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Statement by

Arthur F* Burns

Chairman, Beard of Governors of the Federal Reserve System

before the

Committee on Banking a.nd Currency

House of Representatives

April 26, 1971

I appreciate the opportunity to participate in these hearings,
which seek ways to strengthen our financial system and the economy
that it supports.
We at the Federal Reserve welcome this inquiry, and want to
be as helpful as we can.

Amr>ng the variety of proposals before you,

there are some which would alter established patterns of doing
business--not just for banks or other financial institutions, but also
for business firms of all kinds, in small towns as well as major
financial centers.

Before you act on these proposals you will need

to know a good deal about these existing business relationships, in
order to assess the consequences, good and bad, of changing them.
In testifying for the Board, I am very much aware of the limits of
our knowledge about these relationships.
to comment on all the proposals.

Therefore I will not try

Rather, I will offer for your

consideration only those judgments that the Board feels reasonably
confident are supported by our experience and understanding*
One area with which we are familiar involves interlocks
among banks.

Section 8 of the Clayton Act deals generally with

interlocking relationships and specifically with interlocking bank

The Board is responsible for enforcing section 8

to the extent that it involves member banks of the Federal Reserve


Our experience has convinced us that there is nothing inherently
wrong about interlocking directorates.

On the contrary, corporate

boards of directors should be composed of men having diverse backgrounds, so that the corporations they serve may benefit from their
ideas and experience* I might add that bankers, because of their
broad experience, are especially qualified to serve as directors of
other corporations, and this accounts for the fact that many serve in
this capacity.

The cross-fertilization which director interlocks have

provided America1 s corporations has been manifestly healthy for
business and the nation.

Public policy, as embodied in the Clayton

Act, has recognized this fact.

The Clayton Act was designed to

prohibit only those interlocks which tend to diminish or eliminate

Aside from this salutary prohibition, interlocks are

In view of the difficulties involved in determining on a case
by case basis when banks are in competition with each other, section
8 uses a simple test.

Interlocks are prohibite'-} when the two banks

are in the same or neighboring cities and towns.

In 1935, when this

test was adopted, it was believed to be a workable way of confining
the restriction on interlocks to those situations where it is really
needed to avoid anticompetitive consequences.
the test has worked well over the years.

Generally speaking,


The risk of thwarting competiton within a city is not confined,
however- to interlocks involving member banks.

We believe therefore

that the prohibition of interlocks should cover all insured commercial

Indeed, we believe the prohibition should extend to savings

banks and savings and loan associations, as well as commercial banks*
There is sufficient overlapping of functions among these institutions to
support a general presumption that those in the same or neighboring
communities compete with each other.
You may wish, as well, to consider covering institutions whose
deposits are not federally insured.

Exempting uninsured commercial

banks may be of minor importance, since only about 200 banks
accounting in the aggregate for less than 1 per cent of total deposits
are uninsured.

However, about a third of all mutual savings banks

and a fourth of all savings and loan associations are uninsured, and
they hold about 13 per cent and 3 per cent of their respective total
While H« R. 5700 would exempt interlocks between banks
that are owned by the same company, it would prohibit interlocks
between those that are owned by the same individuals--so-called
"chain banking, !f The exemption should apply to both instances, inasmuch
as interlocks cannot reduce competition between banks that are already

-4under common control.

Section 8 of the Clayton Act now exempts

interlocks between two or more banks where a majority of the common
stock is owned by the same persons.

We believe a comparable exemp-

tion should be written into H«; R. 5700*
We also believe that the types of interlocking service that
are now prohibited should be reexamined.

For member banks,

section 8 covers interlocking service as a "director, officer, or
employee,11 whereas for other corporations it applies only to service
as a director.

It seems needlessly restrictive to cover all employees;

we recommend instead that coverage be limited to service as a

director or an officer, or an employee with management functions. M
H. R* 5700 would prohibit bank interlocks without regard to

th<* competitive relationship of the banks or their geographic location.
The Board recommends, instead, retention of the present geographic
test--so that interlocks would be barred only where they involve banks
located in the same or adjacent communities—with two exceptions*
First, we recognize that some banks compete in markets
that are nationwide.

Nationwide competition for both deposits and

loans has been increasing and can be expected to increase further
in the future.

The Board recommends, therefore, that interlocks

be prohibited among all banks over a certain size--perhaps $1 billion


in assets — regardless of where they are located.

Admittedly, there

is an element of arbitrariness in this test, but we think that the
alternative of making detailed analyses of competition in various
banking markets would be impractical*

Provision should perhaps be

made for administrative waivers of this prohibition upon a showing by
the banks involved that they operate in separate markets.

And it

could prove useful to grant authority for changes in the $1 billion
figure by regulation.
Second, we suggest a variant of the geographic test for
holding company banks, namely, interlocks should be prohibited
between a holding company or any of its subsidiary banks, wherever
located* and any other bank located in or adjacent to any community
served by a subsidiary bank*
In weighing the need for the additional restrictions in
sections 2through 10 of H. R, 5700, it should be borne in mind that
section 8 of the Clayton Act now prohibits interlocking directorates
between corporations engaged in interstate commerce which are

by virtue of their business and location of operation, competitors,

so that the elimination of competition by agreement between them
would constitute a violation of any of the antitrust laws, fl It would
be helpful if the Congress made it entirely clear that this provision


applies to interlocks between banks and nonbank businesses.


action would provide ample protection against interlocks where the
anticompetitive effects may be significant.

In considering further

restrictions, Congress should proceed very cautiously so as not to
inhibit banks or other corporations--particularly new or smaller
ones--in their search for directors of the highest caliber available*
Let me turn now to sections 12 and 13 of H. R* 5700, which
relate to the trust departments of insured commercial banks.
Section 13 prohibits a trust department from holding stock
issued by the bank itself or its parent holding company.

In such

situations, if the bank has sole voting rights there is a risk that the
stock may be voted to perpetuate the bankTs management in office.
Where a national bank holds its own stock as sole trustee, it is not
permitted under section 5144 of the Revised Statutes to vote that
stock in an election of directors unless the !ldonor or beneficiary
actually directs how such shares shall be voted. !l The essential
purpose of the prohibition in section 13 against a bank holding its
own stock in its trust department can be better served by extending
the provisions of section 5144 to insured State banks.


Section 13 would also prohibit a bank trust department from
holding more than 10 per cent of any class of stock registered under
the Securities Act of 1933•

The Board doubts the wisdom of such a

Among other difficulties, it would deny individuals with

very substantial holdings in the stock of a corporation access to the
services of bank trust departments and thereby practically force
them to rely on individual fiduciaries*

This could cause serious

problems for individuals and families that need or want to rely on an
institution with a permanent life.

Furthermore, if individual bequests

naming a bank's trust department as trustee should raise that department's aggregate holdings of some stocks above the 10 per cent limit,
this bill would force the trust department to sell off some of such
holdings even if it were adverse to the investment interests of the
beneficiary to do so#
The argument for the limitation is that bank trust departments
hold large blocks of stock in major corporations, and thus could
exercise influence over them.

However, as the SECTs Institutional

Investor Study Report points out, the "existence of potential power
on the part of institutions to influence corporate decisions by reason
of their substantial shareholdings does not demonstrate that such
influence is in-fact .exercised* lf (Summary Volume, p, 124) If the


Congress concludes, nonetheless, that a 10-per cent limit ie needed,
its potentially disruptive effects could be lessened by applying it only
to future purchases made at the initiative of the trust department.
Section 12 of the bill would require bank trust departments
to disclose annually a list of all securities held (other than Government securities), indicating the name, class, value, and number of
each security held, the authority of the trust department to exercise
voting rights, and the manner in which it exercised proxies.
In other words, section 12 would require public disclosure
of all assets, debt instruments as well as equities, small interests
as well as large, without regard to the bank's role in acquiring the
assets or its ability to exercise voting power.

Such a sweeping

requirement would result in the disclosure of interests that could
be readily associated with trust customers who would consider such
disclosure an invasion of their privacy.

As a consequence, much

of this business may well be transferred to unregulated trustees.
Compilation of the vast array of statistics required would also
necessitate changes in procedures that conld prove too costly for
all but the biggest banks.
It would appear that the objectives of section 12-~public
disclosure of information needed to assess the impact of bank trust

-9investments on securities markets and on economic concentration-could be accomplished with a requirement confining disclosure to
holdings where the stock is registered under the Securities Exchange
Act of 1934, where the trustee has exclusive voting rights, and where
the trustee's aggregate holdings of the stock exceed a specified amount,
say, $1 million.

The Board also recommends that this disclosure

requirement apply to all fiduciaries, not only the bank trust departments.
Section 14 oi the bill would prohibit banks, other thrift institutions,
and insurance companies from accepting any equity participation in
consideration of making a loan,


Equity participation" is defined to

include two quite different kinds of economic relationships:


an ownership interest in any property or enterprise; second, a right
to any payment which is linked to the income from any property or

The first relationship is clearly susceptible of speculative

abuse; the second may provide a constructive method for adjusting
credit charges to changing economic conditions.

As recent experience

has demonstrated, the second form of financing can in fact facilitate
extensions of credit to relatively new firms and real estate developers
which typically lack ready access to the public capital markets.
A ban on acquiring of ffownership interests11 by banks is not needed,
in view of the prohibitions in existing law against bank purchases of



Howe-ver> banks may—and gome do--make loans that provide

for a return to the bank that varies according to the income of the
property or business financed.

Heavy concentration in loans with

such variable-return provisions could pose a threat to bank safety,
While bank examiners are mindful of this risk, the Congress may
deerp it prudent to lirr-it the aggregate of loans with such provisions
to a specified percentage of a bank's total assets or its capital and
Section 15 of the bill would require each insured bank to report
to the FDIC all loans it makes to any of its directors, trustees,
or employees, or their families.


It would also prohibit the bank from

extending credit to any corporation in which such persons (as a group)
have as much as a 5 per cent stock interest.

These provisions would

change existing banking practices far more than is wise, particularly
in small towns.

It is quite common and salutary for a bank to include

on its board of directors individuals who have substantial interests in
business firms in town.

These firms are likely to do business with

the bank in a number of ways, including borrowing.

To force the bank

to choose between cutting off credit to such firms and excluding their
principal stockholders from its board of directors could result in
stagnant towns or weaker banks.

-11Still, something needs to be done to provide more protection
against unsound loans to insiders.

One possibility would be to amend

the Financial Institutions Supervisory Act of 1966 to make cease-anddesist orders more readily available to stop these practices when they
are discovered in the course of bank examinations.

We have in mind

a provision that would establish a presumption that it is an unsafe and
unsound banking practice for a depositary institution to lend to insiders
or enterprises controlled by insiders an amount that in the aggregate
exceeds a specified percentage of the institution's capital and surplus.
If a bank failed to observe this rule the supervisory agency could file
a notice of charges, with the bank bearing the burden of establishing
that the loans in excess of the limit are safe and sound.
Section 19 of the bill would prohibit insured banks from paying
compensation to brokers or others for obtaining deposits for the bank*
Brokered deposits at State member banks have not posed serious

As of July 31, 1970, according to a survey of State member

banks, only 30 out of 1, 157 reporting banks held brokered deposits and
they amounted to less than 1 per cent of total deposits in those 30

A case can be made that brokers help to channel funds into

capital-poor areas.

However, in view of the part that loans tied to

brokered deposits have played in bank failures in recent years, we are


inclined to agree with those who conclude that the benefits of brokering
are outweighed by the dangers, and we therefore support section 19*
We recommend against enactment of the criminal sanctions provided
in section 21, since we believe the civil penalties provided in section
19 plus other remedies available are sufficient for enforcement purposes.
Moreover, section 21 as drafted would seem to prohibit legitimate
activities such as paying an employee for bringing in new deposits,
whereas section 19 m^eta this problem by authorizing the FDIC to prescribe
regulations, which presumably would exempt such activities.
Sections 25 and 26 provide for full insurance of public deposits
in institutions insured by FDIC and FSLIC.

The Board is concerned

about the impact of these sections on the markets for Federal and
municipal obligations.

Banks are now generally required to pledge

collateral as security for uninsured public deposits.

A sizable portion

of the Treasury and municipal obligations held by banks is pledged
under these collateral requirements.

For example, according to the

latest survey available (1966), over half of the Treasury obligations
held by commercial banks were pledged for this purpose; among
larger banks the proportion was even higher.

Extending insurance

coverage as proposed by H. R. 5700 would reduce the attractiveness
of such securities as investments for the banks, and thus tend to raise
borrowing costs for the Federal, State, and local governments.

-13Let me turn now to Mr, Gonzalez1 bill, H. R. 3287, which
would prohibit any insured bank from making a loan to finance the
purchase of stock or obligations of another bank.

A flat prohibition

of this kind would reduce flows of capital into banking and severely
restrict ownership of banks, eliminating potential entry by those who
cannot afford to buy bank stock without a bank loan.

The Board

therefore recommends against enactment of H. R, 3287.


theless, while H, R. 3287 is too restrictive, some additional controls
over bank loans on bank stock are needed.

We believe Congress

should authorize one or more of the regulatory agencies to prescribe
regulations applicable to all insured banks, with a view to ensuring
that loans made to finance the purchase of bank stock meet sound
banking standards and are not used as devices to promote the interests
of speculators or the lending bank to the detriment of the purchased
In conclusion, let me say that the Board fully joins this
Committee in its efforts to improve the organization of finance in
our country*

We can and do support numerous provisions of H. R.

We also support the objectives cf H. R. 3287.

We believe,

however, that the legislation before this Committee goes beyond what
is necessary to achieve the objectives that their distinguished authors
seek to promote.