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NEWS RELEASE FEDERAL DEPOSIT INSURANCE CORPORATION WASHINGTON, D. C. 20429 FOR RELEASE AT 11 :0 0 A.M. MONDAY, OCTOBER h 1965: INTEREST RATE REGULATION An Address By K. A. R andall, Chairman Federal Deposit Insurance Corporation Washington, D. C. Before the STATE BANK DIVISION, AMERICAN BANKERS ASSOCIATION in the C ontinental Room Conrad H ilton Hotel Chicago, I l l i n o i s Monday, October U, 1965 9 :3 0 A. M. Telephone: 393-8400 Br. 221 INTEREST RATE REGULATION I would lik e to discu ss with you today one aspect o f bank supervisory powers th a t has a ttra c te d qu ite a great deal o f a tte n tio n r e c e n tly — the power to se t maximum in te r e s t r a te s payable on time d e p o sits. The su b ject may seem mundane and p rim arily o f concern to bank reg u lato ry ag en cies. It i s a s u b je c t, however, th a t has broad ra m ific a tio n s fo r banking as a whole because o f i t s impact on the com petitive p o sitio n o f in d iv id u al banks or groups o f banks v is - a - v is each other or in r e la tio n to oth er fin a n c ia l in s t it u t io n s . I t i s important a lso because i t a f f e c t s the earnings and p r o f i t a b i l i t y o f banks, and the stru ctu re o f bank a s s e ts and l i a b i l i t i e s - and thus th e o v e r -a ll stren g th o f the banking system, I am not planning to d iscu ss today the separate question whether reg u la tio n s governing in te r e s t r a te c e ilin g s should be reta in e d or ab olish ed . R ather, my p rin c ip a l concern w ill be with the r o le th a t in te r e s t r a te s and in te r e s t r a te reg u la tio n s have played in recen t years in a llo c a tin g funds among variou s fin a n c ia l in s t it u t io n s . In te r e s t r a te s paid by banks fo r funds have become in c re a sin g ly important over th e past decade fo r both in te rn a tio n a l and domestic reaso n s. Since 1958, the United S ta te s has had to take much more e x p lic it reco g n itio n of in tern atio n al considerations in th e form ulation o f monetary and f i s c a l p o lic y - - because o f the r o le o f the d o lla r as the leading in te rn a tio n a l currency, th e p e rsiste n c e o f d e f ic it s in our balance o f payments accounts, 2 and the simultaneous and steady dism antling o f co n tro ls abroad over in te rn a tio n a l trad e and payments. The increased m o b ility o f sh ort-term funds across n a tio n a l boundaries in response to in t e r e s t r a te d if f e r e n t ia ls has added a new dimension to th e s itu a tio n . These movements o f in te r e s t- s e n s itiv e money were at tim es d isru p tiv e both o f fo re ig n exchange markets and n a tio n a l economies. Within our b o rd ers, in t e r e s t r a te con sid eration a lso became more important to commercial banks seeking to m aintain t h e ir share o f th e c r e d it m arkets. The upsurge in th e demand fo r c r e d it to fin an ce higher le v e ls o f consumer and. business spending in th e l a t e 1 9 5 0 's exhausted the previou sly ample lending cap acity o f banks. R e s tr ic tio n s on maximum r a te s o f in te r e s t payable on loanable funds - - .that h ith e r to had caused l i t t l e discom fort — soon placed commercial banks a t a decided disadvantage in competing with other fin a n c ia l in s titu tio n s fo r the lim ite d supply o f sav in gs. Banks found themselves having to compete fo r funds both a t home and abroad on the b a s is o f p ric e - - o r in t e r e s t r a te s — as w ell as on the b a s is o f nonprice con sid eration s — such as m a rk e ta b ility . A ll banks in t h i s country faced com petition from other fin a n c ia l in term ed iaries or money market instruments created outside th e banking system, while th e la rg e r banks a lso encountered strong com petition from the e x isten ce o f a lte r n a tiv e investment opp ortu n ities abroad. Under th ese circum stances, th e c e ilin g s on in te r e s t r a te s payable on time deposits were ra is e d by the Fed eral Reserve and th e Fed eral Deposit Insurance Corporation on January 1 , 1957 fo r the f i r s t time sin ce t h e ir in cep tion 21 years e a r l i e r . The subsequent g re a tly expanded inflow o f funds in to banks and the g re a te r v a r ie ty o f a sse t choice th a t became a v a ila b le presented new and - 3 challenging problems to banks, su c ce ssfu lly and im ag in ativ ely. As an industry., they have met t h i s challenge They have been able to s a t i s f y , more e f f e c t iv e ly and e f f i c i e n t l y , the short- and medium-term fin an cin g needs o f the expanding economy. Some problems have a ris e n , n on eth eless, as w i ll always be the case in an economy and banking system as dynamic and ever-changing as ours, A little Siater I would lik e to o u tlin e a proposal th a t should help to meet one o f the problems th a t has appeared among a sm all number o f banks. F ir s t, I would lik e to sketch b r i e f l y the background o f in te r e s t r a te re g u la tio n s. Federal sta tu to ry co n tro ls over in te r e s t r a te s payable on time and savings deposits were f i r s t in s titu te d in the Banking Acts o f 1933 and 1935« These co n tro ls were p art o f the b a sic banking reform le g is la t io n designed to p ro tect the banking system again st recu rrence o f pressures such as those th a t developed during the Great Depression. Many fa c to r s combined to p r e c ip ita te the economic co llap se o f th e e a rly 1 9 3 0 's — only one o f which Was unhealthy com petition fo r funds and t h e ir subsequent placement in sp ecu lative and unsound investm ents. The in clu sio n o f reg u lato ry c e ilin g s on in te r e s t r a te s payable on time and savings d eposits was motivated p a rtly p o ssib le by Congress’ expressed d esire to curb/excessive and uneconomic com petition among banks.' At th e same time an upper lim it to in te r e s t r a te payments was f e l t to be a co n trib u tio n to holding down c o sts and enhancing needed bank p r o f it a b ilit y . The maximum in te r e s t r a te s o r ig in a lly esta b lish e d on January 1 , 1936* ranged from 1 percent on time d ep osits o f 30-89 days to 2% percent fo r deposits maturing in more than one year and fo r savings d e p o sits. remained in e f f e c t u n t il January 1 , 1957. They During t h is period, the c e ilin g s - k - receiv ed l i t t l e n o tice because ample reserv es were a v a ila b le to th e banking system and market r a te s o f in te r e s t were w ell below the posted c e ilin g s . By 1955-565 however5 the r a te s paid by banks on time and savings deposits were pressing against the c e ilin g , and banks were lo sin g out in the com petition fo r loanable funds. By the end o f 1961, banks were again p ressin g again st the c e ilin g in seeking funds. As a consequence. Regulation Q and th e corresponding FDIC reg u latio n 329 were amended on January 1 , 1 9 6 2 ,to permit higher r a te s on deposits o f more than 6 months’ m atu rity. An a d d itio n al con sid eration at t h is time was the outflow o f short-term c a p ita l from the United S ta te s in search o f higher retu rn s abroad. The heavy flow o f domestic savings, unused manpower reso u rces, and id le p lan t ca p a city a l l combined to hold domestic in te r e s t r a te s down, while in te r e s t r a te s abroad were moving up because o f the s c a r c it y o f c a p ita l and strong in te r n a l demands fo r funds. The upward re v isio n s in the in te r e s t r a te reg u la tio n s in Ju ly 19&3 anJ again in November I 96U th e re fo re were designed p rim arily to discourage the outflow o f funds from the United S ta te s , which would in crease our payments d e fic it. Thus, a f t e r years o f r e la t iv e o b scu rity , in te r e s t r a te reg u la tio n s moved in to a more prominent ro le in in flu en cin g th e flow o f funds both d om estically and in te r n a tio n a lly . The domestic impact o f in te r e s t r a te changes on the l i a b i l i t y stru ctu re o f banks has been p a r tic u la r ly sp e cta cu la r. The growth o f time and savings deposits o f commercial banks sin ce 1957 can be a ttrib u te d in la rg e p art to the payment o f more com petitive r a te s by banks in r e la tio n to the r a te s o ffered by other fin a n c ia l in s titu tio n s or to the y ie ld on other money market instrum ents. The c e ilin g s have been ra ise d to bring - 5 commercial bank r a te s in to lin e with market r a te s and to equ alize com petition among fin a n c ia l in term ed iaries, ra th e r than to in flu en ce or se t th e le v e l o f ra te s. Changes have been made w ithin p a r tic u la r m aturity ranges from time to time to permit banks to tap various sources o f funds, such as those at the d isp osal, o f corporate tr e a s u r e r s , while th e banks themselves have been innovators in developing new methods o f a ttr a c tin g and re ta in in g funds. The most notable development in recen t years has been the n eg otiable time c e r t i f i c a t e o f d e p o sit, which sin ce 1961 has become a money market instrument th a t competes e f f e c t iv e ly with Treasury b i l l s , commercial paper, and sim ila r money market investment o u tle ts fo r th e sh ort-term in v e s to r 's funds. N egotiable CD's provid_e a f l e x i b l e means fo r adjustment o f a bank's sh ort-term requirem ents fo r loanable funds. At the same tim e, they provide a liq u id , convenient, and r e la t iv e ly sa fe investment medium fo r business firm s, s ta te and lo c a l governments, and others th a t have s u b sta n tia l sums to in v est at short term. W isely used, n eg otiable CD's can enhance the a b i l i t y o f an ind ivid u al bank to t a i l o r i t s d ep osits to th e demands on i t fo r c r e d it accommodation. They in crease the e f fic ie n c y with which short-term funds can be channeled in to productive u ses. The use o f neg otiable CD' s, however, i s not without problems - - which can vary by siz e o f bank or according to the p re v a ilin g general economic s itu a tio n . Large banks have some advantage over sm aller banks in a ttr a c tin g funds because o f t h e ir better-known names and the consequently wider market fo r t h e ir CD’ s . They a lso have somewhat g re a te r a d a p ta b ility in the management o f t h e ir p o r tfo lio s in the event o f unforseen co n tin g en cies. N ev ertheless, the sm aller bank a lso has used CD’ s advantageously. - 6 - U nfortunately, however, a few hanks have engaged in u ndesirable p r a c tic e s in s o lic it in g fu n d s.— paying money b ro k ers, funders, or other persons, including at tim es the d e p o sito rs, compensation in excess o f th a t perm itted under Federal Reserve and FDIC re g u la tio n s. These h ig h -co st funds have in turn been employed in highly r is k y and i l l i q u i d lo a n s. Let me emphasize, however, i t is not the CD's themselves th a t c re a te the problem. I t i s p rim arily the d e lib e ra te in te n tio n o f engaging in undesirable p ra c tic e s th a t has been resp o n sib le fo r the d i f f i c u l t i e s th a t subsequently developed fo r the banks involved. I would lik e to s tr e s s th a t th e g reat m a jo rity o f banks have observed f a it h f u lly and co n scien tio u sly the in te r e s t r a te reg u latio n s and have not attempted to circumvent th e s p i r i t or l e t t e r o f the law. N evertheless, because o f th e abuses and because o f th e c r u c ia l ro le th a t in te r e s t r a te reg u la tio n can and does play in in flu en cin g domestic and in te rn a tio n a l flows o f loanable funds, some means o f e f f e c t iv e ly enforcing the in te r e s t r a te c e ilin g s i s em inently d e sira b le - - even ju s t fo r the r e c a lc itr a n t few. E x istin g p e n a ltie s or r e fu s a l to extend insurance coverage to the deposits involved on le g a l grounds are in e f f ic ie n t or tend to fo s te r other problems. Consequently, a ft e r co n su lta tio n with Fed eral Reserve and Treasury o f f i c i a l s , I submitted to Congress e a rly l a s t August a d ra ft o f proposed le g is la t io n to strengthen the enforcement provision s o f the in te r e s t r a te reg u latio n s o f the Corporation and the Federal Reserve. The proposed b i l l would amend the Federal Deposit Insurance Act and the Federal Reserve Act so as to provide e f f e c t iv e p e n a ltie s fo r v io la tio n s o f fe d e ra l reg u latio n s p re scrib in g the maximum r a te o f in te r e s t which insured - 7 banks may pay on d e p o sits. Under the proposed le g is la t io n no insured bank or o f f i c e r , d ir e c to r , agency, or s u b sta n tia l stockholder th e re o f would be perm itted to pay or agree to pay a b rok er, fin d e r , or other person compensation fo r obtaining a deposit fo r the bank, except as the Board o f D ire cto rs o f the Corporation or the Board o f Governors o f the Federal Reserve System may by re g u la tio n p re s c r ib e . Any payment made by any other person to induce the p lacin g o f a deposit in an insured bank would be deemed to be a payment o f compensation by th e bank i f the bank has or reasonably should have accents the d ep o sit. knowledge o f th e payment by such person when i t Any v io la tio n by an insured bank o f the p ro h ib itio n s in the law or reg u latio n s issued pursuant th e re to would su b ject the bank to a p enalty o f not more than 10 percent o f th e amount o f the deposit to which the v io la tio n r e l a t e s . The Corporation and the Board o f Governors o f the Fed eral Reserve System would be empowered to recover th ese p e n a ltie s , by s u it or otherw ise, to geth er with the c o sts and expenses o f recovery. The Board o f D ire cto rs o f th e FDIC and the Board o f Governors o f the Federal Reserve System would d efine what i s meant by "payment o f i n t e r e s t ." Enactment o f t h is p iece o f le g is la t io n w ill co n trib u te to a strengthening o f our banking system and o f p u blic confidence in our banks. The commendable performance o f bankers to date — t h e ir im agination, reso u rcefu ln e ss, p rog ressiv en ess, and a d a p ta b ility — as exem plified by the g e n era lly prudent development and use o f n eg otiable c e r t i f i c a t e s o f d ep o sit, t e s t i f i e s to the dynamism o f our banking system. obscured by the a ctio n s o f a sm all m in ority. an d This record should not be The adm inistration o f Regulation Q 329 by the bank reg u lato ry agencies provides a good il l u s t r a t i o n o f the b e n e fits th a t can be derived from the considered use o f ad m in istrativ e - 8 ~ reg u la tio n s in response to the le g itim a te needs o f banks and the economy in a manner th a t serves the p u blic in t e r e s t . Before I end, I should lik e to make one f i n a l ob serv ation . In the period o f time I have served on th e Board o f D irecto rs o f th e Fed eral Deposit Insurance Corporation, my ap p reciation o f th e depth and v i t a l i t y o f the American system o f banking has continued to grow. As a supervisor I have had a unique opportunity to see the g reat stren g th o f t h is system. Progressive managements, improved techniques o f co n tro l and op eration , increased se rv ice s to the p u b lic , a l l s tr e s s th e good, sound job the industry i s doing. I pledge to you th a t tha FDIC i s firm ly resolved to continue i t s posture o f support and maintainance o f high standards. Through a continued d edication to standards o f e x cellen ce by banks and supervisors we can be assured o f continued stre n g th , s t a b i l i t y , and freedom in American banking. # # M ft # W
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