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NEWS RELEASE

FEDERAL DEPOSIT INSURANCE CORPORATION

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FOR IMMEDIATE RELEASE

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Statement on
Nationwide NOW Accounts, Interest on Reserves
and Related Issues;
Re: S. 1664, S. 1665, S. 1666, S. 1667, S. 1668 and S. 1669.

^Presented to the
Subcommittee on Financial Institutions of the
Committee on Banking, Housing and Urban Affairs,..
United State s Senate

by

George A. LeMaistre
Chairman, Federal Deposit Insurance Corporation
June 20, 1977 ,

EDERAL DEPOSIT INSURANCE CORPORATION, 5 5 0 Seventeenth St. N.W., Washington, D.C. 20429



202-389-4221

Mr. Chairman, I welcome this opportunity to testify with respect
to six bills dealing with financial institution reform - - S. 1664, S. 1665,
S. 1666, S. 1667, S. 1668 and S. 1669.
Because of the magnitude and complexity of the legislation before
us, we have attempted to deal with those points which are of major
significance, those which directly affect the FDIC, and those in which the
FDIC has special expertise.

I should emphasize that we at the FDIC

stand ready to assist you and your staff in whatever fashion you deem
appropriate as you wrestle with the difficult issues raised by the legislation
before you.

Moreover, we would hope from time to time to provide you

with further comments as our analysis proceeds.
Before turning to the specific legislation, I should like to touch
briefly on the matter of financial institution reform generally because my
specific comments do flow directly from certain basic principles.

As you

know, I supported the recommendations of the Hunt Commission and the
goals embodied in the Financial Institutions Act.

I was heartened when the

Financial Institutions Act of 1975 was passed by the Senate and disappointed
at its subsequent demise in the House.

It continues to be my view that more

direct competition among financial intermediaries and greater reliance on
the direct operation of a free market, rather than on a system of controls and
restrictions, is a more efficient and effective way to allocate deposit funds.
Moreover, I believe that the Hunt Commission was essentially correct in its
strong recommendations that financial restructuring should not be accom­
plished piecemeal but rather in the context of a comprehensive legislative




2

package designed to provide as equitably as possible for transition to the
new structure.
Nevertheless, events have shown that supporters of comprehensive
financial reform were perhaps a bit naive.

It is indeed time, as you

suggest, Mr. Chairman, "to engage in the art of the possible; to promote
those measures which are in the public interest and which are capable of
being enacted. " Accordingly, it seems to me that we should work to identify
sub-packages within the framework of financial institution reform which
constitute constructive and progressive steps and which are politically
viable.

The legislation before us represents an attempt to do just that.
At the outset, I would like to interject one note of caution.

Since

the recommendations of the Hunt Commission in 1971, developments in
the marketplace and at the state level have taken us far along toward the
goals that the Hunt Commission envisioned.

Competition among financial

institutions has increased and innovative strategies such as the use of
the telephone and electronic transfers and money market funds have undercut
the effectiveness of rate ceilings and restrictions, leading to an increasing
reliance on the pricing mechanism.

In this light, it seems to me that we

must take special care that, in balancing all the affected interests, we do
not create a regulatory framework which is apparently progressive but which
in the long run serves to impede innovation and stifle competition.

Restrictions

and regulatory mechanisms intended to be temporary often become permanent
This tendency ought to be carefully guarded against in the context of our
frustration with the failure of financial reform in the past.




3

Rather than attempting to deal with all of the issues before us today,
I shall focus on five issues: (1) the extension of NOW and share draft account
authority provided in S. 1664 and S. 1668; (¿) the provisions of S. 1664 and S. 1668
dealing with the problem of attrition of membership from the Federal Reserve
System and the relationship of nonmember institutions to the Federal Reserve
System; (3) the extension of the agencies’ authority to set interest rates dealt
with in S. 1664, S. 1666 and S. 1668; (4) the provision of a Federal chartering
option for mutual savings banks in S. 1665 and S. 1666; and (5) the extensions
of Federal deposit insurance coverage provided in S. 1666,
L

NOW and Share Draft Account Authority

For my own part, I have long supported elimination of the prohibition
of interest payments on all transactions balances.

Economists have

demonstrated that there is no merit to the contention that competition for
demand deposits through the payment of interest led to bank failures during
the Depression as some contend.

Economists have demonstrated, at least

to my satisfaction, that competition for deposits through the pricing mechanism
would result in a more efficient allocation of resources than competition
through indirect means involving the implicit payment of interest by building
more branches, keeping open longer hours, providing free checking services,
offering premiums and free traveler’ s checks, as well as a variety of other
services.

Such competition would also be likely to result in substantial

benefits for both financial institutions and bank customers.




4

The benefits are several.

Free or below-actual-cost checking

encourages inefficient use of resources because depositors have no incentive
to economize on check writing, even though check clearance costs are
substantial.

Direct charges for checks would prompt depositors to write

fewer checks and these fees should cover a substantial cost of clearing
checks.

Explicit pricing of bank services so that each service produces a

profit on its own will enhance a financial institution's capability of paying
a competitive interest rate on deposit balances without impairing earnings.
Such explicit pricing for checking services will also conserve bank
resources by reducing the volume of checks, and payment of competitive
interest rates will lower some operating costs by reducing the need to
transfer funds between transactions accounts and other interest bearing
accounts.

This will benefit customers because they will need to spend less

time and effort in managing deposit balances, particularly when interest
rates are high. Finally, existing inequities, whereby some depositors
subsidize the expense of servicing others’ accounts, will be eliminated.
For these reasons, the extension of NOW accounts nationwide represents
a logical, wholly desirable step in the direction of increasing the overall
efficiency of the banking system.
The growth and success of NOW accounts in New England reflects
consumer acceptance of the service.

NOW accounts were authorized for all

depository institutions in Massachusetts and New Hampshire on January 1,
1974 and in Connecticut, Maine, Rhode Island and Vermont on February 2 8 ,
1976.




After three years, 1 .2 million NOW accounts totaling over $1.6 billion

5

have been opened in Massachusetts and New Hampshire and 77 percent of the
depository institutions were offering these accounts. NOW account balances
amounted to 5. 5 percent of total commercial bank deposits and 2. 8 percent
of mutual savings bank deposits at the end of 1976.

In the other four New

England states, 52 percent of the authorized institutions had 123, 000 NOW
accounts totaling $402 million at the end of 1976.
Moreover, the experience of institutions in New England indicates
that thrifts and commercial banks alike can compete in a wholly safe and
sound fashion.

At present, we know of no bank that is on the FDIC problem

bank list as a direct result of NOW accounts.

Some banks offering NOW

accounts have suffered an earnings decline, although it is not clear that
NOW accounts are the cause.

In the opinion of FDIC examiners, problems

caused by NOW accounts are unlikely to be much greater than those
encountered when "fre e ” checking accounts and consumer certificates of
deposit were offered.

Well managed banks should experience no significant

adverse effects if NOW accounts are authorized, although marginal banks
may experience somewhat greater adverse effects in absorbing costs and
employing funds profitably, as is the case with any new promotional offering.
Thus, in those states where NOW accounts were authorized without a transition
period and where most institutions pay the commercial bank passbook savings
ceiling of 5 percent, no institution has failed and none has been judged to be
in an unsafe and unsound condition because of NOW accounts. In short, our
examiners report that the ability of an institution to manage change and
maintain profitability depends predominantly on the caliber of its management.




6

This conclusion, based on the experience and reports of our examination
force, is also supported by the tentative results of staff studies currently
underway at the FDIC.
For example, Massachusetts commercial banks’ average return on
total assets before taxes and securities transactions declined 32 percent
from . 94 percent in 1972, the year before mutual savings banks first
began offering NOW accounts, to . 64 percent in 1976. Although this is a
substantial decline, there is reason to believe that NOW accounts may have
played only a small role, or none at all.

For example, the spread between

interest earned and interest paid relative to total assets actually increased
from 3. 06 percent in 1972 to 3.7 0 percent in 1976. This implies that the
return on assets actually would have increased over the period if the ratios of
non-interest revenues and expenses to total assets had remained the same.
Wages and salaries, occupancy expense, provision for loan losses and other
operating expenses relative to total assets all increased over the period.
In fact, if the provision for loan loss expense is added back to earnings
before taxes and securities transactions, the earnings rate actually increased
from 1.1 2 percent in 1972 to 1.27 percent in 1976.

Comparable nationwide

figures were 1.11 percent in 1972 and 1.35 percent in 1976.

This casts

considerable doubt on the contention that NOWs have hurt commercial bank
earnings in Massachusetts.
Massachusetts insured mutual savings banks hold approximately
5 percent of total mutual savings bank assets.

Their return on assets before

taxes and securities transactions declined 22 percent from 1972 to 1976.




7

However, the return on assets declined by the same percentage for all
mutuals over the same period.

Most of mutual savings bank assets are

situated in New York where NOW accounts have not been authorized.
Some concern has been expressed that competition for nationwide
NOW accounts will impact earnings unfavorably during the first years after
its introduction.

Our staff analysis indicates that earnings of commercial

banks would not be seriously impaired after the implementation of S. 1664,
assuming that the Federal Reserve pays 2 percent on all required reserves,
the Federal Reserve requires reserves of 5 percent against NOW account
and share draft balances, and institutions pay 5 percent on NOW deposits
and share drafts. The impact on earnings will vary somewhat between
Federal Reserve member and nonmember banks and for banks of different
size.

We expect earnings declines to be lower for member banks than

for nonmembers.

Under certain assumptions, some member banks will

increase their earnings primarily as a result of gains from reserve
requirement adjustments and interest paid on required reserves.
Even under the most extreme assumptions of a 5 percent interest
rate on NOW accounts, no change in service charges, and a 35-50 percent
conversion of household demand deposits to NOW accounts, we estimate
that the average member bank would experience only a 5-10 percent decline
in total earnings over the first few years. Given the more likely scenario
of a 5 percent interest rate on NOW accounts and an increase in service
charges equal to 2. 5 percent on average balances, earnings are estimated
to decline by less than 5 percent on the average.




8

Because state reserve requirements are generally lower than Federal
Reserve member bank reserve requirements, nonmember banks will not
benefit from reserve requirement adjustments or interest paid on reserves.
Again, under the most extreme assumptions mentioned above, earnings of
the average nonmember bank would be reduced by 15 to 20 percent.

However,

I expect that banks have learned from the NOW account experience in New
England and will move toward more rational pricing of NOW account services.
If this occurs, the earnings decline for the average nonmember bank will be
less than 10 percent.
The movement to nationwide NOW accounts may result in higher
earnings for thrift institutions and credit unions.

Assuming that these

institutions acquire 25 percent of the household demand deposits of commercial
banks that are converted to NOW accounts, and under the extreme assumptions
of a 5 percent interest rate on NOW accounts and no service charge increases,
our estimates indicate that these institutions, on the average, would suffer
earnings declines of only 5 percent.

But, with service charge increases

equal to 2. 5 percent of average balances, thrifts and credit unions stand to
improve their earnings from 15-20 percent.
Another staff study has developed estimates of the costs of servicing
individual NOW accounts having various characteristics and has assessed
the impact of alternative interest rate and service charge policies on NOW
account profitability. The analysis is based on the Federal R eserv e's 1974
and 1975 Functional Cost Data Base, and the known characteristics of NOW
accounts in Massachusetts and New Hampshire for December 1976.




It costs

9

about 2 .0 percent of average balances to service a commercial bank NOW
account and 2.7 percent of average balances to service a mutual savings bank
NOW account.

The difference in rates is due primarily to an average account

balance of $2, 000 in commercial banks versus $800 in mutual savings banks.
The larger average account balances in commercial banks apparently result
from the combining of savings and checking accounts, while mutual savings
bank NOW accounts are essentially similar to personal checking accounts
in commercial banks.

The study concludes that if personal checking and

regular savings accounts are combined, commercial banks charging
10 cents for each draft can afford to pay 4. 0 percent interest without hurting
existing profit levels.
about 4.7 5 percent.

Banks charging 20 cents per draft can afford to pay

Furthermore, if customers wrote as many drafts on

their NOW accounts as are written on average on personal checking accounts,
banks could easily pay 5 percent interest without reducing profits.

Finally,

the study concludes that a 5 percent interest rate should induce a more
rational pricing of NOW account services than any lower rate.

Lower rates

are likely to reduce average NOW account balances, make it less likely
that checking and savings balances will be combined, and retard rational
pricing decisions.
Based on the considerations I have outlined and the fact that the move
to NOW accounts poses no significant threat to safety and soundness, I support
wholeheartedly the Administration’ s proposal to expand NOW account authority
nationwide.

Id o , however, have certain reservations and questions regarding

specific provisions of Title I of S. 1664 and will attempt to outline what I
believe to be more desirable alternatives for your consideration.



10

The Celling Setting Mechanism
Section 104(a) of S. 1664 provides for the setting of an interest rate
ceiling on NOW accounts and share draft accounts during a transition period
and is presumably aimed at providing banks with time to adjust to the payment
of interest on NOW and share draft accounts. The initial ceiling on these
accounts would be set by a committee composed of the Chairman of the
Federal Reserve Board, the Chairman of the Federal Deposit Insurance
Corporation, the Chairman of the Federal Home Loan Bank Board, the
Administrator of the National Credit Union Administration or their designees.
In the event that the agencies are unable to reach a majority decision on
the rate ceiling within six months after the enactment of the legislation,
the initial, rate would be determined by the Federal Reserve Board with
changes effected only by majority vote of the four agencies. The bill provides
further that rate setting authority shall expire three years after the effective
date of the act.

Then for a period of three years after that expiration

date, the agencies would have standby authority to impose a ceiling if a
majority of the agencies determines that a continuation or reimposition
of the limitations is appropriate.

After six years, the authority would expire

altogether.
I have several problems with Section 104(a).

As the bill stands, it

would become effective one year after enactment. At that time, the threeyear authority would come into play.

With the further standby authority for

three more years, financial institutions could have up to seven years to adjust,1
It should be recalled that the institutions in New England had no such transition




11

period, and as I have indicated, in New England, which was especially
hard hit by the recession and by general economic decline in the region,
no bank has been accorded problem status directly or indirectly as a result
of excesses in dealing with NOW accounts. Certainly no bank failure can
be attributed to NOW accounts in New England. There is little reason to
believe that bankers elsewhere would act less prudently. Indeed, with the
lessons of the New England experience well known, there is every reason
to believe that the adjustments would be made more smoothly. Thus, we
at the FDIC do not believe that safety and soundness considerations weigh
heavily in support of any transition period.
Given the experience of our examination staff and the tentative
conclusions suggested by available data, I cannot recommend that Congress
provide a transition period to cushion the impact of offering NOW accounts.
Certainly, seven years' authority, even partly on a standby basis, would
be unfair to consumers and potentially counterproductive for banks.
However, if Congress should decide that an adjustment period is
necessary, then a schedule of rates moving quickly to the commercial bank
passbook savings ceiling rate should be set forth in the legislation. I believe that
only in the context of certainty will most institutions make the management and
policy adjustments necessary in a world of explicit pricing.
Finally, assuming that Congress chooses to give the agencies
discretionary authority rather than fixing by statute the ceiling rate to be paid
during a transition period or eliminating a transition period altogether,
Section 104(a) is far from optimal.




It would be preferable to rely instead

12

on the existing mechanism under which interest rate ceilings are currently
established - - modified appropriately to include the National Credit Union
Administration. Certainly there is no logical reason why the Federal Reserve
System should be given primacy for setting the rates on NOW accounts,
particularly when the ostensible concern in setting such rates is not monetary
policy, but the safety and soundness of banks during the transition period.
I believe that there is great danger in charging one agency which regulates
1,023 State member commercial banks with primacy in a rate setting
mechanism which affects 35, 276 depository institutions varying greatly in
size and powers.
It follows, of course, from this that I find the ceiling setting
provisions of S. 1667 more objectionable because that proposal would
consolidate all interest rate ceiling setting authority in the Federal Reserve
Board.

No agency with jurisdiction over only certain depository institutions

should have rate ceiling setting audiority over all such institutions.

This

point has been brought home to me dramatically at the FDIC as a result
of our supervisory responsibilities v is-a -v is mutual savings banks.
Because of these duties, we, as an agency, are well acquainted with their
problems and goals and with the perspective of thrift institutions, as well
as commercial banks, which in my judgment results in a more balanced
view.




13

The Grandfathering Provision
A separate set of concerns arises as a result of Section 104(b), which
provides, as I read it, not for the grandfathering of institutions currently
authorized to offer interest-bearing third party payment accounts, but rather
only for grandfathering individual deposit and share draft accounts which at
the time of enactment of the legislation paid a rate of interest higher than
the initial ceiling.
This provision reflects a recognition that it would be inequitable and
unfair to roll back the rates of interest now paid to consumers on transactions
in New England and to a far lesser extent around the country.

Because any

grandfather provision is to a certain degree inequitable, the problem in
drafting such a provision involves devising one which minimizes inequity as
well as the cost of enforcement and compliance.

Addressing this problem,

I assume that the drafters considered at least two other alternatives to the
scheme devised.

First of all, instead of focusing upon individual accounts,

the legislation might have grandfathered those institutions which, at the date
of enactment or some other date, were actually offering interest rates higher
than the initial ceiling.

Alternatively, the legislation might have grand­

fathered those classes of institutions which at the date of enactment or some
other date had already been authorized to offer an account at a rate higher
than the initial ceiling.
Among the three possible choices, my strong preference would be for
the last.

In my judgment, the choice set forth in S. 1664 is the least desirable,

both because it is the most inequitable and because it involves the establishment
of yet another costly and burdensome regulatory apparatus.




14

Although the FDIC staff has not yet determined precisely what would
be entailed, it is clear that the problems associated with enforcement of such
a provision would be substantial.

An effective enforcement effort would at

least require additional bank examination procedures, the imposition
of recordkeeping requirements and the application of formal enforcement
machinery where necessary.

Paralleling regulatory costs are the costs which

must be borne by institutions in establishing procedures to assure compliance.
These costs would, of course, fall most heavily on smaller institutions.

It is

ironic, indeed, that a ceiling- setting apparatus aimed at minimizing bank costs
might well generate significant additional costs.
And, while any grandfathering involves certain inequities, it strikes me
that the proposal contained in S. 1664 is especially unfair.

Such a provision

would tend to penalize the cautious institution which had not rushed aggressively
into the NOW account experiment and the unsophisticated depositor who may
not have fully understood his or her options.
Most of these objections to Section 104(b) as drafted would be met by
a provision which would simply allow those classes of institutions that are
currently authorized to offer accounts at a rate higher than the initial ceiling
set by the agencies under this law to offer such accounts at rates up to the
commercial bank ceiling rate for passbook savings during the transition
period.

This would be simple and far less costly from an enforcement and

compliance point of view; would involve no inequity within a given market area;
and would involve the least amount of rollback of services currently offered
consumers.




15

It should be noted, of course, that the problems associated with
grandfathering would not exist if the transition period were simply
eliminated.

As I indicated earlier, the facts and analysis which I have seen

do not warrant either the costs or inequities associated with grandfathering.
The Definition of NOW Accounts and Enforcement Mechanism
Section 101(c) of S. 1664 defines the term ’’negotiable order of
withdrawal account” as:
. . . a deposit or account (1) on which payment of interest
or dividends may be made, (2) with respect to which the
depository institution may require the depositor or account
holder to give notice of an intended withdrawal not less than
thirty days before the withdrawal is made, and (3) on which
the depositor or account holder is allowed to make withdrawals
by negotiable or transferable instrument or other similar item
for the purpose of making payments to third persons or others.
Such deposit or account shall consist solely of funds in which the
entire beneficial interest is held by one or more individuals.
In his letter to the President of the Senate, Secretary Blumenthal stated that
"A NOW account or share draft account is an interest earning account on
which checks may be drawn. ” By so restricting the definition to accounts on
which checks or other similar instruments may be drawn, the bill avoids the
coverage of accounts which are accessed solely by telephonic or electronic
means.

This approach is altogether preferable to one which would auto­

matically subject those facilities to the regulatory and definitional constraints
of the Act.




16

Section 103 of S. 1664 provides:
In order to prevent evasions of the interest rate limitations and
reserve requirements imposed by this Act, after consultation,
the Board of Governors of the Federal Reserve System, the
Board of Directors of the Federal Deposit Insurance Corporation,
the Federal Home Loan Bank Board and the Administrator of the
National Credit Union Administration are further authorized to
determine by similar regulation or order that an account or
deposit on which the payment of interest or dividends may be made
is a negotiable order of withdrawal account or share draft account
where such account or deposit may be used to provide funds directly
or indirectly for the purpose of making payments or transfers to
third persons or others.
This provision provides each of the banking agencies with the authority
to determine by similar regulation or order that an account or deposit used to
provide funds is a NOW account where the effect of such an account is to
evade the thrust of the Act.

This is an appropriate specification of regulatory

authority and one which is appropriately dealt with by each of the agencies
v is-a -v is the institutions which they regulate.

Taken with the definition of

NOW account in Section 101(c), this provision provides the means of
eliminating evasions of the thrust of the Act without establishing a structure
which would roll back existing facilities or stifle future innovations involving
telephonic or electronic procedures.




17

EL Interest on Reserve Balances and the Relationship of
Nonmember Institutions to the Federal Reserve System
Title II of S. 1664 includes two very important provisions pertaining
to reserve balances with the Federal Reserve System.

It would require that

nonmember institutions maintain reserve balances on NOW accounts equal to
those applicable to member bank NOW accounts, with provision for such
requirements for nonmembers to be phased in over a four-year period.
Title II would also permit the Federal Reserve to pay interest on required
reserve balances maintained within the System.

These provisions would have

important implications for the competitive position of member versus
nonmember institutions and for the structure of the banking system.

These

issues are quite complex and are not necessarily related to permitting
interest-bearing NOW accounts on a national basis.

It therefore seems

preferable to me that these issues be separated from S. 1664 and subjected
to more thorough study.
For the most part, the proposal for payment of interest on required
reserve balances grows out of the Federal Reserve's concern with declining
membership.

There has been a slow but steady erosion of Federal Reserve

membership as nonmember banks leave the System.

Member banks held

83 percent of total domestic commercial bank deposits in the U. S. in 1965,
and that has dropped to 74 percent at the present time.

The Federal Reserve's

concern about this decline focuses on its ability to conduct monetary policy.
While the erosion of Federal Reserve membership does have an impact on the
role of the Federal Reserve as a supervisor of banks, in the view of most




18

independent observers, this decline in membership does not have a significant
impact on monetary policy.
The Federal Reserve has stressed that the precision with which
monetary policy can be carried out is adversely affected by the growing
percentage of bank deposits accounted for by nonmember banks. The same line
of reasoning appears to underlie the proposal to extend reserve requirements
to the NOW accounts of nonmember institutions.
Of course, estimating the impact on the monetary aggregates of a
particular change in reserves becomes more difficult when different banks are
subject to different reserve requirements.
if all banks were member banks.

But this problem would exist even

Under the Federal Reserve’ s reserve

structure, time deposits are subject to different requirements than demand,
and different classes of member banks are subject to varying reserve
requirements.

Hence, a shift of funds among member banks has precisely

the same effect of blurring the precision of monetary policy that disturbs
the Federal Reserve when nonmember banks are involved.
There have been several studies of the monetary control issue by
economists outside the Federal Reserve.

All of those that I am familiar

with have concluded that increased Federal Reserve membership is not
important to the effectiveness of monetary policy, at least with member banks
comprising the proportion of the money supply that they do now.
There have been two major empirical studies which attempted to
ascertain the impact of nonmember banks on the implementation of monetary
policy.




The first was conducted by Clark Warburton for the Commission on

19

Money and Credit.

Warburton concluded that nonmember banks are affected

by Federal Reserve monetary policy actions in approximately the same way
that member banks are.

Another investigation was reported recently by

Dennis Starleaf of Iowa State University.

In Starleaf's study, the actual Mj

money m ultiplier for the period 1962-1972 was com pared with a m oney
multiplier series simulated under the assumption that all banks were subject
to Federal Reserve reserve requirements.

That is, the simulation

indicated that had nonmember banks been subject to such reserve require­
ments, the money stock would have experienced even greater variations.
Starleaf thus rejected the argument that uniform Federal Reserve reserve
requirements are necessary for the implementation of monetary policy.
There have also been a number of articles that attempted to analyze
the logical arguments and the empirical data that exist on this issue.

The

Hunt Commission concluded that "reserve requirements are unnecessary for
open market operations to control the monetary base effectively. "
Carter Golembe, after discussing the difficulties in conducting monetary
policy with precision, concluded that,
. . . so many factors contribute to the lack of precision and
certainty that simply changing the proportion of deposits
subject to Federal Reserve requirements from almost
80 percent to nearly 100 percent would be of relatively minor
importance.
In a 1974 study, Professors Ross Robertson and Almarin Phillips investigated
the argument that nonmember banks behave in a manner different from member
banks, and that such behavior thwarts implementation of Federal Reserve
monetary policy.




They concluded that these arguments have no validity:

20

This contention deluded those who are innocent of money
matters and even a few who should know better. As has
been observed, open market operations are for all
practical purposes the instrument of monetary control.
Like the rain from heaven that falls on us all, regardless
of our m erits, open market operations affect member and
nonmember banks alike. There is not one shred of evidence
to the contrary.
A study conducted by Gary Gilbert and Manferd Peterson found results similar
to Robertson and Phillips.

They concluded that,

. . .the behavior of nonmember banks under varying degrees
of monetary ease or restraint is relatively similar to that
of country member banks. To the extent that systematic
behavior of the demand deposits components is important
^or the effective control of the money supply, there is no
indication from available evidence that the nonmember
banking segment has hampered monetary policy.
Several of these studies have stressed the caveat that while the Federal
Reserve can control the monetary aggregate without member banks or without
reserve requirements, it does need good information on the reserves and
deposits of all banks.

S. 1664 covers that point by requiring that all banks

offering NOW accounts submit reports on deposit liabilities requested by the
Federal Reserve.

We support this proposal and believe that the Federal

Reserve should be authorized to obtain all of the information it needs to
conduct monetary policy.
Several years ago, the Federal Reserve became concerned about the
adequacy of its data on the money supply, and established a committee,
chaired by Professor George L. Bach of Stanford University, to recommend
changes in money supply statistics.

One of the major recommendations of the

Bach Committee was that better and more frequent data on nonmember bank




21

deposits was desirable.

Following that report, the FDIC instituted a weekly

survey of a sample of nonmember banks in order to provide the Federal
Reserve with better informa.tion on the money supply.

This collection was

initiated with the spring 1976 Call Report.
A second step, also recommended by the Advisory Committee on
Monetary Statistics, is scheduled to go into effect in the first week of July
this year.

A sample of 580 nonmember banks will be asked to report deposit

and cash items on a regular weekly basis, the same items as all nonmember
banks do four times a year.

The Federal Reserve has indicated that they expect

that the use of the data from the two projects mentioned will enable them to
achieve significant improvements in their estimates for the nonmember bank
component of the nation1s money supply.
Concern with the effectiveness of monetary policy is not the only
argument that has been advanced in support of mandatory Federal Reserve
membership and the imposition of Federal Reserve reserve requirements.
The issue of equity is an important one.

The equity arguments in support of

a uniform reserve requirement structure focus on the issue of competitive
advantage.

As stated earlier, nonmember banks are subject to diverse state

reserve requirements.

All states permit banks to count vault cash and

correspondent balances as reserves.

Approximately 20 states allow banks to

hold some part of reserves in earning assets.

On the other hand, Federal

Reserve member banks must hold reserves in the form of vault cash or non­
interest earning deposits at a Federal Reserve bank,

insofar as correspondent

balances and earning assets do not qualify as reserves for member institutions,




22

nonmember banks (at least in those states counting some earning assets as
reserves) have a competitive advantage over member banks in that they have
an opportunity to invest a larger proportion of their funds in earning assets.
Many view this as an inequitable situation.

Others point out that

since membership in the Federal Reserve is voluntary, and since all banks
that are members of the Federal Reserve have made their judgment as to
whether membership is worthwhile or not, there cannot be any serious
issue of equity involved.

In a major study for the Conference of State Bank

Supervisors, Dr. Lawrence Kreider found that most state banks that are
members of the Federal Reserve are receiving benefits in the form of
correspondent business that makes Federal Reserve membership attractive
to them.

To the extent that equity is a problem and member banks are being

treated unfairly, I believe that the payment of interest on reserve balances,
if handled properly, would resolve the problem.

A lowering of member bank

reserve requirements could also be used to achieve the same end.
In summary, I believe that the reserve provisions of the proposed
legislation could have significant implications for the banking system that
need to be examined carefully.

I do not oppose the payment of interest on

reserves by the Federal Reserve although I would prefer to see Congress
deal with that issue separately from NOW accounts.

I do oppose that provision

of Title II that imposes reserve requirements on NOW accounts of nonmember
institutions.

The extension of such requirements for monetary control

purposes, as I have indicated earlier, is not supported by the weight of
available evidence.




The thrust of the evidence to date suggests that the

23

monetary problem is one of adequate data and proper estimation procedures
rather than reserve requirement jurisdiction. And, even if the case could be
sustained for the proposition that uniform reserve requirements are necessary
for the effective conduct of monetary policy, certainly the requirement of
uniform reserves on NOW accounts would not achieve the desired effect.

The

subject of the relationship of nonmember institutions with the Federal Reserve
is one on which I have an open mind but one which I believe should be dealt
with carefully and with reasoned study.
HL

Extension of Regulation Q Authority

Title III of S. 1664 would extend to December 15, 1979, the flexible
authority to impose interest rate ceilings on deposits.

In his letter

forwarding this bill to the President of the Senate, Secretary Blumenthal
stated that, "this would allow the Administration sufficient time to study the
impact of (1) Regulation Q on financial intermediaries, consumers, and the
mortgage market, and (2) the elimination of unnecessary Federal regulatory
constraints. " Although I do not object to a two-year extension of Regulation Q
authority in order for the Administration to develop its position on this matter,
I would prefer that the Congress face up to the issues raised by Regulation Q
and the rate differential this session and devise a strategy for phasing out
this inefficient and inequitable form of credit allocation now.
Notwithstanding the linkage of interest rate ceilings and housing goals,
the ceilings are an inefficient means of assisting housing and assuring the
stability of thrift institutions.

Regulation Q simply does not work well as a

device for allocating funds to housing.




Although it may protect thrift

24

institutions from commercial bank competition to a certain extent, it does not
protect them from competition from the unregulated money market. In times
of high interest rates, such as was the case in 1966, 1969-70, and 1973-74,
many depositors forsake depository institutions and invest their funds directly
in market instruments.

As a result of this disintermediation, the mortgage

market dries up and thrift institutions suffer earnings and liquidity pressures.
Moreover, even if the ceilings were effective in assuring a stable flow
of funds to the housing market, they would still be highly objectionable
because they constitute a regressive and inequitable tax on small savers.
With respect to this matter, I have been puzzled by the relative silence in the
past of consumer spokesmen, but I am heartened by recent statements by
consumer representatives favoring the abolition of Regulation Q. The
inability of the small and unsophisticated saver to obtain market rates of
interest on his passbook savings, while sophisticated larger investors are
able to achieve market rates, should be a major consumer issue.
In short, because I believe that interest rate ceilings are an ineffective
and sometimes disruptive form of credit allocation and because I believe that
they impose significant inequities on small savers, it is my judgment that the
proper focus of our attention should be upon how and when, and not whether, to
phase out interest rate ceilings.
specific date for their demise.

For this reason, I favor designation of a
I believe that only in the context of such

certainty will bankers and regulators begin to plan seriously.




25

While working toward the phasing out of this particular restriction
which serves to protect the less efficient institution, action should also be
taken to eliminate other restrictions which place unnecessary and burdensome
costs on depository institutions - - costs which inevitably work to the detriment
of the consumer as well as the banker.

One particularly noteworthy set of

restrictions which parallels the Regulation Q ceilings on the other side of the
balance sheet is usury laws imposed in some states.

As I indicated earlier,

our examination force has informed us that the NOW account experiment in
New England has had no significant effect on the safety and soundness of banks
there.

This is not the case with respect to usury laws in various states.

For example, in Tennessee, usury laws have imposed a profound restraint
on banks and, in the minds of many, constituted one reason why Hamilton
Bancshares, In c., chose to use Hamilton Mortgage Co. as a vehicle to
generate increased revenues, a decision which subsequently led to the failure
of Hamilton National Bank of Chattanooga.
I am not so unrealistic as to believe that the movement toward market
pricing of deposits can be accomplished overnight, even though the time is
probably ripe to phase out the ceilings.

However, I do believe that it is

important that we work toward the establishment of meaningful phase-out of
these controls in a context that safeguards financial institutions.

This cannot

be accomplished without the constructive and forthright political leadership
of the Congress and others aimed at eliminating artificial constraints of this
type and developing alternative strategies to assure an adequate flow of funds
to housing.

The result will redound to the benefit of the consumer and

financial institutions alike.



26

IV.

Federal Chartering Option for Mutual Savings Banks

Title I of S, 1665 and Title VII of S. 1666 would provide a fed eral
chartering option for mutual savings banks.

I strongly favor immediate

adoption of legislation which would provide a fed era l chartering option for
mutual savings banks.
Mutual savings banks have moved a long way down the road in the
evolution toward being "full service family banking institutions. " In some
states, mostly in New England, this evolution is virtually complete.

In

other states, however, there are important gaps in savings bank powers
and restrictions on their operations.

In New York, for example, savings

bank lending powers are restricted and there are important limitations with
respect to demand deposits.

It is true that some state laws are unduly

restrictive with respect to commercial banks as well, but the choice provided
by the dual banking system means that innovations which genuinely satisfy
customer needs will be adopted over time.
It is clear that regulatory decisions in the early sixties which gave
national banks powers already possessed by some state banks helped banking
meet the challenges of a changing economy.

Similarly, state legislatures and

state regulators have taken the lead in pursuing alternative strategies of
dealing with financial reform and electronic funds transfer systems.

As a

result, the states often serve as laboratories where innovation can provide
insights as to the best approach to take at the fed era l level.

In my judgment,

mutual savings banks and their customers should not be denied the considerable




27

benefit of this unique and positive feature of American financial regulation.
While I do support the federal chartering option for mutual savings banks,
I would like to enumerate some suggestions for implementing this objective.
First, I do not favor restricting the federal chartering option
geographically, nor do I favor limiting this option to existing institutions.
It seems to me that mutual savings banks have been effective, viable
competitors in the 17 states where they exist and there is no reason to limit
their benefits to these states.

Second, I think it appropriate to point out that

the FDIC has more than 40 years of experience in examining and supervising
the mutual savings bank industry - - experience which would be most useful
to a chartering authority.

It seems to me that your Subcommittee should

not overlook our long experience in this area in determining who should be
the chartering authority for federal mutual savings banks.

It seems highly

desirable to us that there be at least one federal financial institution
regulator which is concerned with both commercial banks and thrift
institutions in order to ensure a balanced regulatory perspective.

I know, for

example, that this is most useful in our deliberations with respect to interest
rate ceilings.
The third point which I would raise arises out of Section 103 of S. 1665
and Section 701(d) of S. 1666 which provide in essence that when a mutual
savings bank insured by the FDIC converts to or consolidates with a federal
savings bank insured by the FSLIC, the FDIC would be required to transfer
to the FSLIC that bank's accumulated insurance assessment, less the bank's
pro rata share of FDIC operating expenses and insurance losses.




This approach

28

seems to assume that an insured bank, by paying deposit insurance
asessments, builds up some sort of entitlement to a pro rata share of the
Federal deposit insurance fund which it can take with it to the new insuring
entity (FSLIC).

It should be noted that if the converting bank failed prior to

its conversion, assessments against other FDIC-insured banks would have had
to make up any loss to the Federal deposit insurance fund.

Accordingly, the

fund should not be required to rebate any part of previous assessments, which
should be regarded as payments for the benefits of past insurance coverage
received by the converting bank.
Deposit insurance has been viewed as more in the nature of casualty
or term life insurance rather than whole life insurance in that a bank's
deposit insurance assessment pays for current coverage and should not be
refunded upon cessation of insured status.

This is supported by the case law

which indicates that an insured bank builds up no "cash value" in paying its
insurance assessments.
In addition, our staff has expressed serious reservations about the
workability of the formula detailed in these two bills.

Indeed, the staff

believes that it would be virtually impossible to accomplish a transfer
consistent with the provisions of the bills as drafted.

I have requested the

staff to prepare a detailed analysis of this matter and will be happy to
provide the Subcommittee with the results of that analysis.
I reiterate, however, my support of a federal chartering option
for mutual savings banks and urge that these technical and policy problems
be resolved expeditiously and not serve as a reason for delay in adopting




29

this long overdue measure.
V.

Extension of Deposit Insurance

Title IH of S. 1666 pertains to insurance of deposits. Section 301
requires the Federal Deposit Jhsuance Corporation, the Federal Savings and
Loan Insurance Corporation, and the National Credit Union Administration
to insure public deposits for the full amount thereof.

Section 302 removes

the dollar restriction on insurance of accounts for retirement savings placed
in Individual Retirement Accounts and Keogh plans and provides for full
deposit insurance for such accounts at federally insured savings and loan
associations.
The proposal to fully insure public deposits is timely in light of the
study, "The Impact of Increased Insurance on Public Deposits, " submitted
by the Advisory Commission on Intergovernmental Relations to the Committee
on Banking, Housing and Urban Affairs of the United States Senate.

In that

study the Advisory Commission recommended that "the appropriate Federal
agency insure the full amount of public deposits in commercial banks, savings
and loan associations, mutual savings banks and credit unions. " It also
recommended that federally insured deposits not be subject to any pledging
requirements and that the total amount of public deposits in a single financial
institution should be limited to a reasonable percentage of total deposits
and/or total capital.
In 1974, the FDIC interposed no objection to the principle of full deposit
insurance for public funds.

However, it has been the Corporation’ s view, as

stated by former Chairman Frank Wille in his testimony before your Subcommittee




30

on March 19, 1974, that full coverage of public deposits should be
accompanied by a provision which would require the FDIC, the Federal
Savings and Loan Insurance Corporation, and the National Credit Union
Administration to prescribe uniform restrictions with respect to the
aggregate amount of public funds that could be deposited in a bank, a
savings and loan association or credit union. This provision has also been
recommended by the Advisory Commission on Intergovernmental Relations.
Although present law authorizes the imposition of such limitations as to time
and savings deposits, there is no authority in present law or in S. 1666 to
apply such limitations to demand deposits and no requirement that any such
limitations be uniform as to all depositories.

Absent such a provision, we

would oppose enactment of Section 301 in its present form.
Section 302 of S. 1666 as drafted is wholly inappropriate in that it
extends full deposit insurance to Individual Retirement Accounts and Keogh
accounts held only in savings and loan associations.

Enactment of this

provision would give savings and loan associations an unwarranted and
substantial advantage in competing for these accounts.

Although an

argument can be made for the proposition that these accounts serve as
a substitute for pension funds and should be accorded full protection rather
than forcing individuals concerned about the safety of their accounts to
establish more than one account, there is certainly no reason to limit full
coverage on these accounts to a specific type of financial institution.
would, therefore, oppose this provision vigorously.




We

31

In my judgment, these issues are of sufficient importance and
complexity to warrant separate consideration, and I would recommend that
hearings be held specifically on the subject of deposit insurance,