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THE MUTUAL INTEREST OF COMMERCIAL BANKS AND THE FEDERAL RESERVE Delivered by Harry A. Shuford, President Federal Reserve Bank of St. Louis at the Arkansas Bankers Association Annual Convention Hot Springs, Arkansas May 22, 1963 THE MUTUAL INTEREST OF COMMERCIAL BANKS AND THE FEDERAL RESERVE All or a portion of seven different states comprise the Eighth Federal R e s e r v e District. Arkansas i s significant since it is the only one of the seven states which is totally within the boundaries of the district. In Arkansas there are 241 banks. while the other 57 have Federal charters. Of these, 184 are state chartered Roughly, 1/3 of the banks of the state - with 2 / 3 of the r e s o u r c e s - are m e m b e r s of the Federal Reserve System. Each of the 3 kinds of institution - national banks, state member banks, and nonmember state banks - has contributed richly to the development of this nation's economy. The tradition of state chartered banking stretches back through most of the country's history. National banking this year is observing its 100th anniversary, and the Federal Reserve System, which is the nation's regional central bank and monetary authority, will next year observe its 50th anniversary. You may recall that the Federal R e s e r v e Act became law on December 23, 1913 and the Federal R e s e r v e Banks opened for business during November the following year. The history of banking is not all sweet, peaceful and of one accord. To the contrary, in the past, just as with us today, there were i s s u e s to be debated and problems to be solved. Currently, we in banking find ourselves facing problems, some new and some old, and as always there are differences of opinion. Certainly there is no unanimity regarding branch banking, and there are decided differences of opinion with respect to such matters as m e r g e r s and holding companies. Recently, the matter of compulsory membership in the Federal R e s e r v e System for all banks has been raised again I say "again" because this issue was - 2 a matter of debate as early as 50 years ago when the Federal Reserve Act was under consideration. On occasions we are prone to become dissatisfied with ourselves because of this discord, but it i s significant that through these y e a r s and even amid our problems and differences banks, regardless of the source of their charters or their affiliations, through good t i m e s and bad, have made a rich contribution to the growth, development, and well being of our political and economic life. Admitting the differences of opinion in the banking community, through it all there has been and continues to be a great common bond among c o m m e r c i a l banks and between commercial banks and the Federal Reserve. with a public interest. Each i s vested Each and all are concerned with serving their community whether it be local, area, or in varying degrees on a national basis. For the moment I would like to put aside these differences and think with you on this positive side - the side of service. This includes those s e r v i c e s that c o m m e r c i a l banks and Federal Reserve join in providing, such as receiving, holding, and transferring deposits, supplying currency and coin, collecting checks, and numerous other functions, including assisting the U. S. Treasury in several capacities. One current example of our effort to serve the public better and more efficiently is the development of the Magnetic Ink Character Recognition Program. Here all banks have united to develop a means for handling the ever-growing volume of checks. have cooperated. On their own and without any subsidy, the banks of the country When we began there was no plan, no method, no machinery. - 3 Under the l e a d e r s h i p of the A m e r i c a n B a n k e r s A s s o c i a t i o n and with the cooperation of the F e d e r a l R e s e r v e System, we not only have a plan but machine c o m p a n i e s have been stimulated to develop equipment and today the p r o g r a m i s in operation. High speed p r o c e s s i n g of checks is as yet limited but its growth h a s been and continues to be rapid. This is not only fortunate but e s s e n t i a l b e c a u s e t h e r e is no question but that without this p r o g r a m the banking s y s t e m , within a few y e a r s , would not be able to handle the volume of checks which is expected. This p r o g r a m h a s c o s t the baxiking s y s t e m a c o n s i d e r a b l e sum of money for r e s e a r c h and develop m e n t and will be successful only with the continued cooperation of all b a n k s . We in the Eighth D i s t r i c t can be proud of the p r o g r e s s which we have m a d e during the p a s t y e a r when our volume of p r e p r i n t e d checks i n c r e a s e d 26. 7 p e r cent. On the other hand, due to a slow s t a r t we a r e forced to admit with s o m e e m b a r r a s s m e n t that, b a s e d on the m o s t r e c e n t survey, our d i s t r i c t i s low on the t o t e m pole. Our total p e r c e n t a g e of p r e p r i n t e d i t e m s was 63.1 p e r cent a s c o m p a r e d with 86. 7 p e r cent in the Philadelphia D i s t r i c t which is high, and with 78. 7 p e r cent which is the national a v e r a g e fox all F e d e r a l R e s e r v e D i s t r i c t s . We continue in this d i s t r i c t to have much r o o m for i m p r o v e m e n t in this a r e a of s e r v i c e and I hope that the r e s u l t s of the next survey in August will show that we have closed the gap. Let m e t u r n now from our work together in operations and mention the m o n e t a r y s y s t e m of the country. The c o m m e r c i a l banks and the F e d e r a l R e s e r v e s h a r e the r e s p o n s i b i l i t y of providing our economy with an a p p r o p r i a t e amount of money and c r e d i t . We thereby p r o m o t e a high level of b u s i n e s s activity, and - 4 r e a s o n a b l y stable p r i c e s with due r e g a r d to our international balance of p a y m e n t s situation. This public s e r v i c e is a c c o m p l i s h e d by the F e d e r a l R e s e r v e S y s t e m supplying r e s e r v e s to the m e m b e r banks. The c o m m e r c i a l banks, in turn, whether they be m e m b e r or n o n m e m b e r , and whether they be State or F e d e r a l , p e r f o r m the e s s e n t i a l and i m p o r t a n t function of distributing loan funds where they a r e m o s t needed by b u s i n e s s . H e r e again we see the benefit of our cooperation. So, all c o m m e r c i a l banks a r e concerned in the m a t t e r of the availability and c o s t of r e s e r v e s and, consequently, in the m a n n e r in which t h e s e r e s e r v e s a r e supplied. The F e d e r a l R e s e r v e S y s t e m effects the supply of r e s e r v e s and, t h e r e f o r e , of total money supply and bank c r e d i t in s e v e r a l different ways: (1) through changes in the r e s e r v e r e q u i r e m e n t s of m e m b e r banks; (2) through loans to the m e m b e r b a n k s ; and (3) by operations in the open m a r k e t for g o v e r n m e n t s e c u r i t i e s . I would like to touch briefly on one or two a s p e c t s of the discount function of the F e d e r a l R e s e r v e Banks and the m e c h a n i c s of the operation of the Open M a r k e t Committee. With r e s p e c t to advances and discounts, it b o t h e r s me a little to h e a r the discount function r e f e r r e d to a s a "window" which s e e m s to me to imply that it m a y be open, closed, or p a r t l y open. I p r e f e r to think of the function as a " c o u n t e r " r a t h e r than a "window" b e c a u s e it is always available for u s e by m e m b e r b a n k s for a p p r o p r i a t e p u r p o s e s on exactly the s a m e t e r m s except for r a t e s . The discount r a t e usually r e f l e c t s the c u r r e n t m o n e t a r y policy whether that policy be one of r e s t r a i n t or e a s e . It would be p o i n t l e s s to a t t e m p t to r e g u l a t e the growth of the money supply and c r e d i t through open m a r k e t operations if, at the s a m e t i m e , we p e r m i t a free flow of r e s e r v e s by the discount r o u t e . - 5 - While a c c e s s to the F e d e r a l R e s e r v e discount facilities is a p r i v i l e g e of m e m b e r s h i p r a t h e r than one of right, it is a p r i v i l e g e which banks a r e expected to u s e when it is needed and when the p u r p o s e of the borrowing is a p p r o p r i a t e . T h e r e a r e , however, a few b a s i c p r i n c i p l e s which a r e applicable in connection with a d m i n i s t e r i n g the discount function. The B o a r d of G o v e r n o r s of the F e d e r a l R e s e r v e System h a s defined in i t s Regulation A the c i r c u m s t a n c e s under which m e m b e r banks may b o r r o w . The g e n e r a l p r i n c i p l e s covering a p p r o p r i a t e use a p p e a r in the foreword to the r e g u l a t i o n a s follows: F e d e r a l R e s e r v e c r e d i t is g e n e r a l l y extended on a s h o r t - t e r m b a s i s to a m e m b e r bank in o r d e r to enable it to adjust its a s s e t position when n e c e s s a r y b e c a u s e of developments such a s a sudden withdrawal of d e p o s i t s or s e a s o n a l r e q u i r e m e n t s for c r e d i t beyond those which can r e a s o n a b l y be m e t by use of the b a n k ' s own r e s o u r c e s . F e d e r a l R e s e r v e c r e d i t i s a l s o available for longer p e r i o d s when n e c e s s a r y in o r d e r to a s s i s t m e m b e r banks in meeting unusual situations, such a s m a y r e s u l t from national, regional, or l o c a l difficulties or from exceptional c i r c u m s t a n c e s involving only p a r t i c u l a r m e m b e r b a n k s . Under o r d i n a r y conditions, the continuous u s e of F e d e r a l R e s e r v e c r e d i t by a m e m b e r bank over a c o n s i d e r a b l e p e r i o d of t i m e is not r e g a r d e d a s a p p r o p r i a t e . In c o n s i d e r i n g a r e q u e s t for c r e d i t accommodation, each F e d e r a l R e s e r v e Bank gives due r e g a r d to the p u r p o s e of the c r e d i t and to its p r o b a b l e effects upon the maintenance of sound c r e d i t conditions, both a s to the individual institution and t h e ' economy generally. It k e e p s informed of and takes into account the g e n e r a l c h a r a c t e r and amount of the loans and investments of the m e m b e r bank. It" c o n s i d e r s whether the bank is borrowing p r i n c i p a l l y for the p u r p o s e of obtaining a tax advantage or p r o f i t ing from r a t e differentials and whether the bank is extending an undue amount of c r e d i t for the speculative c a r r y i n g of or trading in s e c u r i t i e s , r e a l e s t a t e , or c o m m o d i t i e s , or o t h e r wise. - 6 - This wording i s , of n e c e s s i t y , g e n e r a l but it affords, a helpful guide without setting down a fine line of d e m a r c a t i o n between a p p r o p r i a t e and i n a p p r o p r i a t e borrowing. C i r c u m s t a n c e s with r e s p e c t to each and e v e r y borrowing differ and each c a s e m u s t be a p p r a i s e d individually. Briefly, it s e e m s to m e that this m a y be s u m m a r i z e d by saying that while the m e m b e r banks e n d o r s e the principle that they should o p e r a t e within t h e i r own r e s o u r c e s , they have the p r i v i l e g e of borrowing from their F e d e r a l R e s e r v e Bank for s h o r t p e r i o d s of t i m e to adjust for sudden withdrawals o r s e a s o n a l n e e d s or to m e e t unusual situations such a s might r e s u l t from national or local difficulties. Continuous u s e over a p e r i o d of t i m e can not be r e g a r d e d as appropriate. Another point which I would like to mention is that, c o n t r a r y to some i m p r e s s i o n s , the m e c h a n i c s of b o r r o w i n g from the F e d e r a l R e s e r v e a r e not i n s u r m o u n t a b l e or e x t r e m e l y difficult. Most borrowing is effected by the u s e of a simple c o l l a t e r a l note which is executed by the m e m b e r bank and s e c u r e d by United States government s e c u r i t i e s . In this i n s t a n c e , all the bank needs to do i s to execute the note and a u t h o r i z e its F e d e r a l R e s e r v e Bank to set aside specific g o v e r n m e n t obligations which o r d i n a r i l y a r e in safekeeping with it. The other a s s e t s of a bank can also be used a s c o l l a t e r a l for a loan from the R e s e r v e Bank. E i t h e r of two discount r a t e s m a y apply when c o l l a t e r a l other than g o v e r n m e n t s e c u r i t i e s is offered. lf That c o l l a t e r a l which m a y be classified a s eligible paper 1 1 under the p r o v i s i o n s of the Act would qualify a loan for the b a s i c r a t e which a l s o applies to loans s e c u r e d by g o v e r n m e n t s . A loan s e c u r e d by a s s e t s other than g o v e r n m e n t s or eligible p a p e r c a r r i e s a r a t e which, under the - 7 statute, -is 1/2 p e r cent higher than the b a s i c discount r a t e . This l a t t e r c l a s s of loans was not p e r m i t t e d under the original Act, but was added in the banking l e g i s l a t i o n of the m i d - 3 0 ! s so that m e m b e r banks could still obtain c r e d i t from the F e d e r a l R e s e r v e even though they w e r e out of government s e c u r i t i e s and eligible paper. In m y judgment, the understanding of eligibility r e q u i r e m e n t s i s not difficult. However, classifying a c o m m e r c i a l b a n k ! s a s s e t s a s to eligibility does r e q u i r e understanding of the r e q u i r e m e n t s and examination of the c r e d i t s . In this r e s p e c t , our staff would be p l e a s e d to a s s i s t any bank which has any questions with r e s p e c t to eligibility. Briefly stated, under Regulation A of the B o a r d of G o v e r n o r s , eligible p a p e r m u s t , of c o u r s e , be negotiable and endorsed, and in addition, m u s t be s h o r t - t e r m . A g r i c u l t u r a l p a p e r cannot have m o r e than nine months to run, and other p a p e r not m o r e than 90 days to r u n at the t i m e of the advance. The p a p e r m u s t have a r i s e n in the production, p u r c h a s i n g , c a r r y i n g or m a r k e t i n g of goods, including a g r i c u l t u r a l p r o d u c t s , or to m e e t the c u r r e n t operating expenses of a b u s i n e s s so engaged. Such p a p e r is not eligible if the p r o c e e d s w e r e used for fixed c a p i t a l p u r p o s e s , m e r e l y i n v e s t m e n t s or for the p u r p o s e of c a r r y i n g or trading in s t o c k s , bonds or other i n v e s t m e n t s e c u r i t i e s except those of the United States Government. The other point I would like to mention is the operation of the Open M a r k e t C o m m i t t e e of the F e d e r a l R e s e r v e System. All of you a r e a w a r e that t h i s C o m m i t t e e effects the r e s e r v e s of banks by the p u r c h a s e and sale of government - 8 - s e c u r i t i e s in the open m a r k e t . Its r o l e in formulating m o n e t a r y policy is significant and, I b e l i e v e , its method of operation would be of i n t e r e s t to you. The C o m m i t t e e , which i s provided for by statute, is composed of 12 m e m b e r s , including the 7 m e m b e r s of the B o a r d of G o v e r n o r s and 5 P r e s i d e n t s of F e d e r a l R e s e r v e B a n k s . The P r e s i d e n t of the F e d e r a l R e s e r v e Bank of New York is a p e r m a n e n t m e m b e r of the C o m m i t t e e while the other 4 p r e s i d e n t i a l positions a r e supplied on a rotating b a s i s from the other F e d e r a l R e s e r v e B a n k s . R e s e r v e Bank is grouped with that of Dallas and Atlanta. Your C u r r e n t l y , the P r e s i d e n t of the D a l l a s bank i s a m e m b e r of the C o m m i t t e e , and the P r e s i d e n t of the St. Louis bank is the a l t e r n a t e m e m b e r and, in o r d i n a r y c i r c u m s t a n c e s and p r o c e d u r e s , would be a m e m b e r next y e a r . The formulation of policy by the Open M a r k e t C o m m i t t e e is not done in a vacuum nor on the spur of the m o m e n t nor by any one or two people. The m e m b e r s of the B o a r d of G o v e r n o r s and the p r e s i d e n t s of each of the 12 F e d e r a l R e s e r v e Banks a r e continually studying r e p o r t s , s t a t i s t i c s , and all available information in an effort to keep up with developments nationally and internationally. E a c h of the banks and the B o a r d of G o v e r n o r s is supported in this undertaking by staffs who a r e s p e c i a l i s t s in t h e i r fields. T h e s e staffs a r e r e g u l a r l y engaged in gathering s t a t i s t i c s , making s u r v e y s , analyzing r e p o r t s and formulating views and c o n s i d e r a t i o n s for t h e i r r e s p e c t i v e p r i n c i p a l s . In addition, the 12 R e s e r v e Banks and t h e i r 24 b r a n c h e s each h a s a B o a r d of D i r e c t o r s with a total of b e t t e r than 250 m e n who come from v a r i o u s a r e a s of banking, b u s i n e s s , and p r o f e s s i o n a l life. T h e s e also a r e i m p o r t a n t - 9 s o u r c e s , not only of c u r r e n t b u s i n e s s and s t a t i s t i c a l information, but a l s o of g r a s s r o o t , p r a c t i c a l understanding and judgment. The Open M a r k e t C o m m i t t e e m e e t s at the offices of the B o a r d of G o v e r n o r s of the F e d e r a l R e s e r v e System in Washington, D. C. approximately each t h r e e weeks and m o r e often when it is advisable. These m e e t i n g s a r e attended by the 7 m e m b e r s of the B o a r d of G o v e r n o r s and the 12 p r e s i d e n t s of the F e d e r a l Reserve Banks. In addition, selected and key m e m b e r s of the staffs of the Banks and the B o a r d a r e a l s o p r e s e n t . The C h a i r m a n of the C o m m i t t e e opens the meeting and c a l l s on m e m b e r s of the staff of the B o a r d of G o v e r n o r s for r e p o r t s . These include information on the g e n e r a l economic situation, the banking and financial p i c t u r e , and r e g a r d i n g our b a l a n c e of p a y m e n t s . This is followed by a r e p o r t made by the Manager of the Open M a r k e t Account who is the staff m e m b e r r e s p o n s i b l e for c a r r y i n g out the p o l i c i e s e s t a b l i s h e d by the Open M a r k e t C o m m i t t e e for the p u r c h a s e and sale of government securities. Another r e p o r t on international a c t i v i t i e s and o p e r a t i o n s is submitted by the Special M a n a g e r for foreign c u r r e n c y operations for the Account. Following the staff r e p o r t s , the P r e s i d e n t of the F e d e r a l R e s e r v e Bank of New York m a k e s a r e p o r t and concludes by making a s t a t e m e n t with r e s p e c t to what he thinks m o n e t a r y policy should be for the c u r r e n t p e r i o d . The C h a i r m a n then c a l l s on each P r e s i d e n t and each m e m b e r of the B o a r d of G o v e r n o r s for h i s c o m m e n t s and statement. The P r e s i d e n t of each F e d e r a l R e s e r v e Bank c o m m e n t s specifically on the economic and financial situation in h i s d i s t r i c t in addition to making such other o b s e r v a t i o n s as he may choose, and a l s o m a k e s a s t a t e m e n t with r e s p e c t to what he b e l i e v e s c u r r e n t m o n e t a r y policy should be. a r e m a d e by the C h a i r m a n of the C o m m i t t e e . The l a s t o b s e r v a t i o n s - 10 If a c o n s e n s u s for m o n e t a r y policy is apparent, this b e c o m e s the C o m m i t t e e policy. If t h e r e is no c o n s e n s u s and a difference of opinion e x i s t s , the C h a i r m a n c a l l s for a vote and the majority view is established a s the c u r r e n t m o n e t a r y policy. The C o m m i t t e e then f o r m u l a t e s a written d i r e c t i v e a d d r e s s e d to the Manager of the Open M a r k e t Account which guides.him in the a d m i n i s t r a t i o n and operation of the Open M a r k e t Account until that policy is changed at a subsequent meeting of the C o m m i t t e e . An account of the d e l i b e r a t i o n s of the F e d e r a l Open M a r k e t C o m m i t t e e a p p e a r s each y e a r in the annual r e p o r t of the B o a r d of G o v e r n o r s of the F e d e r a l R e s e r v e System. In s u m m a r y , our banking s y s t e m , including m e m b e r banks and n o n m e m b e r b a n k s , national and state, and the F e d e r a l R e s e r v e , provide the public with e s s e n t i a l banking s e r v i c e s and with c r e d i t . In the field of c r e d i t , the F e d e r a l R e s e r v e c r e a t e s the r e s e r v e s which enable c o m m e r c i a l banks to extend c r e d i t to the public. I think we can all r e g a r d the p a s t 50 y e a r s with some d e g r e e of satisfaction. Our economic growth under our competitive e n t e r p r i s e h a s been r e m a r k a b l e and would not have been p o s s i b l e without the functioning of the banking s y s t e m . There w e r e rough spots during the p a s t 50 y e a r s , it is t r u e , but in the b r o a d view, the banking s y s t e m h a s worked, and worked well.
@FedFRASER