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For release upon d e l ivery

Thursday, September 5, 1974
1:00 P M E.D.T. (3 p.m. E .D.T .)




PROGRESS A N D PRUDENCE
IN BANKING

Remarks of
Robert C. Holland
Member
Board of Governors
of the
Federal Reserve System
To Members and Guests of the
Boards of Directors
of the
F e deral Reserve Bank of San Francisco
and Its
Salt Lake City Branch

Salt Lake City, Utah
September 5, 1974

I a m pleased to be w i t h you and your guests today.
I w o uld like to take this opportunity to share w i t h you some
of m y thoughts about tension in b a n k i n g — at least, about
one fundamental kind of tension that is being accentuated
in banking today.
This audience, I know, is k e enly aware of the
importance to our nation's economy of a progressive and
healthy banking industry.

What I w o uld like to do this

a fternoon is first to highlight some of the progress that
we have seen banking make over the past decade or so.
Then, I w o u l d like to turn your attention to some of the
present and potential adverse situations facing banking.
Such adverse developments have in certain instances
been un w a n t e d side effects of some of the progressive
activities we have seen banks undertake.

These, and

other obstacles to further healthy progress in banking,
appear now to require all of us to place renewed emphasis
on a quality that historically has always been closely
associated w i t h healthy b a n k i n g - - p r u d e n c e .
For assistance in the preparation of this paper, I am
indebted particularly to Mr. Paul M e tzger of the Board's
staff. The views expressed herein, however, are my
personal responsibility.




- 2 B anking Progress
Over the last ten to fifteen years progress in
banking has virtually transformed the industry.

When

compared with the business of banking as it was practiced
historically, at least through the Depression era, these
recent changes have been sufficiently m a r ked to warrant
being called "revolutionary."
Consider, for example:

the mushrooming reliance

of larger banks on "liability management," namely, the
issuance of large certificates of deposit and other mone y
market instruments in order to raise loanable f u n d s ; the
increased use of charges for services by banks to offset
the growing reluctance of their customers to maintain any
more than minimal demand deposit balances; the expansion
a nd diversification

of bank holding companies both here

and overseas; the rise of the Eurodollar market; the
almost universal employment of computers bot h w i thin and
b etween financial institutions; and the increasing i n t e r ­
a ction of the world's financial systems, especially among
the. more industrialized nations.




- 3 The s e changes I regard as by and large progressive
ones.

Th e y benefit broad segments of the public, both in

the United States and overseas, and are indicative of
the greatly enhanced capacity of A m e rican banking to
r espond to continuing demands for change.
Our banks have been spurred by heig h t e n e d c o m ­
petition, coming not only from w i t h i n the banking industry
but also from thrift institutions, insurance companies,
d i versified financial corporations and even nonfinaneial
firms that e x tend consumer credit.

In turn, the competitive

climate of our entire economy has broadly b e n e f i t t e d from
banking's response to the challenges of rising competition.
Wha t we have witnessed, in short, is the o n ­
going transformation of banking.

Our nati o n has been an

ultimate beneficiary of the increased resourcefulness and
s o phistication of the banking community.

It is a record

of progress of which bankers can be justifiably proud.
Banking Prudence
Progress, however, is not enough.
more is needed.




Something

- 4 Banking has traditionally been treated--with
justification--not just as a business but as a profession.
W h e n asked wh y they have v i e w e d their occupation in this
light, bankers more often than not w o u l d respond that
theirs was no ordinary business, but one vested w i t h the
public interest.

T h e y dealt in other peoples' money.

Funds were entrusted to them by broad segments of the
public.

This established, in a v e r y real sense, a public

trust that compelled them to act w i t h greater care than
individuals engaged in commerce and industry.

In

significant measure, it was because of this attitude on
the part of bankers that the public came to have a high
regard for, and confidence in, the banking system.
Over time, bo t h legislation and watchful r e g u l a ­
tion of the banking industry have served to buttress the
public's confidence in the safety and soundness of our
b anking system.

Nonetheless, this attitude of bankers

themselves continues, I believe, to be a substantial
element in maintaining the public's trust.




- 5 -

If prudence and the promotion of public c o n ­
fidence have been basic ingredients of good banking, then
surely an extra measure of these indispensable ingredients
is called for today.
attendant evils

Double-digit inflation and its

(not only in the United States but in

most other highly industrialized nations) have produced
a situation w h i c h has led to ver y considerable pressure
being placed on banks.

M o netary policy has assumed a

major role in the fight to reduce the rate of inflation.
Accordingly, the Federal Reserve has had to supply new
bank reserves m u c h less generously.

Meanwhile, credit

demands from would-be borrowers have been v e r y strong.
In this atmosphere, banks could and have charged high
interest rates on loans, but they have also been pinched
by sharp increases in the interest rates they have had
to offer to attract funds.
These conflicting pressures have been so e x t r a ­
ordinary as to generate a certain amount of market anxiety
concerning the ability of some banks to bear them.

Con­

cerned customers are closely scrutinizing their banks'




- 6 -

financial condition, and some u n e a s y m o n e y could decide
to seek haven elsewhere if signs of weakness should
multiply.
To minimize such troubles, one simple slogan
commends itself to each bank management today:
HU S BAND YOUR BANKING RESOURCES.
Tr y to preserve the bank's liquidity.
the average m a t urity of its purchased money.

Length e n

Buttress

its capital position whenever the opportunity affords.
Place a tight leash on officers in charge of n e w business
d e v e l o p m e n t s , and tell them to concentrate on arrangements
w h i c h will not place drains on bank liquidity or capital
for a year or two.

Tell loan officers to screen out

non-essential loans.
At the same time, good bankers will not dodge
their responsibility to lend to creditworthy regular
customers, whether large or small, the m i n i m u m amounts
n e eded to keep those customers' activities viable.

It

is ha r d work to pursue all these objectives at once, but
being able to do so is the mark of a successful banker Ln
1974.




-

7

-

Progress versus Prudence
There is a kind of dynamic tension bet w e e n
the forces impelling the progressive activities of banks
and the compelling need for prudent conduct of the nation's
banking business.

For example, when bank holding companies

expand and diversify, they seek to enter b a n k - r e l a t e d
businesses partly to reach new sources of earnings by
performing various services for a fee as an offset to
declining demand deposit balances.

In so doing, holding

companies have sometimes sought permission from the Board
of Governors to go beyond the fairly extensive list of
activities n o w permissible to bank holding company
subsidiaries, in order to engage in significant n e w
activities

either in the U n ited States or overseas.

Such applications often represent a progressive step that
will benefit both the bank holding company and the public.
Occasionally, however, they can stretch the bounds of
prudence.

T h e y sometimes involve the management of risks

qualitatively different from those likely to be familiar
tc bank management.




Sometimes, too, the proposed activity

-

8

-

m ay require a sizable amount of capital a n d specialized
m a nagerial r e s o u r c e s .

It may therefore divert capital

and management talent away from the banking subsidiary w here
they might in fact have been helpful in shoring up a thin
capital position or a shallow layer of management.
This question of the adequacy of capital is,
of course, a major issue in banking today.

It is a part

of the underlying tension between progress and prudence.
As yo u know, this issue has become one of particular c o n ­
cern to the Board, for many of our leading banking
institutions have tended to pursue a poli c y of rapid
e xpansion in both domestic and foreign markets.

Prudence

w o u l d dictate that such expansion be supported by a strong
capital base and an adequate liquidity position.

The

t ension of which I have spoken is h e ightened when a bank's
m anagement must make the hard choice between continuing
e x pansion into possibly highly profitable fields or
slowing that expansion to permit augmentation of capital
a nd to ensure appropriate liquidity.




- 9 W h i l e I am well aware of the pressure bankers
are under to show a record of profitable performance to
current and potential stockholders, I believe that the
wiser choice for bankers today is to go slow on expansion
plans, and to emphasize instead actions to bolster the
long-run strength of their institutions.

The capa c i t y

to sacrifice short-term gains to protect a l o n g er-term
position has always been a mark of the prudent banker.
Whi le a m e a sure of entrepreneurial aggressiveness by
bank managements has helped make our banking s y s t e m a
progressive one, in the final analysis only a prudent
management can assure that system's continued well-being.
In the ultimate test of banking, of course,
public confidence is the key.

It cannot be otherwise

for institutions that have promised to pay a major part
of their liabilities on demand.

Bankers have a h e a v y

responsibility to avoid actions that w o uld result in
w eakening the public's confidence in our banking system,
particularly in difficult times like these.




Tha t k ind

-

10

-

of banker prudence is more important than Federal Reserve
w illingness to serve as l e n d e r - o f -last-resort or FDIC
insurance of deposits in reassuring the public of the
fundamental soundness of our banking, system.
Having spoken at some length now about b a n k e r s :
responsibilities, let me say something about how I see
bank regulators' responsibilities for attempting to
achieve that same difficult balance between progress
and prudence.

You can be assured that I and my colleagues

on the Board are sensitive to banks' needs to seek new
sources of funds and to engage in profitable undertakings
b oth at home and abroad.

For it is only in this fashion

in today's highly competitive environment that banks can
hope to perform adequately their intermediating function
of marshalling funds from savers and investors and
dispensing them to meet growing public and private needs.
T he importance of this function may be made even more
a pparent in the future as rising world-wide demands for
capital make their full weight felt.




- 11 -

We are also sensitive, however, to the even
more vital need to preserve the basic h e alth of this
country's banking system.

For if prudence is the h a l l ­

mark of sound banking, it is even more the necessity
of sound banking regulation.
We realize, I might add, that we are imposing
a heavy burden on bankers by sometimes urging t h e m to
increase their equity capital and improve their liquidity
positions at a time whe n tight monetary policy has made
these more difficult to accomplish.

But w h e n we see some

banks u n dertaking costly expansionary activities without
providing commensurate capital and liquidity bases, we
cannot help but think that the time has come, b y denying
certain applications, to urge such institutions to
reconsider the balance they have struck between the
dictates of progress and those of prudence.

In such

cases, a slowing of too-rapid expansion by holding
companies has seemed to us to be the wisest course.
r e sponsibility as regulators of banking in the public




Our

interest has impelled us to act in these instances to
tip the balance in favor of prudence.
C o nelusion
What I have been speaking about this afternoon
has ostensibly been the tension between the need for a
progressive, forward-looking and responsive banking
system on the one hand, and the need for prudent conduct
to assure the continued health and safety of our banking
institutions, on the other.

I have also been talking

about the responsibilities of bankers and bank regulators
to achieve a balance between these two sometimes c o n ­
flicting needs.

But actually, I have been discussing

s o mething that both underlies and encompasses these
subjects.
My topic today has really been the nature of
the public interest in our banking system and how bankers
and ba n k regulators alike can better help to promote
that interest.

This is a joint undertaking, one made

particularly difficult--and all the more important--by
the troubling economic circumstances of our time.




It

requires that we strive together to see that the public's
interest in banking is both thoroughly protected by
a ppropriately wise and prudent conduct a n d well served
by soundly progressive and innovative undertakings.

Our

nation's economic and financial well - b e i n g is significantly
dependent on maintaining a proper balance between these
two g o a l s .