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Statement on

S. 85, the "Monetary Policy Improvement Act of 1979"
S. 353, the "Federal Reserve Modernization Act of 1979"

Presented to

Committee on Banking, Housing and Urban Affairs
United States Senate


Irvine H. Sprague, Chairman
Federal Deposit'Insurance Corporation
March 27, 1979,

FEDERAL DEPO SIT IN S U R A N C E CO R P O R A T IO N , 550 Seventeenth St. N.W., Washington, D.C. 20429


Mr. Chairman, I appreciate this opportunity'to testify on
this question of Federal Reserve membership.
We in the FDIC share with our partner agency its concern
about the steady decline in membership, particularly with regard
to its effect on the conduct of monetary policy.
This committee has a number of proposals before it to deal
with this matter.

I believe that any solution should incorporate

the following elements:

The Federal Reserve should have the tools it needs to

conduct monetary policy.

The Treasury should suffer minimal loss of revenue

as a result of this legislative initiative.

All similarly situated deposit accounts should be

treated alike, regardless of the type of financial institution.

Membership in the Federal Reserve System should remain

voluntary, but reserves should be made mandatory for institutions
designated under this legislation.

All depository-type institutions should have a lender

of last resort.

The Federal Reserve should be relieved of the burden of

bank supervision, especially in view of the additional workload
that a substantial transfer of state banks to Federal Reserve
membership would entail, and the federal supervisory function of
state banks should be consolidated within the FDIC.



I want to say at the outset that we feel that the Federal
Reserve should have the tools it needs for the successful conduct
of the nation's monetary policy.

That prime function of the

nation's central bank is critical to the nation's economy, to
the well being of our people here at home, and to the mainte­
nance of the value of the dollar in international exchange.
To the extent that the Federal Reserve is handicapped in its
exercise of monetary management, the nation runs a greater risk
of runaway inflation or devastating depression.
The FDIC has long supported the Federal Reserve in its mone­
tary policy function by supplying necessary financial information
on the banks we supervise, an estimated 8,827 state banks which
are not members of the Federal Reserve System.

In recent years,

in response to requests from our partner agency, we stepped up
the flow of information.
In early 1976 the FDIC instituted a quarterly survey of all
8,827 nonmember banks in order to provide the Federal Reserve
with better information on the money supply.

Then in July of

1977, a sample of 580 nonmember banks began reporting deposits
and cash items on a regular weekly basis, the same items as all
nonmember banks report quarterly.

The Federal Reserve has

indicated that it expects the data from these two surveys to
significantly improve its estimates of the nonmember bank com­
ponent of the nation's money supply.

Just this past week, the

Federal Reserve has asked us, and we have agreed, to continue
the surveys for the time being.

The FDIC and the Federal


Reserve have agreed to review these programs in the very near
future to determine how important nonmember bank data are for
monetary policy purposes and whether the sample of nonmember banks
is adequate.
Traditionally, the Federal Reserve has employed open market
operations and the adjustment of reserve requirements as its two
major levers in administering monetary policy.

Now the Federal

Reserve is concerned that the erosion in its membership is seriously
undermining one of its two principal controls of monetary policy.
The Federal Reserve further contends that reserve levels
serve as a benchmark against which open market operations can be
gauged and that the effectiveness of such operations is impaired
as reserve coverage shrinks.
There is no question that the drop in membership has been

The Federal Reserve has estimated that the proportion

of commercial bank demand deposits subject to reserve requirements
has declined from 86 percent in 1960 to 72 percent in mid-1978.


Federal Reserve estimates that this is about the minimum level at
which reserves can be an effective implement in conducting monetary

Further, we can anticipate a substantial increase in the

rate of membership withdrawals, especially if no action is taken
It is not difficult to understand the reason for the steady
decline of Federal Reserve member banks.

Reserve requirements

which cannot earn interest have always constituted a burden


on members.

In fact, a staff study by the Federal Reserve

estimates that this cost of belonging to the system exceeds
$650 million annually, based on 1977 figures.

That would be

about 9 percent of profits of member banks before income taxes.
If that were not reason enough for member banks to chafe
under the burden, the situation is made worse by the fierce and
steadily increasing competition of thrift industries.


example, commercial banks, which once held a virtual monopoly
on check writing services, are now subject to such competition
as interest-bearing NOW accounts, credit union share drafts,
and a variety of transaction services which permit patrons to
transfer funds from savings or other interest-earning accounts.
We can see similar competition for non-demand deposits
from thrifts and a growing number of non-bank industries which
are bidding for new sources of funds.

The distinction not only

among financial institutions, but also between such institutions
and the business world at large, is becoming increasingly blurred.
Federal Reserve member banks resent the fact that while
they continue to be required to hold non-income producing reserves,
they must now contend with a new wave of financial services com­
petition from institutions which have no such reserve requirements.
The upshot of all this has been mounting pressure to alleviate
the Federal Reserve membership problem.

Your committee gave this

matter intensive consideration at the end of the 95th Congress,
but there was not time for Congress to act.

Since then, both

your committee and the Federal Reserve have given the matter
more study and refined proposals.


Two of the most important are before you today —

S. 85, the

Monetary Policy Improvement Act of 1979, and S. 353, the Federal
Reserve Modernization Act of 1979.

There are any number of other

proposals, and variations on proposals, as to the best way of stemming the ebb of Federal membership.
Most proposals before your committee recommend reductions
in reserve requirements so that institutions would have additional
funds for investment or other earnings purposes.

We would support

this and would add that the reduction should be substantial.


combined with the requirement for reserves at similarly situated
institutions, would, in effect, broaden the reserve base, but
lower the amounts of the reserves so that the burden is not too
onerous for any one institution and is more equitably shared by
all institutions.
I believe that two precepts should be incorporated into what­
ever membership course this committee ultimately chooses:
First, membership in the Federal Reserve System should continue
to be voluntary, but the reserve requirement should be made manda­
tory for institutions designated under this legislation.
Second, all financial institutions equally situated should
be subject to' the same restrictions, i.e., reserve requirements
should be applied alike on a uniform basis to all types of financial
institutions offering the kinds of services against which reserves
must be held.



There are proposals for exemptions for small banks, and
I would support an exemption of whatever size the committee feels
appropriate, provided that it meets the standard of treating
equally situated financial institutions alike.
Your committee at this time may also want to consider a
simplification of the reserve structure.

Under the present system,

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

Reserves on demand deposits now

range from seven percent to sixteen and a quarter precent, depend­
ing on the status and size of the bank, and between one and six
percent on savings deposits.

As deposits are switched among member

banks of different sizes and between demand and savings accounts,
the effective reserve requirement changes.

This makes it difficult

to calculate the effect on money supply of a given change in

The problem increases as new developments, such as

telephone transfers and NOW accounts and automatic transfer from
savings to checking accounts which took effect last November 1,
make it much easier for customers to shift funds between demand
and savings deposits.

Let us now take a look at aspects of this problem that
are of particular interest to the FDIC as the insurer of most of
the nation*s banks.


-7 -

Since the inception of the Federal Reserve System, its
lender-of-last-resort function has been one of the most important
benefits of bank membership.

The so-called discount window is

essential to the smooth functioning of our banking system.


banks can turn to it for prompt assistance in meeting unexpectedly
heavy obligations or in coping with the effect of restrictive
monetary and credit policy.

It is a convenient and indispensable

cash-flow bridge.
But as the Federal Reserve itself points out, the effective­
ness of the discount window, which is available only to member
banks, declines in step with the decline in bank membership.


that extent, the decline in membership makes more likely the
possibility of a crisis in banks caught in a monetary cash-flow
Virtually all proposals before your committee would broaden
access to the discount window. We believe that all depository-type
institutions should have a lender of last resort.

As part of this

package, a universal access to the discount window would provide
a vital back-up support to the vast majority of the nation's banks
which are now closed out of the Federal Reserve's window.

This brings us generally to the question of cost to the
Treasury of the various Federal Reserve membership proposals.
This is very much a question of imponderables.

It is difficult

to guage the effect of any action on membership under a volun­
tary system.

Another consideration is that any direct loss to



the Treasury in terms of transfers from the Federal Reserve is
partly recapturable in the form of taxes on new earnings poten­
tial of banks and bank stockholders.
The Treasury Department has voiced concern about the cost
of this legislation and has suggested a dollar figure on Treasury
net loss above which Treasury Department support for this legislation would be withdrawn.
My hope would be that through the appropriate combination
of reduced but broader-based reserves and charges for Federal
Reserve services, we could compensate for loss to the Treasury
to a major degree and thus avoid transferring the present cost
from the banks to the general taxpayer.

The nation is well served by a massive collection and
payments system that safely and surely handles the clearing
of millions of transactions every day. The process takes place
within the Federal Reserve System as a benefit of membership and
outside the System in major correspondent banks that provide
similar services for nonmember banks.

We want to assure that

our collection and payments system remains as risk-free and
effective as it is today.
Several proposals would seek to offset the cost to the
Treasury of Federal Reserve membership revision by charging
for Federal Reserve services, pricing them individually, and
perhaps making some of them available to nonmember institutions.


This would allow various financial institutions to purchase
the services they desire from the Federal Reserve or private

Among the Federal Reserve System’s major services

are operation of the payment system, including check processing
and transportation and automated clearinghouse functions; pick
up and delivery of coin and currency; wire transfers; purchase,
sale, safekeeping and clearing of securities; and operation of
the discount window.
The effect of explicit pricing would be to provide a better
opportunity for competition from those correspondent banking
systems that provide payments

and other clearinghouse functions

outside the Federal Reserve System.
The Federal Reserve has circulated a tentative pricing
schedule but has considered the separate-pricing feature a part
of the entire membership package.
S. 85 provides guidelines to assure that the competition
is fair.

Federal Reserve prices would be required to take into

account all direct and indirect costs plus an adjustment for
taxes and a payout to stockholders that would be required of
private firms.

S. 85 also requires that pricing give due regard

to competitive factors and to the provision of an adequate level
of services nationwide.
We would certainly support that.

We must preserve and

strengthen the risk-free collection system that has developed
within and without the Federal Reserve System.

Fair competition

and explicit pricing should be designed to nurture that dual
enterprise and to encourage the growth and development of safe,
reliable services to the banking public at minimum cost.


10 -

One of the unintended and undesirable side effects of this
legislation could be a rapid burgeoning in the bank supervisory
workload of the Federal Reserve.

If reserves are made mandatory,

a substantial transfer of state banks to Federal Reserve member­
ship could follow.

This would be almost a certainty if discount

window access were to continue to be limited to members.


FDIC now supervises 8,827 state banks that are not members of the
Federal Reserve System; if many of these were suddenly to join
the System, the Federal Reserve, which now supervises about 1/000
banks, could easily find itself with a massive increase in its
bank supervisory workload.

This additional responsibility would only further detract
from the Federal Reserve's primary concern of conducting mone­
tary policy.

Such an occurrence would be most unfortunate

because these functions —

monetary policy and bank supervision

are each important enough in their own right to merit and

demand the full time attention of a single agency.
Therefore, we would recommend that as an essential part of
this legislation the entire federal supervisory function for
state banks, regardless of Federal Reserve membership, be
consolidated within the FDIC.

This would provide economy in

operations and would be a major move toward more uniform

Reserve for financial information on state bank operations, and



under any circumstances we will continue to work with the Federal
Reserve and to provide this information as we always have in the

We will continue to fulfill our responsibility to cooperate

with its conduct of monetary policy.
The proposals I have outlined will strengthen the dual
banking system, support monetary policy objectives of the
Federal Reserve, be fair to all segments of the banking industry
and foster the continued safety and soundness of our banking