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The Banker's Responsibility

Address delivered by
Governor, Federal Reserve Board

before the


at its
Annual Convention
at Philadelphia, Pa.
October 3, 1928

14 G. V S

The Banker's Responsibility
IF THE economic life of the country be compared to
the automobile, the natural resources represent the
machinery and human endeavor the fuel. The function of the banking system in this machine would be
to provide proper lubrication. Banks can not create
natural resources nor can they be a substitute for
human labor, but they can work toward a more efficient use of resources and a more effective application
of labor and thereby contribute to a smoother and
more even working of the mechanism to prevent
overheated parts and possible explosions.
There is nothing in the country's business life that
approaches the banks in the wide-spread influence of
their activities which are not confined to any particular line of commerce or industry but reach and
influence all lines of endeavor. It is for this reason
that banking can not be considered as a purely private
business and so banks are supervised by Government
agencies and regulated by statutory limitations.
Essentially, the function of a bank is to convert a
person's ability to pay in the future into ability to
pay at once. A storekeeper who wishes to lay in a
stock of goods may not be in a position to pay for
all of them at the time, but will be able to pay for
them after some of the goods have been sold to the
public. It is the bank's function, by lending him
money, to enable him to convert his future paying
capacity into present paying capacity. This is a


The Banker s Responsibility
simple and fundamental function. It involves no
great or complicated mechanism and contains no
mysteries in its workings. The great Dunbar said
many years ago: "These functions imply no very
complex operations. They require prudence, integrity, and patience, but they have no mystery."
With this definition of the primary functions of
banks in mind, let me analyze the nature and order
of importance of their responsibilities. First and
foremost, their responsibility is to their depositors
who have entrusted them with funds and are entitled
to receive them either on demand or on dates stated
in their deposit contract. In order to provide additional safeguard for the interests of the depositors,
the owners of the banks contribute capital, and to
this they gradually add undistributed profits in the
form of surplus. These funds, placed by the owners
of the business in a bank, vouch for the good faith
of the proprietors. They are also a buffer between
the banks' liabilities to their depositors and their
claims on their borrowers. An adequate proportion
of capital funds is, therefore, essential to the discharge
of a banker's responsibilities.
More important, however, than the capital contribution is the exercise of care in making loans and
buying investments. A bad loan is rarely a kindness
to the borrower. Too many bad loans are a betrayal
of the trust placed in the banks by the depositors.
Therefore, the banker must discharge his responsibility to depositors by a careful scrutiny of his loans.
If it were possible for a banker to confine all his



The Banker s Responsibility
advances in his own community to conservative and
safe loans based upon production and distribution,
with the assurance of assistance from the Federal
reserve bank for seasonal and emergency requirements, there could be no serious objection to his
conducting his institution in such a manner. However, I know from my own experience that loans of
this character are not always available and even if
they were available, such a policy would result in
the banker having his deposits employed only a part
of the time.
Loans of a capital or speculative nature made
locally, even though they are good, do not always
represent good banking. A bank should not be entirely dependent for solvency on developments in its
own community, but should, in the great majority
of cases, carry secondary reserves in the form of
liquid investments—funds placed on deposit with
out-of-town banks, commercial paper, bankers' acceptances or security loans the liquidity of which
depends upon the marketability of the securities back
of the loan. A certain proportion of funds not directly
dependent upon the developments in a community
has come to be considered as a fundamental condition
of sound banking.
Second to the banker's responsibility to his depositors is his responsibility to the bank's stockholders.
They have contributed capital to the enterprise and
are entitled to as large a return on this capital as can
be obtained by safe and legitimate use of the funds.
It is the universal acceptance of the priority of the


The Banker s Responsibility
depositors' claims over those of the stockholders
that indicates the extent to which a bank is a public
utility. Fortunately, however, the concern of stockholders about bad loans is greater than that of the
depositors; in fact, depositors begin to be concerned
about bad loans only when their magnitude is such
as to endanger the bank's ability to meet its liabilities. Stockholders, on the other hand, are constantly
interested in the success of the bank's operations,
because every profit made by the bank increases the
value of the stockholders' equity in the business.
Responsibility of banks does not end with their
depositors and stockholders. Banks also have a
responsibility to the community in which they are
located and from which they derive their deposits.
If a bank invests all of its deposits in outside loans
and securities, it is not fair to its community. If
its outside loans and investments are safe and profitable, it is dealing fairly with its depositors and stockholders, but it fails in its responsibility to its own
community. In so far as the use of a bank's funds
in its own community is consistent with safety, local
industries and enterprises are entitled to the first
claim on these funds. This does not mean that
bankers must be philanthropists. It simply means
that their self-interest must be intelligent and farsighted. For if a community should be constantly
deprived of its funds by investment outside, sooner
or later this is bound to arrest its growth and prosperity. Ultimately it would lead to a drying up of
the flow of deposits which supplied the bank with


The Banker s Responsibility
funds for its operations. The responsibility of the
banker to his community is an application of enlightened self-interest. In popular parlance, the
banker must play the game and do his bit in the
community's work.
At this point I want to consider in what way the
Federal reserve banks enter into the picture. Their
capital, as you know, is supplied by their members.
They are in substance a cooperative enterprise among
banks for the purpose of taking care of seasonal and
emergency needs for credit and currency. They prevent excessive strains by lending the support of the
financial strength of the entire System to the needs
of any community that requires and is entitled to it.
Even more than the commercial banks, the Federal
reserve banks are public institutions and the public
interest is paramount in their responsibilities.
It is the business of the reserve banks to see to it
that there is no shadow of doubt cast upon the validity of their note issue. The reserve banks must also
safeguard their own deposits, which are the reserves
of the other banks. These deposits must be used in
such a way as not to permit the slightest doubt of
their immediate availability upon demand. It is
for this reason that the Federal Reserve Act prescribes rigid limitations about the use of reserve bank
funds. While the direct responsibility of the reserve
banks on deposits is to their member banks, it goes
beyond that. It extends to the depositors of the
member banks, because the safety of their funds
depends to a certain extent upon the safety of their


The Banker s Responsibility
reserves carried with the reserve banks. Back of
these reserve balances of the member banks are the
reserves of the reserve banks themselves. These are
the ultimate reserve basis of our entire banking structure. An all-important responsibility of the Federal
Reserve System is the conservation of these reserves
upon a proper gold basis.
At the risk of tiring you by stating what you already know, I remind you that for $100 of deposits
carried by a member bank, the reserve bank receives
on the average about $7.50 as a reserve balance.
Against this reserve balance of $7.50 the reserve bank
must hold about $2.50 in gold or lawful money. Thus
the $2.50 held by a reserve bank is the basis of $100
of member bank credit. This in turn may be the
basis of a still larger amount of non-member bank
credit, because a large part of the reserves of nonmember banks is held with member banks. This
apparently narrow base of our credit structure is
sufficient for safety only because of the cooperation
of the banks through the Federal Reserve System.
It emphasizes the extent of the responsibility of the
reserve banks in protecting these reserves. The reserve banks must take a far-sighted view of the needs
of the community and must maintain a stock of gold
sufficient to provide for the country's growing needs.
It is, therefore, a responsibility of the Federal Reserve System to shape its policy in such a manner as
to protect our gold reserves against too rapid depletion. During the past year, we lost $500,000,000 in
gold, and no one knows whether the redistribution

The Banker s Responsibility
of gold has been completed or whether the United
States will lose additional gold to the rest of the
world. Our gold reserves at the present time are
$1,000,000,000 in excess of the legal requirements
and it is fortunate that they are, because it puts the
bankers in a position to handle further export movements of gold if they should develop and to meet the
growing credit needs of the country. The loss of gold
for the past year has been a desirable thing, not only
from the point of view of those who received it and
used it as the basis of monetary reconstruction, but
also from the point of view of the United States. It
has removed from the foreign trade of the United
States the risks arising from unstable exchanges and
disorganized conditions among its foreign customers.
The Reserve System's responsibility is to make such
use of its reserves as are in the interests of the country
in the broadest sense of the word. This involves close
attention to developments both here and abroad and
makes the framing of Federal reserve policies not only
a matter of national but of international importance
of the first magnitude.
The Federal Reserve System has also a measure of
responsibility for the rapidity of the growth of bank
credit in this country, although the experience of the
last 14 years has demonstrated conclusively that this
movement frequently attains such momentum that
it is some time before Federal reserve policies become
effective. You are familiar with the methods at the
disposal of the Reserve System to accomplish these
ends. They are primarily changes in discount and


The Banker s Responsibility
open-market rates and open-market policies in the
purchase and sale of Government securities. Through
these means the System can be an influence toward
easier or tighter conditions in the money market,
even though the influence may he slow in operating.
It can, therefore, to a certain extent, encourage or
discourage the growth of bank credit. All loans and
investments of the member banks result in the creation of deposits. The growth of deposits in turn increases reserve requirements of member banks and
when these are met by rediscounting, reserve policies
and rates begin to be effective. It is a mistake, therefore, to assume that only one or another class of loans
or investments may be supported by the reserve
banks, while other classes of loans and investments
may not.
Since the Federal reserve banks furnish the basis
of credit growth in any field, whether it be commerce,
industry, agriculture or the trading in securities, the
Reserve System feels concern about excessive growth
in any line of credit. It is impossible for a reserve
bank to earmark the credit it releases, but when too
rapid growth in any line of credit threatens to upset
the financial structure of the country and make undue
demands on the reserve funds, which should be conserved for the legitimate growth of the country's
business, the Reserve System can properly use its
influence against these undesirable developments.
Within the limits of its powers, the responsibility
of the Federal Reserve System is for the credit structure as a whole. A healthy banking situation must


The Banker s Responsibility
be forever the primary concern of the managers of
the Federal reserve banks and of the Federal Reserve
Board. These responsibilities are sufficient to require
our best efforts in the determination of the wise course
of action. This is one of the reasons why it would be
unfortunate if the Federal Reserve System were to
be charged with still further responsibilities which
are not directly related to banking, such as responsibility for the stability of the general price level or for
the moderation of ups and downs in business conditions. It is my conviction, and 1 want to leave this
thought with you in conclusion, that a healthy banking situation is the best guarantee of a healthy
economic development in so far as it depends on the
use of bank credit. It is towards sound banking
conditions that the Federal reserve banks must work
in cooperation with their member banks and with
other banks which are a part of our banking structure.
In my opinion, the country's entire banking system,
from the smallest country bank to the greatest financial institution, and this includes the Federal Reserve
System, can best discharge its public responsibility
by concentrating its efforts on the maintenance of
sound banking conditions.