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Speech delivered before
The Army Industrial College
Washington, D. C.
April 27, 1938
THE ROLE OF THE FEDERAL RESERVE SYSTEM
IN FINANCING A WAR
If we were engaged in war it would not bring about a change in the
nature of the Federal Reserve functions so much as in the conditions to
which those functions apply.
As fiscal agents of the United States Treasury, the Federal Reserve
banks would, of course, have to assist with the very great burden of war
financing. They receive subscriptions to Government issues, allocate
the issues to the subscribers, deliver the issues and receive payment.
They pay interest coupons and maturing obligations and effect exchanges
of issues. In time of war, when, presumably, efforts would be made to
secure as wide spread a subscription to Government issues as possible,
the volume of work involved would be enormous.
In connection with Government financing but not as an activity of
the fiscal agency function, the Federal Reserve banks would also have
to assist in the financing of the public's purchase of Government
obligations.
The function of issuing currency and coin would presumably not be
greatly changed by war conditions. Any increase in the volume of money
in circulation would be readily effected through the utilization of
existing machinery. However, since the greater part of the increased
demand for means of payment in time of war would be met by the use of
bank deposits transferable by check, it is not to be supposed that any
very great increase in the volume of money in circulation would occur.
The services of the Federal Reserve banks in facilitating the
clearance and collection of checks and the transfer of funds in general
would presumably be called on to a greater degree during war time than
at present. The increased volume of business incidental to war would
entail an increased volume and velocity of payments, but the machinery
of the Federal Reserve System is adequate to meet without strain any
conceivable increase in the volume of items to be handled.
In the field of credit control also the Federal Reserve banks
would presumably exercise their normal central banking functions,
though possibly more actively than they have been called upon to do
in recent years. With our present enormous supply of gold, with
banks holding vast excess reserves, and with the ready possibility
of increasing through central banking action the volume of those reserves, there is no prospect of any difficulty in providing adequate
credit for war-time industrial activity. The System has available, as
you know, the power to decrease reserve requirements and thereby enlarge very greatly the basis for the extension of credit. It has the
pov/er through the purchase of securities in the open market to increase
that reserve base still more. It also has the pov/er through discount
to enlarge and replenish the reserves of individual banks to the full
extent of any conceivable demand.

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The exact conditions under which the System would be called on to
exercise these powers would depend, of course, upon the nature and
extent of the war in which we vrere engaged and upon our relations with
our allies. I think that I cannot do better than describe to you
informally the present structure and functions of the Federal Reserve
System and then indicate very briefly the use to which they would be
put in war time.
The Federal Reserve System was originally organized for the purpose of decentralizing the currency and credit supply of the country.
This being a very large country, we deviated somewhat from the central
bank idea in Europe. European countries have in most cases one central
bank with branches, but here, because of the area we have to cover and
because of the variety of economic conditions in the various sections
of our country - agricultural, industrial, commercial, financial - we
have 12 autonomous Federal Reserve Banks located in 12 different districts. The districts, as you will remember, are Boston, New York,
Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis,
Minneapolis, Kansas City, Dallas, and San Francisco. If the area is
large there are branches in that area. For example, in the San
Francisco district, which covers a nuvber of states, there are 5
branches. On the other hand, in the Philadelphia district, which has
a small area, there is no branch. New 'fork has a branch in Buffalo.
Chicago has a branch in Detroit. Altogether there are 25 branches.
The tranches enable the banks to serve all parts of their districts
promptly. Then, to meet special currency demands, 2 agencies were
organized, one in Savannah and the other in Havana, Cuba. Altogether,
therefore, we have 12 Federal Reserve Banks, 25 branches, and 2
agencies.
The Federal Reserve Act provided that there should be a board,
known at that time as t he Federal Reserve Board, to be appointed by
the President of the United States, with the advice and the consent
of the United States Senate. This board was to have supervisory and
coordinating power over the activities of the 12 Federal Reserve
Banks, the 25 branches, and the 2 agencies. In process of time the
Federal Reserve Board was given additional power in the field of
monetary control.
7fith the Banking Act of 1935 greater power to influence credit
conditions was given to the Board in Washington, whose name was then
changed to "Board of Governors of the Federal Reserve System". On
that board are 7 members, appointed for a period of lU years, to give
them independence of thought and action. The Federal Reserve Banks
are not owned by the Government. They are owned by the 6300 banks,
approximately, which are members of the Federal Reserve System. There
are altogether about 16,000 banks in the country. Less than half,
therefore, are members of the System. Yet the 6300 which are members
hold about three-fourths of the total assets of all the banks in the
country. In other words, the member banks include nearly all the
larger banks of the country. Uenbership in the Federal Reserve System
is obligatory on all national banks. Each such bank purchases stock
in the Federal Reserve Bank of its district, equal to % of its own
capital and surplus. There are also about 1,000 state member banks
that have applied for membership and been admitted to the System.

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They too have to purchase stock of the Federal Reserve Bank of their
district equal to 3% of their capital and surplus. Each member bank
subscribes for 6$, but only 3% has been called for. The other %
could be called for if necessary. The member banks receive dividends
of 6 S per annum cumulative on this stock.
;
Now there are, as I told you, about 6,300 member banks, about
5,300 of which are national banks and required to be members. State
banks which become members obtain their charters from the state
authorities. In each state we have a state bank supervisor, so that
makes UO banking systems, one in each state. Then we have the
Comptroller of the Currency, supervising the national banking system;
that's U9. There is also the Federal Deposit Insurance Corporation,
which came into existence not so long ago. It insures the deposits
of its member banks. Membership in the Federal Deposit Insurance
Corporation is not to be confused with membership in the Federal Reserve System. Every bank that is a member of the Federal Reserve
System ipso facto becomes a member of the Federal Deposit Insurance
Corporation. But there are a great many state banks which are not
members of the Federal Reserve System but are members of the Federal
Deposit Insurance Corporation. Then there is also the bank supervisory authority of the Federal Reserve System, which supervises
national banks in addition to the supervision they receive from the
Comptroller of the Currency, and supervises state member banks in
addition to their supervision by state authority. The Federal Deposit Insurance Corporation supervises also those state banks whose
deposits are insured.
In addition, there is the Reconstruction Finance Corporation.
It is not primarily supervisory, but is an organization that lends
to banks. It owns preferred stock in many banks and it has power to
examine those banks that it has stock in.
There, briefly sketched, is your banking picture - over 16,000
banks scattered all over the country, some national banks and some
state banks; some mutual savings banks, others commercial, others
trust companies. Then we have, in addition to that, all of these
supervising agencies, the states, the Comptroller, the Federal Deposit Insurance Corporation, the Federal Reserve System, and the
Reconstruction Finance Corporation. You can see that that is a
difficult situation. It has just grown up like "Topsy". It will
take some while to reconstruct it because it isn't as though you
had a clean sheet of paper to write on and say "This is the way it
ought to be." You just can't do that.
Even though we have the Federal Reserve System, banks continue to
have correspondent relations with other banks as well. That means,
for example, a bank in Milwaukee will keep part of its reserves with a
bank in Chicago. A bank in Chicago will deposit part of its reserves
with a bank in New York.
The reason for the correspondent relationship is that the smaller
banks get certain services from the larger banks. For example, they
get advice on their portfolio of securities, or the New York bank may
invest some of their funds for them.

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There is still another factor that came into the picture recently,
the Securities and Exchange Commission. We are discussing with them
the possibility of their modifying their regulations some-what, and they
have already done so to an extent. We are also suggesting to the
Comptroller of the Currency that he modify certain of his regulations.
Of course it is always presumptuous to suggest something like that to
the other fellow, because he can turn around and say, "You have enough
to do in your own backyard vathout coming over here and telling us what
to do." 7 e are suggesting that the Comptroller modify his regulations in
/
respect to the kind of securities that can be purchased by member banks.
When he says only certain securities can be purchased for the portfolio
of the national bank that at once becomes our regulation and applies also
to State member banks. If we can we would like to modify those regulations
somewhat so as to provide a larger base upon which the banker can choose
the kind of securities that he wishes to purchase for his portfolio. It
seems to us that this would make capital more easily available. Today if
you float an issue you have difficulty getting it on the market. It may
be a very sound issue, but the bank can't buy it because it is not
marketable, it hasn't the volume, it is not registered, and it is not in
the manual. Therefore, the banks are obstructed from investing as they
otherwise might and that makes it difficult for the smaller fellow to get
his capital needs.
We are also discussing adoption of a uniform examination policy. You
may have read something of that in the newspapers this morning. The idea
is to get all of the supervising agencies to adopt a more uniform policy
of examination. Each of these agencies I have mentioned has power to
examine banks, though in practice only one authority goes in to examine
a bank. The Comptroller examines the national banks and that is all. " e
W
receive a copy of his examination report and pay him for it. In theory
we too can go into the national bank to examine it but we don't do it.
The state member banks are examined by us and the state banks that are
not members of the Federal Reserve System but are members of the Federal
Deposit Insurance Corporation are examined by the Federal Deposit Insurance
Corporation. Whenever one agency goes in to examine, the other agenfcies
stay out, and they merely get a copy of the examination report. Therefore, there isn't the duplication of examination that might be supposed,
but there may be differences in the policy of examination. "What we are
trying to do now is to get all of these, the Federal Deposit Insurance
Corporation, the Comptroller of the Currency, and the Federal Reserve
System, and eventually the bank supervisory agencies of the forty-eight
states, to agree upon a more uniform policy of examination, particularly
on the question of securities and also on the question of a classification
of some of the assets under the column headed "slow". Many loans are made
for a longer period than 30, 60, or 90 days, which is the average commercial loan. Many loans are made for 2, 3, U, or 5 years, and the moment
you classify them under the "slow" heading of course it looks like
criticism, when, as a matter of fact, the loans may be sound. In order to
have a real expansion in industry, commerce, or agriculture one must
obtain money for a longer period of time than 30, 60, or 90 days. These
loans ought to stand upon their own merits of soundness rather than upon
the time element.
With that in mind, the Banking Act of 1935 provided that any sound
assets, regardless of maturity or classification, might be discounted by
a member bank at its Federal Reserve Dank.

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This provided a broader base upon -which the Federal Reserve
Banks can extend credit to the member banks of the country, so that
today, in place of being limited to what was originally designated
as eligible paper for discounting purposes, a member bank can borrowon any kind of sound paper with 30, 60, or 90 day maturities or 1
year or 5 or 10 year maturities. Such borrowings must be for U
months or less and bear a rate of interest one-half of 1% higher
than the discount rate of that district. You get a loan, for
example, from a bank and the bank needs cash and so it takes your
paper over to the Federal Reserve bank, if it is for industrial,
commercial or agricultural purposes and it discounts that paper at
from 1% to 2%. In other words, if it had h% or
interest, it pays
1% to 2%; it collects the 1$ or % but it pays part to the Federal
Reserve bank. The Federal Reserve bank holds that paper for that
bank and gives credit to that bank on the account. The Federal Reserve Banks are lenders of last resort. Their lending powers are
practically inexhaustible.
However, banks as a usual thing don't like to borrow from the
Federal Reserve bank or anybody else because they don't like to show
in their statement that they owe any money to anybody. Therefore,
there is very little occasion for the Federal Reserve banks to use
their discount powers. Yihen the Federal Reserve bank came into
existence in 191i| this was considered to be not only an important
power but one to be most frequently exercised. It " a presumed that
ws
the banks would borrow from the Federal Reserve and we could either
supply them with credit or refuse. As a matter of fact, even though
that was one of the principal purposes, todiscount and lend to banks,
the banks have refrained from coming to the Federal Reserve banks
except in times of emergency. It would be desirable if we could get
bankers to take-the point of view that borrowing from the Federal
Reserve Bank is -a normal and proper procedure when it enables them
to meet the legitimate requirements of their customers, but I don't
know how we can. They seem to feel that borrowing is always objectionable.
For reserve purposes, there are three different classifications
of banks. First are the central reserve city banks. The banks in
New ^-ork and Chicago are called central reserve city banks, and their
rate of requirement of reserves is higher than is the rate for the
banks in reserve cities. There are about sixty reserve cities, excluding New York and Chicago. Then banks in all other places are
called "country" banks, even though they may be in relatively large
cities. The rates of required reserves are different for the banks
of those three different classifications, the central reserve city
banks, the reserve banks,and the country banks. That is, the rate
on demand deposits is different. The rate on time deposits is the
same in all three classifications.
The requirements as stated in the Federal Reserve Act are 13%
for central reserve cities on demand deposits; 10$ for reserve
cities; 1% for country banks; and 3% on time deposits. The Board
was given power to double those requirements or raise them to any
figure in between. "While the Board could double the original requirements, it can't go below the 13, 10 and 7. It could go up to
twice the amount and then come back to this amount but it couldn't
go below that.

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The present reserve requirements on demand deposits are for the
central reserve city banks 22-3/1$; for reserve city banks, 17-1/2^;
for country banks, 12$j and on all time deposits for all classes of
banks,
I v i l also give you the figure for excess reserves. They
r.l
enter into this picture very definitely; they are the reserves that the
member banks have in the Federal Reserve bank in excess of Yihat they
are required to have by law. The required reserve is frozen and can't
be taken out. The excess reserve is the base upon which we can extend
credit in this country. It is lying in the Federal Reserve banks idly
without paying a penny of interest to the member banks, but -when the
memberbanks begin to lend, they lend on it.
Now in war time, as I said at the outset, the regular services of
the Federal Reserve banks will be employed, but I find it difficult to
say how they will be employed without knowing what the war is. There are
certain to be, however, two main lines of credit required: one for the
Government and one for industry.
With respect to Government financing, the Federal Reserve banks
would have a double role to play: first, as fiscal agents of the
Treasury in handling subscriptions to securities, receipt of payment
therefor, and delivery; and second, as a central banking organization,
assisting the banks of the country in financing flotations.
With respect to the financing of business, the task of providing
ample credit, if conditions were anything like those at present, would
not be difficult. The banks of tne country have abundant excess reserves. Those reserves could be replenished by purchases of securities
in the open market on the part of the Federal Reserve banks. They could
be further replenished by rediscount of paper by member banks. They
could still further be replenished by a reduction of reserve requirements. The difficulty would not be to supply sufficient credit, but
to avoid supplying too much. The least of our worries, it seem to me,
if we were engaged in war, would be the adequacy of our credit facilities.