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Portion of Statement of
/■

Hugh D. Galusha, Jr.
President
Federal Reserve Bank of Minneapolis

Before
The Financial Institutions Committee
of the
M i n n esota House of Representatives

Concerning
Par Banking Legislation

February 24, 1967

What is i t ?
A nonpar bank is a bank that pays less than the face amount of
checks presented to it through the mail.

The difference between the face

amount of the check and the amount paid is called exchange.

It is best

illustrated by an example.
Mr. Merchant of East Town buys a load of seed for $1,000 from
Mr. Farmer across the state in West Town.

In payment of the bill,

Mr. Merchant sends Mr. Farmer a check for $1,000 drawn on Mr. Merchant's
account at Nonpar Bank of East Town.
account in the Bank of West Town.

Mr. Farmer deposits the check to his

The Bank of West Town then sends the

check for payment either direct to Nonpar Bank of East Town or by way of a
correspondent bank through which Bank of West Town ordinarily collects
checks.

Upon receipt of the check, Nonpar Bank of East Town charges

Mr. Merchant's account the full amount of $1,000.

However, it remits to

Bank of West Town only $999 for the account of Mr. Farmer.

$1.00 is

retained by Nonpar Bank of East Town as a so-called exchange charge.
Understandably, Mr. Farmer is distressed, but there isn't a great deal he
can do about it.

First, the size of the exchange charge, although it

aggregates over $3-% million a year in Minnesota, usually is not large enough
on the individual transaction to justify the costs of prolonged correspondence;
and secondly, it is not only a legal charge in Minnesota, but an accepted
practice for a majority of the state banks.
Viewed in the context of normal trade relationships, it is an
unusual one, for banks, like other businesses, ordinarily charge only for
services performed for their customers.




1

I say ordinarily because nonpar

banks also collect from third parties like Mr. Farmer, who are not customers
of that bank as we ordinarily think of the term "cu s t o m e r 11.

In reality, the

person who pays the exchange charge to a nonpar bank is an innocent bystander.
Obviously, it w a s n ’ always so.
t

During much of the 19th Century, when checks

were usually paid in gold and coin, there was a cost involved in shipping
the gold and coin to distant points.

The cost of this transportation gave

rise to exchange charges, for there was a service outside the normal course
of bank collections involved.

This is no longer the case.

Checks are no

longer paid in coin, much less gold--the latter is illegal and the former
obsolete.

Interbank settlements are now accomplished by bookkeeping entries

in accounts with Federal Reserve Banks or correspondent banks.




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Where are these b a n k s ?
But there are nonpar banks left in either 14 or 15 states depending
upon the date of the statistics.

Except as otherwise noted, the charts I have

to show you today are based upon statistics accumulated by the Federal Deposit
Insurance Corporation, which is the agency that insures deposits in nearly
all commercial banks.

In 1965 the last nonpar bank in Oklahoma converted,

reducing the total to 14.
United States banking.
significant p r o p o r t i o n .




This chart shows the par/nonpar structure of

In only 6 states do the nonpar banks constitute a

Chart

Why leg i s l a t i o n ?
The point is sometimes made that legislation is u n n e c e s s a r y - - that the
practice is gradually disappearing.
between 1919 and 1966.

This chart indicates the sharp decline

But the decline in numbers is no longer very fact,

particularly in these states.

The practice is deeply rooted in custom, and

there is no reason to believe it will decline significantly without
legislation.
this route.

Three states, Iowa, Nebraska, and Wisconsin, have followed
Federal legislation has been introduced, but it seems obvious

that the vitality of our state banking system will be better safeguarded by
corrective legislation at the state level.




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Chart

How large are these b a n k s ?




Deposits/number of banks.

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Chart

Where are they l o c a t e d ?
Where are these banks located?

Seventy-five percent of them are in

towns of less than 2,500 population, although they are also to be found to a
degree in Twin Cities suburbs.

There are 42 in the seven counties of the

metropolitan area.




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Chart

What is the competitive p a t t e r n ?
Generally they exist in one-bank towns.
with a par bank in the same community.

In only 18 do they compete

Incidentally, though, there are 83

par banks operating in one-bank towns, so a generalization that nonpar banking
is related to the survival of small towns is not valid.
In addition to my commitment as president of the Federal Reserve
Bank of this district to the economic growth of this entire district which
has far more small towns than large ones, I have a personal conviction born
of years of a professional practice involved in the main with small towns
throughout the district that the fact some bankers collect exchange does not
enhance their role in community development over that of the par banker in the
same or similar towns.

Many nonpar bankers,

like their par counterparts, are

useful, constructive and important members of their communities.

I believe in

small towns and their right to survive and grow, but there are too many small
towns in this district doing very well without exchange revenue flowing to
their banks to warrant a conclusion that the small town banks need be
subsidized by the exaction from those beyond its borders of charges not
warranted by the service rendered.




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Chart

H ow important is exchange revenue to these b a n k s ?
Every bank whose deposits are insured by the FDIC has to file a
periodic report with the FDIC.
to other service charges.

On this report appears a line item related

This includes service charges assessed against

depositors, exchange charges, as well as non-operating income such as income
from insurance agencies, etc.

It is important,

though, to note that the

total of these items as a part of total operating revenue has declined
from 19% to 9% from 1942 to 1964.

In an effort to isolate the contribution of exchange charges to

Chart

this line item, a special survey was made by the FDIC of nonpar banks on a
sample basis.

In Minnesota figures were obtained from 104 nonpar banks.

Of the total item, exchange charges make up approximately 6.2%.




How do the earnings of nonpar banks compare to par b a n k s ?
Commercial banks generally (both par and nonpar) obtain the bulk
of their income from interest earned on loans and investments, but both
need supplemental income, as well.
come from?

Where does this supplemental income

The par banks rely heavily upon service charges, whereas the

nonpar banks place their reliance on exchange.
difference in gross profitability.

There is very little

While it is true that this is related

to total operating income rather than net profit, and therefore the exchange
charges in many cases bulk large as a proportion of net profit, so is it
true of the service charges for par banks.

In visiting with Mr. Jessup

about this, the problems of dealing with net profit figures instead of total
operating income were insurmountable, because of the lack of comparability
in expense charges and income composition.

Some banks, for example, had a

higher proportion of tax exempt municipals than others; some had insurance
agencies and others did not; and in some, owners took out a greater share of
the earnings through salaries than others.




Chart

How difficult is it to make the c h a n g e ?
A study was made of all banks in the United States that changed
from nonpar to par in the years 1962 and 1963.

There was a total of 42.

Of these, 16 were in the typical one-bank rural towns.

The earnings of

these 16 were compared in 1961, before the change, with the earnings of all
the other nonpar banks in these same states in rural, one-bank towns, and
then again in 1964 after the change.

You will notice that they not only

survived, but did slightly better than those that did not change.




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Summary
The reasons for the change to par clearance may be summarized in
this way:
First of all, its the cost of the exchange charges themselves.
Although the individual items are not especially significant, in the aggregate
they total over $3-*% million for Minnesota.

These charges are collected

from a variety of people who receive checks drawn on nonpar banks--big
business,

little business, farmers, h o u s e h o l d e r s --in short, almost everyone

who does business with a customer of a nonpar bank.
More than this cost, however, is the cost imposed on the banking
system as a whole, and on business generally.

We are gradually becoming a

nation of bookkeepers of necessity, but bookkeeping costs money.

To handle

unusual items--such as nonpar checks that require computation and special
entry--adds to regular and normal costs.

This additional cost has been

projected for the banking system at roughly the same amount as the charge
itself.

The cost to businesses,

large and small, and the social cost of the

irritation to all people, is in the same proportion.
The second reason has to do with the onset of automation.

The day

is coming--and in some areas it is already here--when money and credit will
be transferred by electronic means.

Through joint use of computers, even small

businesses are now sharing in the economy of mechanization of accounting
through the computer; but when the national system becomes operational, which
it is estimated will be in the mid-70's, those communities that will not be
part of this hook-up will suffer.
system.

Banks must be an integral process of this

Nonpar banks, because their items require special handling, do not

adapt to c o m p u t e r i z a t i o n - - and those communities where nonpar banking persists




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will be at a disadvantage.

And this means not only the businesses there, but

everyone who has any credit transactions at all--the housewife,

the farmer,

all will be touched.
The third reason has to do with equity among classes of people.
The statement is frequently made that this does not affect the farmer or the
small businessman, because it is aimed only at large business.
true.

This is not

The larger customers of a nonpar bank frequently are able to make

special arrangements to have their checks cleared at par to avoid criticism
from their suppliers and creditors.
arrangements in this district.

There are roughly 2,000 special clearing

But the suppliers and creditors of the small

customer of the nonpar bank, who are unable to work out special arrangements
to have their checks cleared at par, pay the exchange charge.
Most checks do not move very far.

In a study made a few years ago,

it was found that for banks of less than $7-% million, 80% of the checks
drawn on them cleared within their own federal reserve d i s t r i c t - - and of these,
30% cleared within a relatively restricted area around the bank.
Finally, and perhaps most significantly, to those of us who are c o n ­
cerned with the economic development and growth of this area, is the adverse
contribution that nonpar banking makes to the image of Minnesota.

In the

competition for new business among the states, we have to have everything going
our way to get a fair share, simply because we are trying to break into the
national scene against firmly lodged competitors.

The difficulties of nonpar

banking are well known in the financial community of the United States--witness
an editorial in the New York Times a year ago about the subject.

It does not

contribute to the image of this state to have the practice continue.




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I have had assembled and will now furnish each committee member
a leaflet containing:




(1) a 1-page summary of the principal points I have touched on today,
(2) a condensation of Paul Jessup's thesis based largely on the
FDIC's special study of nonpar banking*

and

(3) reproductions of the charts you have seen today.

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