa utility) Seasonal issues Total By selected rating Aaa Baa By group Industrial Railroad Public utility Residential mortgages Conventional first mtgs. New homes Existing homes Home mortgage yields Primary market (conv.) FHLB Bd. series New homes Existing homes Memorandum Prime lending rate Comm. banks (year-end) Source: Federal Reserve Bulletin. * Data is for September 1972. p indicates preliminary data. Table 2. Sector and Type of Loan Interest Rates on Selected Loans to Households and Businesses, 1972 January February March April May Jul* August 10.02 September Households Bank Loans: consumer 1/ Instalment credit New automobiles (36 months) Mobile homes (84 months) Other consumer goods (24 months) Other personal exp. (12 months) Credit card plans Finance Company Loans 4/ Automobiles: Total New Used Mobile homes Other consumer goods Personal loans 10.26 10.20 10.88 10.94 12.57 12.74 17.11 12.50 12.72 17.13 13,.09 12,.07 16..17 13.06 11.99 16.27 — — 10.12 10.61 12.43 12.60 17.20 2/ 10.00 10.45 12.37 12.58 17.221' 9.96 10. 73 12.44 12.63 17.25 9.98 10.49 12.38 12.65 17.25 9.97 10.77 12.39 12.73 17.25 13.01 11.86 16.47 12.29 I*. 30 21.23 13.02 11.85 16.52 13..02 n . .84 16.>57 12.,26 19.,43 21.,24 13.04 11.85 16*62 7. 34 7.32 7.44 13.02 11.92 16.32 12.57 19.73 21.21 13..00 11..87 16..40 7. 21 7.28 7.23 — 10.71 12.47 12.72 17.25 10.02 10.67 12.47 12.70 17.25 — Businesses Bank loans Small, short-term noninstal. 5/ Farm production loans, banks 1/ (less than I yr. maturity) Feeder cattle operations Other farm production Operating expenses 7. 31 7.19 7.16 7.55 7.46 7.37 7.44 7.35 7.44 7.34 7.54 7.55 7.63 7.62 7.51 7.57 7.58 7.73 7.55 7.58 7.75 Bank Loans (By size and maturity) 6/ Short-term All sizes ($'000) 1-9 10-99 100-499 500-999 1,000 and over Revolving credit All sizes ($'000) 1-9 10-99 100-499 500-999 1,000 and over 6.16 5.60 5.31 5.18 Long-term All sizes ($'000) 1-9 10-99 100-499 500-999 1,000 and over 5.64 6.98 6.85 6.19 6.13 5.44 Prime rate, banks 7/ Floating rate 1/ 2/ 3/ 4/ 5/ §/ 7/ 5.52 7.08 6.44 6.76 5.44 5.31 5.59 7.07 6.53 5.94 5.57 5.33 5.24 5.59 6.52 6.60 4-3/4 4-1/2-5 4-3/4 4-3/8-4-3/4 5 5-5-1/4 6.2 0 5.91 5.59 5.69 5.60 5.57 5.83 6.78 6.51 5.93 5.83 5.81 5.87 7.03 6.65 6.31 7.47 6.80 6.26 6.51 5.87 5.78 6.27 6.28 6.28 4-3/4 4-3/4-5 5.84 7.27 6.72 5 5 5-1/4 5-1/4 5-1/2 5-1/2 5-5-1/4 5-3/8-5-1/2 5-1/4-5-1/2 5-1/4-5-3/4 Interest rates in this category are based on a survey conducted jointly by the Federal Reserve System and the Federal Deposit Insurance Corporation of loans made during the first full calendar week of each month by a sample of 370 insured commercial banks. They represent simple unweighted averages of the "most common" effective annual rate reported by respondents in each loan category. The "most common" rate is defined as the rate charged on the largest dollar volume of loans in the particular category during the week covered in the survey. Consumer instalment loan rates are reported on a Truth-in-Lending basis as specified in the Federal Reserve Board's Regulation Z. Includes upward revisions of data for a few respondents to correct reporting errors. Revisions not carried back, and March data therefore are not fully comparable with earlier months. Includes upward revisions of data for one respondent to correct a reporting error. Revisions not carried back, and April data are therefore not fully comparable with earlier months. Interest rates on automobiles are finance rates on new and used car instalment credit contracts purchased from dealers by major automobile finance companies. Interest rates on mobile homes, other consumer goods, and personal loans are compiled from a bimonthly survey conducted by the Federal Reserve Board. For mobile homes and other consumer goods, the data cover contracts purchased by finance companies, primarily from retail outlets; for personal loans, they cover secured and unsecured loans made directly by finance companies for household, family, or other personal expenditures. Loans of $10,000 to $25,000 maturing in one year or less. Data are from the Federal Reserve Board's "Quarterly Survey of Interest Rates on Business Loans." Beginning November, 1971, several banks adopted a floating prime rate keyed to money market variables. The first rate shown is that charged by the majority of commercial banks; the second is the range of rates charged by those banks with a floating rate. Rates recorded are those prevailing on the last day of the month. Table 3 Rates of Return and Operating Costs in Commercial Bank Lending, By Size of Bank, 1971 (Size: [ \ l Deposits. Rates are percentages of^^lume outstanding.) O Category Up to $50 million (684 banks) 1 $50-200 million (231 banks) Over $200 million (79 banks) Total Loans Gross yield Less-expense Net yield before losses Losses Net yield after losses Cost of money Net yield after cost of money 8.255 1.980 6.274 .107 6.167 3.694 2.473 8.082 1.907 6.175 .120 6.055 3.438 2.617 7.994 880 114 154 960 346 2.614 Real estate mortgage loans Gross yield Less-expense Net yield before losses Losses Net yield after losses Cost of money Net yield after cost of money 7.047 .806 6.242 .029 6.213 3.906 2.307 7.101 .686 6.414 .024 6.391 3.662 2.729 7.422 .617 6.829 .031 6.798 3.609 3.189 Consumer instalment loans Gross yield Less-expense Net yield before losses Losses Net yield after losses Cost of money Net yield after cost of money 10.417 3.501 6.915 .354 6.561 3.801 2.960 10.169 3.445 6.725 .363 6.362 3.558 2.804 10.690 3.891 6.799 .369 6.430 3.500 2.930 Credit card loans Memo: Number of banks Gross yield Less-expense Net yield btrore losses Losses Net yield after losses Cost of money Net yield after cost of money 136 17.180 17.142 .038 1.962 - 1.924 3.676 - 5.600 101 17.951 14.215 3.736 1.953 1.783 3.484 - 1.701 54 18.862 14.431 4.431 2.682 1.749 3.369 - 1.620 Commercial and other loans Gross yield Less-»expense Net yield before losses Losses Net yield after losses Cost of money Net yield after cost of money 7.557 1.377 6.180 .240 5.940 3.767 2.172 7.311 1.113 6.199 .254 5.945 3.513 2.432 7.052 .912 6.140, .304 5.835 3.500 2.335 Investments Gross yield Less-expense Net yield before cost of money Cost of money Net yield after cost of money 6.674 .155 6.519 3.801 2.718 6.567 .112 6.454 3.559 2.895 6.729 151 6.578 3.500 3.078 7.590 1.213 6.377 7.459 1.168 6.290 7.513 1.223 6.290 3.801 2.576 3.558 2.732 3.500 2.790 Portfolio, loans and investments Gross yield Less-expense Net yield before cost of money (taxable basis) Cost of money Net yield after cost of money Source: Federal Reserve Board. Functional Cost Analysis: 1971 Average Banks. Ratios based on data for 994 participating member banks in Twelve Federal Reserve Districts. Table 4: 1961 Subject to AdminTotal istered Outstanding Rates Total Outstanding Household JL/ Consumer Credit Instalment Other Home Mortgages Other Bank Loans, NEC Security Loans Deferred & Unpaid Insurance Prem. Business Corporate Bonds Mortgages Home Multifamily Commercial Bank Loans, NEC 2/ Open Market Paper Finance Co. Loans U.S. Government Loans Trade Debt Other Liability Government State and Local Short-term Long-term A U.S. Government Marketable Bills Certificates Notes Bonds Non-Marketable Savings Bonds Special Issues Trust Foreign Other 792,,862 223,,046 57,,982 A3,,891 14,,091 147,,678 8,,138 6,,736 2,,512 388,,625 216,,310 57,,982 43,,891 14,,091 147,,678 8,,138 236,,954 79,,952 35 ,967 1 ,146 11 ,178 23 ,643 38 ,133 1 ,541 2 ,525 922 53 ,888 24 ,026 118,,115 332 ,862 76 ,062 3 ,636 72 ,426 256 ,800 158 ,600 39 ,500 3 ,700 50,,200 65,,200 54 ,200 98,,200 47,,400 44,,000 43,,500 500 6,,800 54,,200 47,,400 — 2,,512 — 1,,146 1,,146 — — 38 ,133 Amount Outstanding (Millions) 1971 Subject Subject to to AdminMarket Total istered Rates Outstanding Rates 404,,237 6,,736 1,556,,880 475,,875 137,,237 109,,545 27,,692 296,,117 25,,773 11,,180 5,,568 806,,054 464,,695 137,,237 109,,545 27,,692 296 ,117 25,,773 582,,102 187,,305 89,,046 2,,615 23,,014 63,,417 101,,807 9,,577 13,,562 1,,604 119,,276 59,,925 285,,227 278 ,662 76 ,062 3 ,636 72 ,426 202 ,600 158 ,600 39 ,500 498,,903 166,,471 19,,179 147,,292 332 ,432 173 ,400 65,,900 56 ,132 3,,700 50,,200 65 ,200 69,,300 38,,200 — — — — — 6,,736 - 118,,839 79,,952 34,,821 — 11,,178 23,,643 — — 1,,541 — 2,,525 922 53 ,888 24 ,026 — — 54 ,200 — — — — — 6,800 Debt Outstanding by Type and Sector and Interest Rate Determination: Administered vs. Market (Amounts in Millions of Dollars) — — - 44,000 — 44,000 43,500 500 — 159,032 53,832 102,900 85,500 17,400 2,300 — 5,,568 — 2,,615 2,,615 — — 101 ,807 — — 1 ,604 119 ,276 59,,925 — — — 56 ,132 - — - 56,132 53,832 __ Subject to Market Rates 750,,826 11,,180 — — — — — 11 ,180 - 296,,875 187 ,305 86,,431 — 23,,014 63,,417 — 9 ,577 13,,562 -- — - 442 ,771 166 ,471 19 ,179 147 ,292 276 ,300 173 ,400 65,,900 69,,300 3fi.200 102,900 __ 85,500 17,400 2,300 1/ Includes some data for personal trusts and non-profit organizations. The line items selected for this part of the table are believed to contain data mostly attributable to the household sector. 2/ With the exception of those banks which follow a floating prime rate. 3/ Percentages are otnitted when all of outstandings belong to one category. Source: Federal Reserve Board Percentage Distribution of Amount Outstanding 1961 Subject Subject to Subject to Adminto Administered Total Market istered Total Rates Outstanding Rates Rates Outstanding 100.00 28.14 7.31 5.54 1.78 18.63 1.03 .85 .32 100.00 55.66 14.92 11.29 3.63 38.00 2.09 29.88 10.08 4.53 0.14 1.41 2.98 4.81 0.19 0.32 0.12 6.80 3.03 30.39 41.98 9.59 0.46 9.13 32.39 20.00 4.98 0.47 6.33 8.22 13.95 12.39 5.98 5.55 5.49 0.06 0.86 13.95 12.20 100.00 30.57 8.81 7.03 1.78 19.02 1.65 .73 .36 100.00 57.66 17.03 13.59 3.44 36.74 3.20 37.38 12.03 5.72 0.17 1.48 4.07 6.54 0.62 0.87 0.10 7.66 3.85 35.38 68.94 18.82 0.90 17.92 50.11 39.23 9.77 0.91 12.42 16.13 32.05 10.69 1.23 9.46 21.36 11.14 4.23 6.96 10.88 10.22 3.46 6.61 5.49 1.12 0.15 100.00 1.67 ------ 1.67 .65 0.29 0.29 29.39 19.78 8.61 __ -- 9.81 -- __ 0.38 0.62 0.24 13.87 6.18 13.95 -- ---- 1.75 2.76 5.85 --- 10.88 10.76 0.12 -- 4.46 2.45 -- Subject to Market Rates 100.00 1.49 Per cent of Total Outstanding^/ 1971 1961 Subject Subject to Subject to Subject Adminto Adminto Istered Market istered Market Rates Rates Rates Rates 48.23 2.35 49.02 96.98 50.98 3.02 51.71 97.65 49.85 50.15 49.00 51.00 3.19 96.81 2.94 97.06 16.28 83.72 11.25 88.25 21.11 78.89 16.88 83.12 55.19 44.81 35.30 64.70 ----- 1.49 .69 -- 0.32 0.32 — -- 12.63 --- 0.20 14.80 7.44 -- i--- 6.96 --- 39.54 24.95 11.52 -- 3.07 8.45 -- 1.27 1.80 --- 58.97 22.17 2.55 19.62 36.80 23.10 8.78 -- — -- 9.23 5.09 — 6.96 6* 68 13.70 -- 13.70 11.39 2.31 --- 0.28 -- -- Table 5. Liabilities of All Insured Commercial Banks in the United States* (Dollar amounts in millions; ratios in per cent) Dec. 30, 1961 Liability Item Savings deposits Time deposits Negotiable CD's Time deposits less negotiable CD's Dec. 31, 1971 $ 63,685 18,770 1/ 1/ $ 111,475 163,151 33 951 129,200 164,721 261,077 2/ 462 2/ 1,689 5,185 24,177 1,451 655 4,038 16,617 2/ 4/ 4 6,429 Total capital accounts Capital notes and debentures Equity capital - total Preferred stock Common stock Surplus Undivided profits Other capital reserves 22,088 22 22,067 15 6,571 10,783 4,153 545 46,731 2,938 43,793 92 11,762 19,829 11,101 1,009 Total liabilities and capital 276,600 635,805 88,123 320,464 Demand deposits - total Federal funds purchased and securities sold under agreements to repurchase Other liabilities for borrowed money Mortgage indebtedness Bankers' acceptances outstanding Other liabilities 3/ Minority interest in consolidated subsidiaries Total reserves on loans and securities Interest - bearing liabilities 5/ Ratio of interest - bearing liabilities to total liabilities and capital * 31.9 50.4 Continental U.S. only. 1/ Not reported separately prior to 1964; subsequently at weekly reporting banks only. 2/ Not reported separately in 1961. 3/ Reported as "rediscounts and other borrowed money11 in 1961. 4/ Not included in balance sheet prior to 1969. 5/ Total liabilities and capital minus demand deposits, bankers' acceptances outstanding, ~~ minority interest in consolidated subsidiaries, total reserves, and equity capital - total. TabLe 6. Income, Expenses, and Dividends of Insured Commercial Banks" (Dollar amounts in millions; ratios in per cent) Income item Operating expenses - total Interest paid on: Deposits Federal funds purchased securities sold under agreement to repurchase Other borrowed money Capital notes and debentures 1961 1971 1/ 7,440 29,651 2,107 12,218 2/ / 38 _1/ 1,096 139 142 Ratio to total operating expenses Interest paid on: Deposits Federal funds purchased and securities sold under agreements to repurchase Other borrowed money Capital notes and debentures 28.3 41.2 2j 2/0.5 3.7 0.5 1/ 0.5 2.7 4.8 Interest on time and savings deposits to time and savings deposits (Time and savings deposits outstanding - in millions) 3/ (77,659) 3/ (255,655) * U.S. and other areas 1/ "Interest on capital notes and debentures" and "Provision for loan losses" not included in "operating expenses-total" prior to 1969. 2/ "Interest on Federal funds purchased, etc." was included in "Interest on borrowed money" prior to 1969. 3/ For 1961 averages of amounts for four consecutive official call dates beginning with the end of the previous year and ending with the fall call of the current year. For 1971, averages of amounts reported at beginning, middle, and end of year. Table Effective Date 7. Prime Rates Charged by Hanks: Floating vs. Fixed Rates October 20, 1971 to November 6, 1972 Floating Rate Range 1/ (per cent) Fixed Rate 2/ (per cent) Leadership Role of Floating Rate Banks 3/ Success October 20, 1971 November I November 4 November 8 November 22 November 29 December 6 December 27 December 31 5-3/4 5-5/8-5-3/4 5-1/2-5-5/8-5-3/4 5-1/2 5-3/8-5-1/2 5-1/4-5-1/2 5-1/4-5-3/8-5-1/2 5-1/4-5-1/2 5-1/4 5-3/4 5-3/4 5-1/2 5-1/2 5-1/2 5-1/2 5-1/2 5-1/2 5-1/4 January 3, 1972 January 17 January 24 January 31 February 28 March 13 March 20 March 27 April 3 April 5 April 17 May 1 May 30 June 12 June 26 July 3 July 10 July 17 July 31 August 2 August 7 August 14 August 21 August 25 August 29 September 4 September 5 September 11 September 25 October 2 October 4 October 16 November 6 5-5-1/8-5-1/4 4-3/4-5 4-5/8-4-3/4-5 4-1/2-4-3/4-5 4-3/8-4-1/2-4-3/4 4-1/2-4-3/4 4-3/4 4-3/4-4-7/8-5 4-3/4-5 5 5-5-1/4 5-5-1/8-5-1/4 5 5-5-1/8 5-5-1/4 5-1/4-5-3/8 5-1/4-5-3/8-5-1/2 5-1/4-5-1/2 5-3/8-5-1/2 5-1/4-5-3/8-5-1/2 5-1/4-5-3/8 5-1/4 5-1/4-5-3/8 5-1/4-5-3/8-5-1/2 5-1/4-5-3/8-5-1/2 5-1/4-5-1/2 5-1/2 5-1/2-5-5/8 5-1/2-5-5/8-5-3/4 5-3/4 5-3/4 5-3/4-5-7/8 5-3/4 5-1/4 5-1/4 5 4-3/4 4-3/4 4-3/4 4-3/4 4-3/4 4-3/4 5 5 5 5 5 5-1/4 5-1/4 5-1/4 5-1/4 5-1/4 5-1/4 5-1/4 5-1/4 5-1/4 5-1/4 5-1/2 5-1/2 1/ 2/ 3/ ~~ 4/ "" 5-1/2 5-1/2 5-1/2 5-1/2 5-3/4 5-3/4 5-3/4 Time Lag in Adjustment of Fixed Rate Banks 4/ (days) Failure 39 X 21 X 7 14 23 Floating prime rates are defined as those rates charged by large banks which announce that they will tie their prime lending rates to money market variables. Data are necessarily fragmentary since some banks that float their rates do not announce their prime rates. Fixed rates are the prime rates charged by the majority of banks. Floating rate banks are assumed to play a "successful" leadership role when a rate change by one or more of the floaters establishes a trend to a new rate level which is subsequently joined by the majority of fixed rate banks. A "failure" of leadership is assumed to occur when one or more of the floaters makes a rate change but the majority of fixed rate banks do not follow the move to confirm the change as a new, generally accepted rate. The time lag in adjustment is the amount of time it takes the fixed rate banks to change to a new rate after such change has been successfully led by the floating rate banks. Table 8. Funds Raised in the Capital Market, Third Quarter, 1971--Third Quarter, 1972 (Billions of Dollars) 1971 III Total Funds raised by nonfinaneial sectors IV I 1972 II IIIp 173.7 164.1 145.4 156.2 162.5 25.9 25.6 0.3 31.4 30.6 0.8 6.4 4.2 2.2 16.0 14.6 1.5 15.7 12.8 3.0 147.9 17.0 132.7 11.4 139.0 10.3 149.6 15.9 151.8 11.1 130.9 121.2 128.7 133.7 137.7 Debt capital instruments State and local government securities Corporate & foreign bonds Mortgages Home mtg. Other residential Commercial Farm 89.7 19.2 15.9 54.6 32.1 8.8 11.5 2.2 91.2 17.7 18.8 54.6 31.4 9.3 11.7 2.3 82.6 16.7 12.9 52.9 28.7 8.7 12.9 2.6 94.7 14.3 14.7 65.8 38.1 9.9 14.9 2.9 105.7 17.6 14.7 68.3 39.5 10.6 15.3 2.8 Other private credit Bank loans, nec. Consumer credit Open-market paper Other 41.1 23.6 12.6 2.2 2.8 30.1 12.4 14.5 - 3.0 * 6.1 46.1 20.6 13.3 2.9 8.6 39.0 16.9 17.5 0.3 4.2 32.0 16.9 18.6 - 5.5 5.1 147.9 8.0 20.2 46.8 72.9 57.5 10.6 4.9 132.7 3.6 18.0 55.1 55.9 42.8 8.8 4.3 139.0 4.2 17.8 49.2 67.8 53.9 10.1 3.9 149.6 1.5 14.7 61.4 72.0 56.4 10.7 4.9 146.8 3.0 18.0 66.5 59.3 44.8 9.7 4.8 3.4 11.8 - 10.7 4.1 - 5.0 170.4 22.5 152.3 19.6 156.1 17.1 161.5 11.9 167.5 20.7 U.S. Government Public debt Budget agency issues All other nonfinancial sectors Corporate equity shares Debt instruments By Borrowing Sector Foreign State and local Government Households Nonfinancial business Corporate Nonfarm noncorp. Farm Memo: U.S. Government cash balaTotals: net of changes in U.S. C "ernmenf. cash balances Total funds raised By U.S. Government Source: Federal Reserve Board, FLow of Funds Section p « preliminary.
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