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You will recall the case of the man who stated in his will,
that he had led a very unhappy life , worrying about things, 90;' of which,
however, never happened.

This statement, unfortunately, would equally

apply to the attitude of many bankers toward the Federal Reserve System.
It is, also, time that these same hankers have in the past had many un­
happy moments worrying about things which frequently did happen, but
which are not now likely to happen again.

Frank discussion of these

matters with the member bankers would dispel some of the misconceptions
of the effect of this legislation and make clearer scane of the advan­
tages which may not yet have become distinctly apparent.
It has frequently been stated to me that the Federal Reserve
banks will not earn their expenses, much less their dividends, and that
the member banks, either directly or indirectly, must stand some loss.
This surmise is unfounded.

The Federal Reserve Bank of New York in the

past six months, has earned all of its current expenses and a consider­
able sum to be applied towards liquidating the expenses of organization,
and while it may take some months to extinguish the latter item, it would,
if that were necessary, be quite proper to apportion it over a period of
years, as the greater part of the organization expense consisted of the
cost of preparing an initial supply, and a very large one, of Federal Re­
serve notes.

The Federal Reserve Bank of New York has total resources

of $140,000,000,

With but 10-fo of these resources invested and loaned

at

the present very low rates of interest, the bank is to-day making earnings
at the rate of about §200,000, a year, after paying its running expenses.
If from 20$ to 25% of its resources were invested at present rates, it




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would earn its expenses and dividends and have something in excess to
add to surplus, and its reserves would still exceed 75% of its liabil­
ities*
It has not, however, been the policy of the bank to force its
funds into use at a time when huge excess reserves are held by the banks
throughout the country.

Had the Reserve banks been in operation a few

years, and accumulated a considerable loan and investment account, their
policy under present conditions should be to withdraw funds from the
money market for the purpose of correcting undue ease of money rates, which
is only too frequently accompanied by unsound expansion and speculation.
In fact, the policy of the reserve banks in using their funds, should be
influenced by the desire to stabilize rates, rather than to employ their
funds at any rate obtainable, for the sole purpose of earning dividends,
without regard to the effect of such a policy.
The statement has also been made by same bankers of our dis­
trict that very little, if any, of the paper held by their banks is el­
igible for rediscount with the Federal Reserve Bank.

Those bankers who

make this statement are liable to create the impression that this opinion
is held generally by member banks;

but an examination of statements filed

with us disclosed that only about 80 banks, out of 480 members, reported
that they had very little, if any, paper eligible for rediscount.

With

these, we have ccranunicated, in order to ascertain upon what theory their
reports were based.

By correspondence and personal interview with many

of them* we have satisfied them, as well as ourselves, that one-half or
more of the paper they hold is eligible for rediscount.




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The reports, also, disclosed that the banks outside of the
City of New York, which carry about $10,000,000. of reserve deposits
in our bank, claim to hold no less than $79,000,000. of eligible paper,
qnfj the banks of New York City which have on deposit with us $120,000,000.
report $248,000,000. of eligible paper.
Up to the present time, and until July 15th, considerable lat­
itude has been allowed as to the method by which the eligibility of notes
offered for rediscount, shall be determined*

The judgment of the officers

of the member banks and of the Reserve bank has been exercised broadly,
and I may say, without undue regard to technicalities, few notes have been
rejected on account of failure of eligibility;

some having been returned

owing to carelessness in drawing or indorsing;

and it has been our practice

- which we shall continue - to act upon the application on the day of re­
ceipt, and advise credit if so requested by telegraph.

There is, in fact,

no red tape to be untied, nor is there any disposition to use it.

On

July 15th next, however, Regulation B becomes effective, and to the terms
of that regulation your attention should be particularly directed.

After

July 15th, member banks will be expected to furnish more specific evidence
of eligibility of notes when applying for rediscounts*

As to smaller bor­

rowers whose notes are offered for rediscount, considerable latitude will
still be permitted in determining the question of eligibility;

as to larger

borrowers, the member banks are asked to adopt standards of credit infor­
mation which will enable them to promptly determine for themselves the el­
igibility of the paper which they desire to rediscount.

The regulation is

based upon three important general rules:




First:

That the member bank should have in its files an original

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or certified copy of a signed statement disclosing the financial condition
of the borrower in the case of all commercial paper purchased from brokers
or through correspondents.
Second:

That it should have similar statements on file as to

the financial condition of customers whose notes are offered for rediscount
for a total amount of $5,000 or over, or for an amount exceeding 10$ of
the capital stock of the member bank making the application;

that is to

say, financial statements must be held as to all purchased paper, and as
to paper made by the bank*s customers where the amount of the customer’ s
obligation rediscounted exceeds $5,000 or 10$ of the bank’ s capital.

On

the other hand, no such statement is required by this regulation as to
customers whose paper is offered for rediscount in smaller amounts than
those named, in order that they should be eligible.
Third:

That the proceeds of the loan must have been used or

be intended for use in some industrial, commercial or agricultural trans­
action, but not for the purchase of land, buildings or machinery, or other
fixed or permanent assets or investments, or for the purchase of goods
carried for speculative purposes.

Most bank officers are sufficiently

well-acquainted with those who borrow small amounts, to readily ascertain
the purpose for which the loan was made.

In the case of larger bor­

rowers, this can be best determined by an examination of a statement of
the borrower’ s financial condition.

His statement should be made in

such form as to disclose whether the amount of his current assets, that
is to say, cash, bills and accounts receivable, stock of goods, or raw
and partly manufactured material, is reasonably in excess of his current
debts.

Should the borrower’ s statement disclose that his short loans

«nri bills and accounts payable, in other words, his current liabilities,



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are greater in amount than his quickly convertible assets, it would nec­
essarily indicate that seme portion of the proceeds of his short loans has
been invested in more permanent form in his business.

Such a condition

would, in most cases, render the credit doubtful unless strengthened by
an indorsement.

Notes made by borrowers of that character are therefore,

not eligible for rediscount but if the loan is made to a good indorser and
his statement conforms to the same test of eligibility that is required of
a maker of an unindorsed note, it then becomes eligible for rediscount.
Firms and corporations engaged in mercantile or manufacturing
business as a rule can make statements which can be readily analyzed to
determine this question of eligibility.

With an individual, and par­

ticularly the agricultural borrower, this seems more difficult.

If the

loan is made for a commercial purpose, or its proceeds are used in ag­
riculture, its eligibility can usually be ascertained by inquiry of the
borrower at the time the loan is made.

Encouragement of the practice of

requiring financial statements will in itself tend to establish higher
standards of banking.
confused.

Eligibility and goodness, however, should not be

It is assumed that every loan made by a member bank is good,

but only those made for commercial purposes and having the self-liq­
uidating characteristics referred to, are eligible.

There will now be

incentive for bank officers to use greater energy in obtaining definite
knowledge of the financial condition of their customers in order that
their banks may have considerable percentage of paper eligible for re­
discount.

Customers of a member bank will likewise be benefited by the

additional assurance afforded to the bank that at times of seasonal demand




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and in time of crisis, their bank has an assured means of converting a
large percentage of its paper into credits for the benefit of its own
customers.

Officers of member banks have frequently stated that they

felt obliged to keep ^.portion of their resources invested in bonds in
order that they might have collateral readily available at any time for
borrowing purposes.

With standards of canmercial borrowings so estab­

lished that a large portion of the paper held by the banks is readily
convertible at the Federal Reserve Banks, the necessity for carrying a
bond account, simply for borrowing purposes, should no longer exist.
It must not be assumed that these changes can be brought
about at once, nor would the development of the system be promoted by
attempting to force new methods upon member banks, without allowing
ample time for study and preparation.

But the mere establishment of

a standard for canmercial paper which may be rediscounted, will gradually
exert an influence towards the creation of that class of paper, that
will be more effective in bringing about the desired result than will
the establishment of restriction rules.
mand better rates.
irresistible.

Such paper will in time com­

The influence of discrimination will ultimately be

The experience of the past six months has given much ev­

idence of the desire of member banks to gain a better understanding of
what is required in order to make as large an amount of their assets as
possible available for rediscount with the Federal Reserve Banks.
The Reserve banks are at present engaged in the establishment
of a system for collecting cheeks, the details of which plan are so well
known as to require no particular comment,




Discussion of the plan, how­

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ever, discloses two strong objections in the minds of the officers of
member banks, - one being the possible loss of revenue from exchange
charges now made by the country banks, and the other the possible loss
of interest on balances at present carried with Reserve Agents, through
whom collections are made, and which now count as reserves.
As to the first objection:

Experience must demonstrate whether

economies resulting from a more prompt and scientific system for collect­
ing country checks, together with earnings growing out of the enjoyment
of other advantages afforded by the Federal Reserve system, may not en­
tirely make up the loss of exchange charges to the extent that such
charges are reasonable and legitimate.
As to the second objection:

Some of us feel that in many cases,

the present system of check collection necessitates carrying larger com­
pensating balances than should be required or will be necessary when the
Federal Reserve collection system is in full operation.

To the extent

that balances maintained solely for collection purposes can be withdrawn
and used locally, additional revenues will accrue to the member banks.
The statement is, also, frequently made that the member banks
that join the system, are liable to suffer unexpected depletion of their
reserve balances, and on that account, they will find it necessary to
carry unaccustomed excess balances in order to anticipate such depletion.
This, we hope, will not be the case.

As stated in our circular to member

banks and as indicated in a more recent circular letter, it is our in­
tention to cooperate in every way possible with the banks for whom we
are collecting checks, so as to enable them to maintain the reserve




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required by law without unnecessary depletion or unnecessary excess.

If

a member bank finds, after experience, that the charges against its account
exceed the amount of the offset which tv>ey are able to remit, it should
be possible by arrangement with its Reserve Agent to make regular trans­
fers for its credit by a simple transfer entry on the books of the re­
serve bank.

On the other hand, the Federal reserve bank vdll enter into

such arrangement as may be desired to make regular transfers from the ac­
counts of member banks to the credit of the member banks' Reserve Agent,
so that excess balances should not unduly accumulate.

This plan should

u.

prevent unexpected impairment of reserves, as well as unnecessary loss of
interest on balances.
It is also urged that, as a considerable percentage of the checks
handled by country banks are drawn on state institutions, and cannot be col­
lected through the Reserve Bank, country banks nust continue existing col­
lection arrangements, carrying collection accounts with their correspon­
dents, and that after two years such balances will not count as reserve.
On this account, the claim is made that reserve requirements are, in fact,
increased by reason of the Act, rather than decreased and that further
losses of interest will result from this cause.

This conclusion an­

ticipates a possible loss to arise a year or two hence.

The balances

will count as reserve wholly or in part for the next two years.

It

also assumes that no progress will be made in the next two years in finding
a satisfactory method of dealing with the situation.

It also assumes

that state banks will not take membership in the Federal Reserve System,
and such assumption is far from being justified.




To the extent that the

-9member banks employ the facilities of the reserve bank for collecting
checks on member banks, the necessity for carrying outside balances will
be reduced, and to the extent that state banks take membership, the ne­
cessity for carrying outside balances will be further reduced.

In order

to minimize the necessity for carrying additional balances that two years
hence will not count as reserve, member banks should employ the .Reserve
Bank collection facilities to the fullest extent possible, rather than
to reduce the effectiveness of this collection facility by withholding
their consent to the plan.
7/e also frequently hear the claim made by the country banker
that he will be unable to conduct his business and make his collections
economically on the 12> reserve now permitted by the law, and that he is,
therefore, unable to take advantage of the reduced reserve requirements.
This claim is based upon a lack of appreciation of the present flexi­
bility of his position.
If 505» or more of the commercial paper in the portfolios of the
member banks may be promptly converted into reserve balances by rediscounts
with reserve banks, the country banker should certainly be able to take
advantage of the reduced reserve requirements without undue apprehension
as to his ability to meet unexpected demands by his customers.

We ap­

preciate very thoroughly that he is obliged to make every available dol­
lar earn something.

Appreciating, also, the fears that have been ex­

pressed as to the possible effect of the new system of check collection
upon the earnings of member banks, we have arranged with competent ex­
perts to make cartful examinations of typical banks in this district in




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order to ascertain in what respect economies may be effected and earnings
augmented as a result of the changes to be undertaken, and its results
will be made known to the member banks.
The experience of the St. Louis district throws some light on
this matter.

The Federal Reserve Bank of that district undertook to

clear checks for its 459 members seme months ago.
or obtained.

No assent was asked

The adoption of the general collection plan has re­

cently afforded all the member banks of that district opportunity to
withdraw if they so desired.
have withdrawn.
service.

I am advised that only 99 out of the 459

Presumably, the other 360 are satisfied to continue the

It will be a great aid to the officers of the bank, if the

member banks will give patient consideration to the work now being done
and give the new collection system a fair trial.
One other unfortunate aspect of the attitude of member banks
toward the system should be referred to.

They have not yet developed

a proper sense of proprietorship and responsibility as to the reserve
bank itself.

They are too much disposed to regard it as a government

office or department and overlook the fact that the bank was created
by law for the purpose of performing a service to its stockholders and
depositors and not to impose upon them expense and hardship.
cannot be too strongly emphasized.

This

All the stock of the reserve banks

is owned by member banks and all the deposits are the property of the
member banks; two-thirds of the directors are elected by the member
banks; the primary responsibility for the management of the reserve
banks rests upon the member bankers themselves.




It is their duty

and responsibility to see that competent directors are elected and that
efficient and reliable officers are appointed.

They should regard their

ownership and interest as a privilege, and they should likewise feel free
to suggest and criticize - certainly, to a greater extent than they would
feel warranted in making suggestions and criticisms to their Reserve Agent.
The matters I have so far referred to are rather those which
have been a cause of anxiety or criticism in the minds of bankers as to the
future.

Your attention should be directed to one important thing which

has been a cause of anxiety in the past and vihich may mow safely be for­
gotten.

At no time since our Civil War and the financial disturbances

which followed it, has the world faced so many uncertainties regarding
future financial developments as at the present time.

Uncertainty, doubt,

timidity, under old American banking methods have frequently given rise
to occurrences which have been a menace to our whole credit system and
even to the solvency of some of our banks.

The underlying cause has

been doubt in the minds of the banker as to his ability on short notice
to convert his assets, even the most available, into a circulating me­
dium of undoubted goodness and acceptability to the people.
The occurrences of last Fall, when the fear of what might
happen, gave rise to instant demandfor currency, demonstrated that the
ability to promptly satisfy that demand would promptly and effectively
allay apprehension.

The issue of $388,000,000. of Aldrich-Vreeland

currency served on the one hand to protect bank reserves, and on the
other hand to meet the demands of depositors.

The machinery then in

existence for the issue of this currency was necessarily slow in starting







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motion and not completely effective until after the lapse of some weeks.
We have now in existence most complete machinery with which to meet any
normal or exceptional demand for currency, and it can be put in motion
without previous notice or preparation.

The currency to be issued, that

is, the Federal reserve notes, while at present largely secured by the
deposit of gold, may be issued, if required, against deposit of ccmmercial
paper eligible for rediscount and indorsed by member banks, it will be
additionally protected by large gold reserves and it is the direct ob­
ligation of the United States government.

The Federal reserve banks

to-day hold over $250,000,000. of cash resources, principally gold, and
there is no longer need for anxiety by the member bankers as to their
ability to meet the requirements of their customers and depositors.
The last six months have been occupied by the members of the
Federal Reserve Board and by the directors and officers of the reserve
banks in painstaking efforts to gradually develop this great organiza­
tion, so that it may demonstrate in actual operation what it was de­
signed to accomplish..
The reserve system was created to perform a service and pro­
vide protection directly to the banks of this country and indirectly to
the customers of the banks.

However much was accomplished by the

passage of the Act, it cannot serve its true purpose except by efficient
administration;

such an administration depends for its success upon

the cooperation and loyalty of the banks on the one hand and intelligent
work by the manager of the system on the other.
be assured:

Of oie thing you may

this statute is on the books to stay, in fact, the bankers




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of the country would not themselves permit its repeal.