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NOT FOR PUBLICATION.

ADDRESS DELIVERED BEFORE THE KIWANIS CLUB,
CHICAGO, ILLINOIS.

Oct. 15,1935.

"THE FEDERAL RESERVE SYSTEM"

BY

M. S. SZYMCZAK

It is a pleasure to be able to speak in Chicago to a north west
side audience, where I lived my life from the day and hour of my birth.
I left Chicago nearly two anc? one-half years ago to assume my
present duties as one of the members of the Federal Reserve Board in
Washington.

During these years I have had the privilege of partici-

pating in the work of the Federal Reserve System and studying its
operations during one of the most trying periods of its twenty-odd
years of existence.
These two and one-half years have been very difficult ones for me. k
They have been very trying.

It is a grave responsibility to serve one's

country during a critical time in an organization so vital to the nation's well-being as is the Federal Reserve System - especially when
one is suddenly transplanted - away from home.
What I want to do today is to see you and talk to you briefly
about the part which this great banking system plays in the financial
and economic life of our country.

I am truly happy to be here with

you - thinking together - you and I.
In recent years, and particularly during the past year, there have
been frequent discussions of the Federal Reserve System in the nev/spapers and magazines.

Much of what has been said 3eems only remotely

connected with our every day life.

There have been arguments about con-

trol over the supply of money, about the kind of organization which
should be responsible for so-called open-market operations, whether all

-2-

banks should be required to join the System, and whether more flexible
lending powers of Federal Reserve banks would hasten recovery or, on the
other hand, would tend to encourage unsound banking.

A good deal of

what has been said has been more confusing than revealing to those who
try to understand the real functions of the Federal Reserve System.
It is important, however, to realize that these are not academic
questions.

They are of vital importance in the successful operation of

banks, whether or not they are members of the Federal Reserve System.
This talk, then, is not argumentative or news-providing - but explanatory and factual.

In saying this I do not mean to

suggest

that we should all attempt to acquaint ourselves with the details of the
System's work.

That is a big subject involving many technical details

understood by comparatively few people.

The System has been exhaustively

described in a number of large books which make interesting reading only
to the few whose business it is to know

i.btimatoly how our banking in-

stitutions 7/0 rk.
On the other hand, it lias always seemed to me that if our banks
are to operate effectively, the fundamental principles of their operations must be understood by all of us.

I believe it is particularly

worth while, after /the enactment of such important legislation as the
Banking Act of 1935, to consider briefly what the Federal Reserve System
is and what functions it performs for the country.

So I should like to

try, briefly, to brush away the great mass of details and to discuss

-i
i-

simply the main facts which should be helpful for us all to know and
understand, as citizens of this country.
The Federal Reserve System was established in 1913 by the Federal
Reserve Act, one of the most important pieces of financial legislation
ever passed in this country.

The System was created after many years

of dissatisfaction with our banking and currency facilities, brought
to a head by the panic of 1907, and after a thorough study of banking
here and abroad by a National Monetary Commission established by
Congress in 1908.
Since 1913, on the basis of actual experience and in response to
new developments, numerous amendments have been made to the original
Federal Reserve Act.

During the depression changes were made by the

Glass-Steagall Act of 1932, the Emergency Banking Act, the Banking Act
of 1933, the Gold Reserve

Act of 1934, and other acts.

The recent

legislation, approved August 25, 1935, makes important permanent changes
so that the System can be more effective in the future in meeting the
credit needs of the country.
Federal Reserve banks
In talking about the Qystem today I shall begin by considering
the mechanics of its operations which include chiefly the work of the
Federal Reserve banks with the banking institutions of the country.

I

shall follow that by a discussion of its broader responsibilities for
directing the credit policy of the nation which is the work of the

central organization in Washington, now known as the Board of Governors
of the Federal Reserve System.
When the Federal Reserve System was established some of our banks
were operating under national and some under State charters, and the
System was superimposed upon this unwieldy structure.

It might be said

that the purpose of the Reserve banks was to strengthen existing banking
institutions and to coordinate their credit operations . n the interest
i
of the country as a whole.
There are twelve Federal Reserve banks, one in each of the twelve
Federal Reserve districts into which the whole country is divided.

Sev-

eral of the Federal Reserve banks have branches which operate in different parts of their district.

Chicago has a branch at Detroit. There are

now in all twenty-five branches and two agencies.
The banks of the country become eligible to use the facilities offered by the Reserve banks by becoming members of the Federal Reserve
System.

All national banks were required by law to join and State banks

are permitted to become members if they fulfill certain requirements as
to capital structure and as to the general nature of their business.
About forty percent of the banks in the country now belong to the
Federal Reserve System and these banks account for about seventy percent of the country's banking resources.

The member banks include

5,425 national banks and 985 State banks and trust companies.

The State

banking institutions which are still outside the System are for the

-ii-

most part small banking organizations.
Under provisions of the Banking Act of 1935 State nonmember banks,
with certain exceptions, having average deposits of 01,000,000 or over,
must become members of the System after July 1, 1942 or lose the right
of having their deposits insured with the Federal Deposit Insurance
Corporation.
The Federal Reserve banks differ from ordinary commercial banks in
both their organization and their functions.
do not deal directly with the public.

Generally speaking, they

Their customers are the member

banks who come to secure credit or currency just as the public goes to
the local banks.

The capital stock of the Federal Reserve banks is owned

by the member banks, which are required by law to subscribe to capital
stock equal to six percent of their capital and surplus.

One-half of

such subscription is paid in cash and the other half is subject to call.
The management of the bank is in the hands of a board of directors which
represents not only the member banks but other business interests of the
community.

Of the nine directors of each Federal Reserve bank, three

known as Class C directors are selected by the Board of Governors of the
Federal Reserve System and six are selected by the member banks, three
known as Class A directors representing the stock holding member banks,
and three known as Class B directors representing commerce, agriculture,
or industry in the district.

The chief executive officer of the bank,

designated as president under the new banking act, is appointed by the
board of directors of the bank subject to the approval by the Board of

-i
i-

Governors of the System.

The legal requirements for ownership and man-

agement of the Reserve banks, therefore, recognize that their functions
must be performed in the public interest and that their management must
take account of both the banking and the general business interests of
the community.
Holding member bank reserves
One of the purposes of the Federal Reserve Act was to provide institutions which would hold the reserves of the nation's banking system.
It is necessary for all banks to keep a certain proportion of their deposits liquid, that is, in cash, in order to meet emergency demands of
their customers.

Before the establishment of the Federal Reserve System,

national banks were required to keep part of their reserves in their own
vaults and part on deposit in other banks, usually city banks.

Banks in

the central reserve cities, however, of which there were then three, New
York, Chicago and St. Louis, had to .hold all their reserves in cash.
When there was a scarcity of funds and country banks everywhere wanted
to withdraw their funds from their city correspondents, a currency and
credit crisis of greater or less magnitude was likely to occur.

Country

bonks had difficulty in securing their deposits from city banks and the
public in turn had difficulty in withdrawing deposits from the country
banks, as well as from the city banks.
Now all member banks are required by law to keep their reserves
on deposit in the Federal Reserve bank of their district and it is the

business of the Reserve banks to supply member banks with credit or
cash in such emergencies.
The required reserves vary v/ith the type of deposit and the class
of bank.

For banks in the largest cities, called central reserve cities,

now only New York and Chicago, the law requires reserves equal to thirteen percent of demand deposits, that is, deposits which can be withdrawn without advance notice.

If a customer of a Chicago bank borrows

$1,000, his deposit balance is credited with $1,000 and the bank in turn
must provide for $130 of reserve deposit at the Federal Reserve Bank of
Chicago, unless its reserve balance prior to the loan was already in
excess of required reserves by that amount or more.

For banks in so-

called reserve cities, of which there are about sixty, the reserve requirements for demand deposits are ten percent and for all other banks
seven percent while reserves of three percent are required against time
deposits in all banks.

Member bank reserve balances on deposit with

the twelve Reserve banks amount today to over $5,000,000,000.

Owing to

unusual conditions, the total of these balances is about twice as much
as the banks are required to have.
TtoReserve banks are sometimes known as the central reservoirs of
credit of our banking system because of this function of holding in
trust the reserves of the member bunks.

Under the Federal Reserve

System our banks no longer have any fear that they will be unable to
get their reserves when needed.

One important risk has been eliminated

-8-

from commercial hanking.

Equally important with their function of holding member bank
reserves is the power of the Reserve banks to make loans to member
banks.

Through these loans the member banks are able to increase

their deposit balances and thus provide the reserves necessary for
the expansion of credit.

The Reserve banks may supply funds to mem-

ber banks by rodiscounting paper or by making advances to member banks,
as provided by law and Board regulations, or by purchasing bills and
securities, and entering corresponding credits to the account of tho
member banks, thus increasing their reserve balances.

Member banks

in turn can increase their loans to the public in the aggregate by an
amount several times the amount of the additional reserves.
The Federal Reserve Act, however, places limitations on the character of paper on which loans may be obtained from the Reserve banks.
For many years Reserve banks have had tho power to discount only shortterm self-liquidating commercial paper, that is notes, drafts, bills
of exchange and bankers1 acceptances arising out of commercial industrial and agricultural transactions, and to make advances to member banks on their promissory notes backed by paper eligible for discount or purchase or by United States Government obligations.

They

were not authorized to make advances on a wide range of other assets

-9-

which made up an important part of the total earning assets of banks.
These included real estate loans, securities other than those of the
United States Government, and loans to business men which did not
meet the requirements of the narrowly-defined eligible commercial
paper.
As a consequence of many developments in our financial organization, paper which qualified for borrowing from the Reserve banks has
constituted a constantly decreasing proportion of the total assets
of member banks ever since the System was established.

In 1929 it

was only about twelve percent of total loans and investments of such
banks, and in 1934 it was but eight percent.
In these circumstances banks were dependent for help from the
Reserve banks upon their eligible paper and Government obligations.
In 1931 and 195?, when the great liquidation occurred, many banks
with assets which were good but technically ineligible for borrowing at Reserve banks, were obliged either to dump them on a falling
market, suffer severe loss and contribute to the deflation in values
or to close their doors.
The new banking act corrects this situation.

It authorizes the

Reserve banks to make advances to member banks for periods not exceeding four months on any security satisfactory to the Reserve bank,
at a rate of interest at least one-half of one percent above the

-10-

highest discount rate in effect at the particular Reserve bank.
This amendment modifies and makes permanent the emergency legislation which it was necessary to pass in 1932 after many banks closed
in order to meet a critical situation.
byiRogorve banks
Another phase of the activity of the Reserve banks is the issuance of Federal Reserve notes, which are the paper money put out by
the Reserve bank under the provisions of the act for supplying the
country an elastic currency.
By elastic currency we mean currency whose volume can be readily
increased or decreased according to the public demand for it.

For

example, during the Christmas season we all need extra money for shopping.

On holidays such as the Fourth of July and Labor Day, people

get extra pocket cash from their banks for trips and other celebrations.

On such occasions, the public expects to go to the banks and

draw more cash than usual against deposit balances.

On the other band,

shop keepers and others who receive cash for what they sell expect to
deposit their extra cash in the banks.
Federal Reserve notes are obligations of the United States and
are secured by specific collateral pledged by the issuing bank.
bank

The

is required to keep reserves in gold certificates at least equal

to forty percent of the notes in actual circulation.

The Federal Reserve

banks, however, do not supply the entire currency of the country.

The

-ii-

Government issues silver dollars, minor coin and some paper money and,
until July of this year, the national banks continued to have the privilege of issuing national bank notes.

The larger part of money in cir-

culation, however, consists of Federal Reserve notes.
A bank that has satisfactory assets can always secure all the
currency that it needs.

If a customer wants more cash than the bank

has in its vaults, such a bank can readily obtain Federal Reserve notes
at its Reserve bank.

It can borrow and take the proceeds in notes or

it can draw against its account and restore the account to the required
level by borrowing.

When customers deposit more currency at a bank than

it requires, the bank sends this cash over to the Reserve bank to be
added to its reserve account.
The function of supplying elastic currency is important but it is
not as vital a factor as the lending power of banks because currency
does not play a major role in present-day business transactions.

About

ninety percent of our business is conducted by the use of checks with
the use of no currency at all.

Currency is used by the public as pocket

cash for such transactions as retail purchases, gasoline for automobiles,
car fares and, by employers, for pay rolls.

These account for only

about ten percent of the total transactions in the country.

Of course,

there are fluctuations in the demand for currency which appear regularly such as on pay days, during the period of Christmas shopping,
and near holidays.

The machinery provided by the Federal Reserve Act

meets these needs completely.

- 12 -

The currency-issuing function is by many viewed as the most
important function of the Federal Reserve System.

This is for

the reason that it was currency shortage that appeared to have
caused our panics in pre-Reserve days.

Also our confidence in

the banks depends on whether we can got cash whenever wo want it.
A system which provides for special institutions to hold bank reserves
a

nd to supply currency whenever needed is indispensable.

Other activities of Reserve banks
The work of the Reserve banks in holding the banking reserves
the country, in making loans to member banks, and in supplying
currency when needed is their principal contribution to our banking
system.

They have, however, other important functions which facilitate

the smoother working of our financial machinery.
The Reserve banks have greatly simplified the procedure whereby
banks collect checks they receive which are drawn against other banks.
This has been vory useful to business men because it has permitted more
Prompt and cheaper settlement of many business transactions.
servo banks in effect act as a nation-wide clearing house.
Merely

sen( j

The ReBanks

the checks against other banks to the Reserve bank of

their district.

Checks on banks in the district are cleared on the

books of the Reserve bank and those on banks in other districts are
cleared through the other Reserve banks.
i

The Reserve banks perform

similar services in connection with other crcdit items such as collection of notes, drafts, bonds and coupons, and the acceptance of exchange
drafts.

- 13 -

Machinery has also been set up for prompt, payment of funds
from one part of the country to another without actual movement of
currency.

The System maintains a fund in Washington called the Gold

Settlement Fund established by deposits of the twelve Federal Reserve
banks.

Transfers from one district to another are made daily by

adjusting the accounts of the various Reserve banks.
The Federal Reserve System has centralized the work of the
fiscal agencies of the United States Government.

The Reserve banks

act as fiscal agents in connection with the issue and retirement of
Government debt and in administering deposit accounts of the Government
in the Reserve banks.
Central control of credit policy
I wish to turn now from this discussion of the functions which
the Federal Reserve banks perform for the local banks to consider how
these activities tie in with the general responsibility of the System,
through its Board of Governors, for the nation's credit policy.
When the Foderal Reserve System was established it was realized
that for certain activities, particularly those related to local banking conditions, a regional organization would, be necessary.. Only
in this way could the System bo organized for understanding local
bank needs in a country as large as the United States where economic
conditions vary so much from one section to another.

The System

Was planned to tako account of the fact that the directors of those
regional banks would have the intimate knowledge of business developments

- 14 in agriculture, commerce arid industry in their district and of any
special credit needs and problems.

The principle was also established

by the original Federal Reserve Act that the Reserve banks have final
responsibility in their dealings with member banks under the authority
given them by the Federal Reserve Act and the regulations of the Board.
It was also realized that the credit policy of the different
Federal Reserve banks must be coordinated so that conditions in one
district would not bo harmful to those in another.

More than that,

there should be a credit policy for the country as a whole which would
take account of general business and credit conditions.

This is the

work of tho Board of Governors of the Federal Reserve System, which
is the central organization located in Washington.

It is aided by

other organizations which work closely with it, the Federal Advisory
Council and tho Federal Open Market Committee.
Board of Governors
The most important duties of the Board of Governors in Washington
relate to the broad credit policy for the country as a whole and are
sometimes spoken of as its power to influence tho volume and cost of
credit.

Experience has indicated that powers of the Board which af-

fect tho expansion and contraction of the general supply of credit
are of vital importance to the country, since the volume of credit is
a factor in determining tho course of business, and proper changes in
the cost and volume of credit may exert an influence toward moderating
excessive expansion or contraction of business, or, in other words may

- 15 reduce the danger of inflation and deflation.
The Board's instruments for influencing the volume of credit
are its

power to change discount rates and reserve requirements, and

trough its majority of members on the Federal Open Market Committee,
to determine open-market policies.
Discount rates
Discount rates are the rates charged by the Federal Reserve banks
loans to member banks.

These rates determine the cost of borrowing

by member banks and consequently affect the cost at which the public
can borrow from these banks.
the money market.

Indirectly they affect other rates in

Under the Federal Reserve Act changes in discount

rates made by the various Federal Reserve banks are subject to review
a

nd determination by the Board of Governors.

f

m a l responsibility on the discount rates so that the cost of borrow-

This gives the Board

ing in the different sections of the country may be kept consistent
wi

th general credit conditions, for the country as a whole.
The new banking act strengthens the Board's power to control these

ra

tos by making the further provision that discount rates must be sub-

mitted to the Board of Governors every fourteen days.
a s a ma

This establishes

tter of law the requirement that the discount rate policy shall

be reviewed at least every two weeks,
fioservo requirements
The Board of Governors also has the power to change the reserve
requirements of member banks.

The volume of credit which any member

~ 16 -

bank may extend is limited by the amount of reserves which are required
by law to be maintained against its deposit liabilities.

An increase

in the reserve requirements reduces and a decrease increases the
potential volume of member bank credit.

Consequently the power to

change reserve requirements give3 the Board an important means of
controlling the general volume of credit.

This power was originally

given the Federal Reserve Board in emergency legislation but the
new act clarifies it.

Under the old law changes could be made only

in the event of an emergency arising out of credit expansion and then
only with the approval of the President of the United States.

Under

the new act changes can be made to prevent injurious credit expansion
or contraction, provided that reserve requirements may not be reduced
below the present requirements specified in the law nor increased to
more than twice the amount of those legal requirements.
Open-market operations
The third important means of control over the supply of credit
arc the so-called open-market operations, responsibility for which
under the new banking act will bo vested in a new Federal Open Market
Committee.

This committee will consist of the seven members of the

Board of Governors and five representatives of the Reserve banks
selected by the Reserve banks in different regions.
Open-market operations consist of the purchase and sale by
Reserve banks of certain classes of securities, chiefly Government
obligations.

These operations have the effect of increasing or

decreasing the supply of credit available in the market.

By selling

securities the Reserve banks withdraw funds from the market and there

-ii-

is a decrease in the supply of credit.

Through a purchase of securi-

ties a Reserve bank puts funds into the market, thus tending to ease
credit conditions.
Purchases and sales of securities by the Reserve banks were
unimportant in the early days of the System.

It was not until 1922

that they were large enough to affect the money market.

At that time

it became necessary to take steps to coordinate purchases and sales
so that credit conditions for the country as a whole would not be adversely affected.

Gradually these purchases and sales have become one

°f the most important means whereby the System can take the initiative
in influencing credit conditions.
The responsibility for determining what security transactions
should be undertaken and the authority for enforcing a program were
not clearly defined by law until the new banking act.

At the time

this act was passed an Open Market Committee consisting of representatives of the twelve Reserve banks was
and sales.

authorized to propose purchases

Its proposals were then submitted to the Federal Reserve

Board which had the authority to approve or disapprove but not to initiate a policy.

Even after purchases or sales by the Reserve banks

had been agreed upon by the committee and the Board, the boards of directors of the twelve Federal Reserve banks throughout the country
could frustrate the policy by refusing to participate in its execution.
The new act clearly places responsibility for determining openmarket transactions on the new Open Market Committee and directs the

-ii-

Reserve banks to carry out tho transactions determined by this committee.

This is one of the most important changes in the Federal Re-

serve System which the new act introduces.
Other work of the Board
The Board of Governors has a variety of other duties which tie
in with its general responsibility for supervision of the System.
These include the examination of Reserve banks, passing on applications
of State banks and trust companies for membership in the System, obtaining condition reports from State member banks, administration of
"those provisions of the Clayton ^nti-trust net which relate to interlocking bank directorates, regulation of the maximum rate of interest
to be paid by member banks on time and savings deposits, regulations
under the Security and Exchange net governing the margin requirements
for loans on securities listed on the stock exchanges, and maintenance
and operation of the Gold Settlement Fund.
In carrying out its responsibilities it is essential that the
Board keep in touch with banking developments in different parts of
the country.

In the organisation of the System provision was made

for regular contacts between the Board and the various Federal Reserve districts.

One of the class C directors at each Reserve bank,

designated by law as the Federal Reserve agent, represents the Board
at the bank and maintains an office of the Board at the bank.

The

Federal Advisory Council, also provided by law, is xmade up of representatives of each Federal Reserve district and meets at least four

-19-

times a year in Washington to confer with the Board and to make recommendations.

The Board also has meetings in Washington with the chief

executive officers of the Federal Reserve banks and with the Federal
Reserve agents.
Information bearing on credit policy
It is also a part of the System's problem to watch indicators of
credit trends and to develop a better general understanding of the
facts bearing upon credit policy.

The System has pursued a policy of

collecting information bearing on banking conditions throughout the
country and on production, employment, trade and prices.

In a monthly

publication, the Federal Reserve Bulletin, and in its Annual Report,
the Board has undertaken to give to the public a comprehensive view of
current banking and financial developments at home and abroad and also
to furnish detailed information on conditions of banks throughout the
country and on the business situation.

Each of the Federal Reserve

banks also publishes a monthly review of the business and banking conditions in its district.
There is no central bank in the world which makes available such
exhaustive information on domestic banking and business developments
and on the formulation of its credit policy as that which is published
by the Federal Reserve System.
The new act will still further increase the publicity given to
the System's operations.

It provides that records shall be kept of

-20-

the actions of the Federal Open Market Committee and of the Board on
all questions of policy.

This information, together with the under-

lying reasons, is to be published in the Annual Reports of tho Board.
The public will thus be given an opportunity to study the reasons for
the Board's decisions in greater detail and will be helped to cooperate
with the System in pursuing a broad credit policy which meets the interests of the nation.
Loans to industrial and commercial businesses
I want to take a few minutes now to tell you about recent special
work of the Federal Reserve banks.

I refer to operations under an

amendment to the Federal Reserve Act approved June 19, 1934 which
authorizes the Federal Reserve banks to make direct loans to industry
and to guarantee for banks certain types of loans to business men which
the banks might not otherwise be willing to make.

The purpose of these

provisions is to give both bankers and business men some added assurance in making commitments during a difficult period when they tend to
feel unduly conservative.
Anyone in an established industrial or commercial business who
wants a loan for working capital purposes which is reasonable and
sound and has a maturity of not more than five years should now be able
to get such a loan from his local bank. This applies to both member
and nonmember banks.

Furthermore, if the local bank cannot accommodate

the borrower, he may be able to borrow from the Reserve bank itself.

No

business man who has assets of value to offer as security need hesitate

-21-

because they do not conform to the types of collateral usually required
by banks.
The local banks are given special assurance in making these loans
through the privileged status which they enjoy at the Reserve banks.
The loans are eligible as a basis for borrowing at the Reserve banks.
More than that, if the bank wants to dispose of a loan it can procure
a commitment from the Reserve bank to take it off its hands and the
bank is guaranteed against loss up to 80 percent of the loan.
As of October 2, 1935 the Federal Reserve Bank of Chicago had
given final approval to 73 loans aggregating $4,826,000.
included $2,582,000 loaned by the

This amount

Reserve bank direct to industrial

and commercial borrowers because local credit was not available on
reasonable terms.

There were also $519,000 of loans for which com-

mercial banks had secured a commitment by the chicago Reserve Bank to
take over all or part of the loan.

These are loans to business which

for the most part would not have been made without the special guarantee
of the Reserve bank.
Finally, therefore, let me say that J feel that the Federal Re.
serve System as changed by the Banking Act of 1935 is in a position
to be more useful than ever before because it can give more help to
the local banks in meeting the credit needs of their communities.

It

must be recognized, however, that if the System is to achieve as much
success as we all hope, it vail need more than mere legal provisions.

-22-

It must depend upon the cooperation of business men, bankers, and the
general public.

I believe that this cooperation will depend much on

the extent to which we in the System are able to encourage the public
to know and understand the principles under which it operates.

For

that reason I appreciate the opportunity I have had today of making
what contribution I can to such a general objective.


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102