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Confidential

UNIFICATION OF THE COMMERCIAL BANKING SYSTEM

December 1-9, 1936

CONTENTS
Pa^e
Summary
Primary Need—A Compulsory System
Constitutional Question
Present Opportunity
Compulsory Federal Charters
Most Direct and Effective Method
Safety Record of National System
Lesson of the Banking Crisis
Disadvantages of Continuation of State Powers
Obstacles
Par Clearance Problem
Minimum Capital Problem
Compulsory Federal Reserve Membership
The First Alternative to Compulsory Federal Charters
The Chief Advantages
Favorable Opinion
Obstacles to Compulsory Federal Reserve Membership
Compulsory Deposit Insurance
Present Participation in Deposit Insurance
Compulsory vs. Voluntary Insurance Participation
Greater Power for Insurance Authorities
Wisdom of Extending the Insurance Principle
Savings Institutions
Non-commercial Banks
The Insurance of Savings Accounts
Building and Loan Associations, Credit Unions, etc.
Savings Deposits in Commercial Banks




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UNIFICATION OF THE COMMERCIAL BANKIHS SYSTEM

SUMMARY

The staff Relieves that unification should he obtained "by re*»
quiring all commercial hanks l/
1#

To operate "under Federal charter, to be-

come members of the Federal Reserve System, and to
participate in Federal deposit insurance; or if
this program appears inexpedient
2®

To become members of the Federal Reserve

System and to participate in Federal deposit in~
surancef or if this program appears inexpedient
3©

To participate in Federal deposit insur-

ance and to conform to certain of the minimum
standards to which member banks are now subject©
It is further believed that participation of savings banks in
Federal deposit insurance shoxild be continued on a voluntary basis*
If the program described under either 1 or 2 is adopted, it
probably will be necessary as a practical matter to change some of
the existing requirements of Federal statutes with which many sound
State banks would have difficulty in complying©

11 Banks receiving any deposits withdrawable by check or similar
instrument •




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PRIMARY HEED—A COMPULSORY SYSTEM
There has never "been a single authority in this country which was
in a position to impose minimum standards of good banking practice upon
all commercial banks, despite the fact that the checking deposits of the
commercial banks are by far the most important means of making payments
at the present time®
juriiriictior.

The possibility of a bank*s escaping from the

of a particular banking authority has for decades been

the outstanding shortcoming of the dual banking system®

The manage-

ment of a bank operating under national charter which did not wish to
submit to the banking standards required by the national system sometimes converted the bank to a State institution®

Likewise a State bank

member of the Federal Reserve System which did not wish to comply with
the standards of the System could avoid them by withdrawing from the
System®

Similar motives have caused some State banks to convert to

national charters®
Standards have from tine to ti~e been lowered for all classes of
banks due to the statutory and administrative competition in laxity
which has resulted from the efforts of the State and Federal authorities to retain banks under their jurisdiction or attract additional
banks®

The establishment of a single authority with power to set

minimum standards from which commercial banks cannot escape is the
imperative need for a fundamental improvement in the banking structure®
The dual arrangement for chartering and supervising banks by both
the Federal and State authorities, long recognized by many prominent
bankers, business men, economists, and others as one of the inherent




weaknesses of the American "banking structure, has contributed to the
record of thousands of bank failures and periodic banking crises and has
resulted in a competition between the national and State banking authorities which has weakened both systems*
A letter dated March 29, 1932, to the Committee on Banking and Currency of the Senate contained the following statement which expressed the
unanimous opinion of the Federal Reserve Boards

" • • * *the establishment

of a unified system of banking under national supervision is essential
to fundamental banking reform®" 1./ During the discussion at the hearing
it was pointed out that competition between the State and national banking systems has resulted in weakening both steadily*
Senator Glass remarked:

At this point

!I

I think the curse of the banking business of

this country is the dual system*" j H e

requested the Board to H suggest

to us a constitutional method of creating a unified banking system in
this country*" 2/
Constitutional Question* - In response to this request the General
Counsel of the Federal Reserve Board prepared an opinion dated December 5, 1932» which concludes that Congress possesses the power to unify
the commercial banking system*

As with other constitutional questions,

however, there are responsible persons who do not share this view*

For

example, Senator Glass has indicated on several occasions in recent years
that he doubts that the powers of Congress are so broad* 3/

The Board1 a

Counsel, in summarizing his opinion, stated:
1/ U* S* Congress, 72nd, 1st Session, Hearings on S* U115, Part 2,
March 29, 1932, p* 35S; see also F* R* Bulletin, April 1932, p* 207*
2/ Ibid*, p* 395*
3/ U. S* Congress, 73rd, 1st Session, March 9, 1933, P* 57*




"I* The power to create the national banking system and
the Federal Reserve System as useful instrumentalities to aid
the Federal Government in the performance of certain important
Governmental functions includes the power to take such action
as Congress may deem necessary to preserve the existence and
promote the efficiency of these systems. McCulloch v. Maryland, k Wheat. 316; Farmers and Mechanics National Bank v.
Bearing, 91 U. S. 29;ffestfallv. United States, 2?4 U. S#
256.
"2. Having provided the country with a national currency
through the national banking system and the Federal reserve
system, Congress may constitutionally preserve the full benefits of such currency for the people by appropriate legislartion. Veazie Bank v. Fenno, 8 Wall* 533; Legal Tender Cases,
12 Wall*
7#
H

3# The existence of a heterogeneous banking structure
in which there have been more than 10,000 bank failures during
the past 12 years constitutes a burden upon and an obstruction
to interstate commerce; and Congress may enact appropriate
legislation to correct this condition. United States v. Ferrer,
250 U. S. 195; Stafford v. Wallace, 258 U. Se ^95; Board of Trade
v* Olsen, 262 Uf S. 1,
n

Any one of these grounds standing alone would be a sufficient constitutional justification for the enactment of
legislation restricting the conduct of the commercial banking
business to national banks; and, when all three grounds are considered together, there can be no doubt that such legislation
would be not only constitutional but also entirely appropriate
and in accordance with a proper division of authority between
the Federal Government and the States*
"Having the power to confine the commercial banking business to national banks, Congress can exercise that power in any
manner which it deems appropriate and adequate for its purposes*
It is not necessary that the legislation assume the form of a
revenue act or an act to regulate interstate commerce, though
either of these means would be appropriate." if
The- opinion also suggested the following methods by which
Congress could exercise the power to confine the commercial banking business to national banks:

1 / Federal Reserve, Bulletin, March 1933, PP« 166-167.




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fr

(l) It could forbid the receipt of deposits subject to
withdrawal by check by any individual, partnership, or corporation other than a bank organized under the laws of the United
States and provide suitable penalties for violations of this
prohibition.
"(2) It could impose a prohibitive tax on all checks and
similar documents drawn on, or payable at, banks not organized
under the laws of the United States©
11

(3) It could forbid any officer of the United States or
any Federal reserve bank, national bank, Federal land bank,
joint stock land bank, Federal intermediate credit bank, or
Federal home loan bank to receive in payment, on deposit, for
the purposes of exchange or collection, or for any other purpose, any check drawn upon any bank not organized under the
laws of the United States*
"(k) It could forbid any bank organized under the laws of
the United States to make loans or extend credit to, or deposit
any of its funds in, or permit the use of any of its facilities
by, any commercial bank not organized under such laws*
,f

(5) It could forbid the deposit of public funds of the
United States in any bank not organized under the laws of the
United States©
,!

(6) It could exempt all national banks from taxation,
State or Federal, except taxes on real estate©" 1,/
Present Opportunity* - With the recollection of the banking crisis
still fresh in mind the present occasion would appear to be a particularly timely one to attempt to unify the commercial banking system©

If

the administration with its overwhelming Congressional majority gave a
program of this character its enthusiastic support, the possibilities
of success would be greater than they may be again for decades*
The following paragraphs will discuss the advantages, disadvantages,
and obstacles to attempting a legislative program of unification through

i/ Ibid*, p. 136,




- 6 requiring all commercial banks
(1) To operate under Federal charters, or
(2) To become members of the Federal Reserve System, or
(3) To participate in Federal deposit insurance®




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COMPULSORY FEDERAL CHARTERS
Most Direct and Effective Method. - Compulsory Federal charters for
all commercial banks would completely eliminate competition in laxity
between Federal and State authorities by bringing to an end the socalled dual banking system of this country, as State authority in the
field of commercial banking would cease*

It would no longer be pos-

sible for a bank to switch from Federal to State charter in order to
avoid complying with banking standards of the Federal system*
A unified banking system was temporarily achieved in a large
measure in the years following IS63, primarily because national banks
were accorded the privilege of issuing bank notei- while the notes of
State banks were subjected to a prohibitive tax©

Senator Sherman,

Chairman of the Finance Committee and chief sponsor of the National
Bank Act, stated during the debates on the measure to tax the circulation of State bank notes:
supersede the State banks*

"The national banks were intended to
Both cannot exist together.*1J

For

about 20 years the amount of banking business controlled by State incorporated institutions was negligible®

During this period about 5

national banks per year failed on the average*

If such a condition had

obtained through the subsequent decades, it is likely that supervision,
unaffected by the kind of competition that was later to develop, would
have been able to maintain a higher standard of banking practice*
Deposit banking began to develop on so large a scale, however, that
State banks found it increasingly profitable to operate without the

l/ Congressional Globe, 38th Congress, 2nd Session, p* II39*




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privilege of issuing notes, and from about 1880 State banks have grown
steadily in relative importance.
State banks have had many competitive advantages over national
banks, notably in the matter of lower minimum capital and other reqtiirements for receiving charters, and in more extensive powers and privileges
which provided greater opportunities for making profits.

Over the dec-

etrl'da. the Federal Government has been under pressure to grant similar
powers and privileges to national banks.

The granting of these powers

has tended to remove some of the sound restrictions previously imposed
by the National Bank Act.

Thus it was that about the beginning of the

present century, or somewhat earlier, there began between the national
and the several State systems that form of rivalry which has been referred to above as competition in laxity.
Safety Hecord of National System. - Despite the competition in
laxity which has weakened the standards of banking practice among banks
operating under Federal charter, the safety record of banks in that system has been superior to that of banks exclusively under the jurisdiction
of the States.
banks.

On June 30* 1920, there were in operation 8,02^ national

In the following decade and a half there were 32 suspensions

among national banks for every 100 in existence in 1920.

The comparable

ratio for State member banks was 38 and for nonmember banks
the decade and a

During

half national banks which suspended involved $15 of

deposits for every $100 of national bank deposits in existence in 1920.
The comparable ratio for State member banks was $17 and for nonmember
banks $37.




Thus the ratio for nonmember banks was more then twice as

great as for national banks.

During the years of liquidation beginning

in 1930 the rate of reduction in deposits of nonmember commercial banks
was about twice that of member banks,
It cannot be doubted that if all commercial banks had operated under
Federal charters during the past 15 years the rate of bank failures would
have been less.

Hot only did the weaknesses of State banking systems re-

sult in the failure of many State banks but their failure affected national banks and made it more difficult for national banks to resist bad
tines.

It is impossible to disassociate the actual failure record from

the competition in laxity existing over the decades which weakened the
national system as well as the State systems.

If all commercial banks

had been under Federal charter, uniform standards of good banking practice could have been enforced.

Privileges, restrictions, and supervision

would have been sounder and more uniform.

Rules with respect to capital-

ization, reserves, branches, and investment policies would have been
equally applicable to all commercial banks.

The banks wouLd have been

unable to play the State and national authorities against each other by
threatening to shift from one system to the other»

As difficulties or

abuses appeared from time to time, they could have been promptly and
adequately corrected without fear that the corrections might be nullified by banks withdrawing from the system.
Lesson of the Banking Crisis. -

No more graphic picture of the

infinite confusion that can be connected with the multiple system of
bank supervision and control has occurred in the history of banking in
the United States than the banking holiday of March 1933 and




-

the events leading up to it*

10

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During the summer of 1932 when there were

signs that the long recession in "business the world over was coming to
an end, it was apparent that at the then existing prices of securities
and other "bank assets a large percentage of the hanks in America was insolvent*

There were those who felt at that time that matters had re-

solved themselves into a race between a recovery in prices and some
spectacular failure*

The Heconstruction Finance Corporation was

propping up one situation after another, but it seemed inevitable
that an unmanageable situation would appear somewhere*
If all commercial banks at that time had operated under Federal
charter, a clear-cut policy might have avoided the banking crisis of
1933«

There existed, however, the State powers in the field of bank-

ing; and because of the great number of parties at interest, they
could not be brought together on common grounds*
It would not be too much to hazard a guess that the American banking system would never have had to go through the banking holiday of
March 1933 ^ competition in laxity had not existed for three quarters
of a century between the multiple banking jurisdictions of the United
States*
It was not a fortunate thing, moreover, that the Federal administration was forced to fall back on a war power in order to
declare the banking holiday beginning with March 6, 1933*

The

administration indeed was on such uncertain ground that prompt confirmation of its action was sought from Congress in the Emergency
Banking Act*




Even then it was said by some that the matter of Federal

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closing of nonmember "bsales was a usurpation of constitutional authority,
that the States were under no compulsion, and that success depended upon
voluntary cooperation.
The Bank Conservation Act, passed by Congress on March 9» 1933»
of tremendous help in rehabilitating national banks.

Since States do not

possess as broad powers in the bankruptcy field as does the Federal Government, it is doubtful whether they could enact as constructive legislation
to deal with a banking crisis.
Disadvantages of Continuation of State Powers. -

The chief disadvan-

tage of a plan for unifying the banking system such as conpulsory Federal
Reserve membership or compulsory deposit insurance, which would retain
State charters and State supervision, seems to be the unfortunate alternative of indirect supervision or double supervision which the Federal
authorities would be forced to accept.

If such a system were adopted,

the Federal supervisory authorities would either be forced to cooperate
with and to a certain extent rely upon the State supervisory authorities
and thus be content with a sort of indirect supervision, or they would
have to institute a complete system of direct supervision while the
banks continued to be subjected to the burden of superfluous parallel
State supervision.
Another objection would be that the State authorities apparently
would continue to handle the receiverships and liquidations of State
banks. Unfortunate preferences often result when an insolvent bank is
allowed to remain open.

Conceivably this might be altered by Federal

statute but to do so would be almost as drastic as requiring Federal
charters.




The present system under which the Federal Deposit Insurance

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12

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Corporation is authorized to accept the receivership of closed insured
State "banks if tendered by the State authorities clearly does not put
this function under Federal authority.

Every one of the eight insured

State banks which suspended in I93U was liquidated by State authorities;
and IS of the 20 such banks which suspended in 1935 were similarly liquidated*

Damage may result to both the solvency of the insurance fund and

the general credit situation of the country from too rapid or too slow
liquidation of suspended insured banks*

There is, of course, the addi-

tional fact that any waste or inefficiency in such liquidations necessarily become a direct burden upon the insurance fund*
Another difficulty which results from retaining State charters is
the fact that although limitations might be placed upon the powers of
the banks by Federal law, the banks would have no greater powers than
those given them under the State law*

Thus when the program was inau-

gurated to strengthen the banks through purchase of stock by the Reconstruction Finance Corporation, banks in many States could not participate in the program until special enabling legislation was enacted.
In some States such legislation could not be enacted because of constitutional pro-visions.

Similar situations arise in connection with re-

organizations and consolidations*

As long as the banks derive their

charter powers from the States, it would seem that such situations are
almost certain to recur*
While compulsory Federal Reserve membership or compulsory deposit
insurance night serve to check the opening of unsound banks or branches,
continuance of the State authorities in this field might greatly hamper
and embarrass the Federal authorities*

For instance, if State authori-

ties char-ored a bank or authorized a branch, even though the Federal
authorities might veto such action and thus prevent the operation of



_

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the bank or branch, the previous favorable action of the State authorities
might easily be used by the interested parties as a strong argument and
embarrassment to the Federal authorities.
Obstacles* - The outstanding disadvantage in a program to legislate all commercial banks under Federal charter is a political one.

There

are many more commercial banks in the country which operate under State charter
than under Federal.

On December 31, 1935, there were 5 33S6 national banks

with deposits of $2}4,300,000,000 compared with State commercial banks of
9,505 with deposits of $20,300,000*000.

This large number of State in-

stitutions and the State supervisory authorities would be the rallying point
of strenuous political opposition to conversion to Federal charter.
The State banking system is regarded by some as a haven from what
they consider oppressive Federalization.

Many of these interests would like

to continue to enjoy the advantages of a system, of competition in laxity.
A former President of the American Bankers Association said that, if all
commercial banking were under Federal control, business could no longer
conduct its affairs in entire independence of Federal influence; ours is
a government of checks and balances, and the fact that banking has a free
choice whether it shall render its services to the people under Federal or
State charter is one of the most important of these.
While many would have been glad to see all commercial banking carried
on wider Federal charter, they have not regarded it as a practical
objective*

For example, the Governor of the Federal Reserve Board, in

testifying before the House Committee on Banking and Currency in
March 1935, told the Committee that, although he thought it would be




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Ik

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desirable to abolish State powers to create banks, it was impracticable
at that time, sincere cannot go faster than the people of the country
are willing to have us go*1 l/
Many of the important institutions in the country have been in
favor of a unified banking system through compulsory membership in
the Federal Reserve System®

Those that operate important trust com-

panies organized under State laws, however, would be likely to join
i
with others in opposition to unification through Federal charters.
When a trust company is converted to Federal charter, various problems
may arise in connection with fiduciary business*

For example, in the

Worcester County National Bank case a Massachusetts trust company was
merged with a national bank and the courts held that under the law of
that State the national bank would be required to procure new court
authorizations for acting in the case of trusts administered by the
previously existing State institution*

Perhaps difficulties of this

character could be overcome by leaving the fiduciary business in the
trust company and transferring the commercial banking business to a
newly organized bank operating under Federal charter*

The definite

termination of competition in laxity might lead to the repeal of State
laws which produce such difficulties*
It is possible that because of sentimental or other reasons some
institutions operating under State charters granted scores of years ago
would have strong objections to conversion to Federal charter.

These

objections might be lessened if institutions in making the conversion
were permitted to retain their well established names*

1/ U* S* Congress, "fath, 1st Session, Hearings on H* R* 5357, March 1935,
P. ^27.




- 15 There are some other requirements, such as certain restrictions
on loans, which apply only to national "banks and which would create
problems only under an attempt to require Federal charters.

Others,

such as restrictions on investments, par clearance, and capital requirements, apply to both national and State member banks and would
create problems in connection with either compulsory Federal charters
or compulsory Federal Reserve membership.

The last two perhaps are

the most prominent.
Par Clearance Problem. - There cannot be any doubt that hundreds
of small banks find Federal charters and the Federal Reserve System
unattractive because of the matter of par clearance.

Although more

than 6,000 banks not members of the Federal Reserve System were participating in the par collection system at the end of 1935* there were at
that time 2, 553 nonmember banks, concentrated largely in 15 States,
which were making charges for remitting funds outside of their localities. Of these 2,553 banks, 2,190 had deposits of less than $500,000
each.

In the case of many small banks the earnings from exchange

charges represent the difference between a little net profit and none
at all,
At a meeting of the Governors of the Federal Reserve banks held
in Washington on May 28, 1935* at which a discussion was held with
respect to why nonmember banks do not join the Federal Reserve System,
reluctance to forego the income from exchange charges, upon which some
of the small banks depend very largely at this time, was given as one
of the principal obstacles to their applying for membership.

In recent

months a number of national banks in the Northwest have converted into
State banks and, upon conversion, have elected not to be included in




- 16 the Federal Reserve par list, apparently so that they night add to
their income by charging exchange.
Minimum Capital Problem. - A requirement compelling all commercial banks to operate unc:u.r Federal charter or as members of the
Federal Reserve System would raise the problem of minimum capital
requirements.

Depending upon circumstances of location one organiza-

tion , banks to be admitted to Federal Reserve membership must in some
cases have capital of $25,000, $50,000, $100,000, or $200,000.

To be

eligible for conversion into a national, bunk a State bank must have a
capital of not less than o50,000.
Of the 8,500 commercial banks which were not members of the Federal Reserve System at the end of 1935 about 1,900 had less than
$25,000 capital and about 600 other bunks could not meet the present
capital requirements for Federal Reserve membership.

This is exclusive

of more than 300 branch operating banks which lacked the even higher
capital requirements prescribed for branch systems.

In addition there

were more than 200 State member banks ..aid 2,900 nonmember banks with
a capital of $25,000 or more but less than $50,000, which could not be
converted into national banks,

Thus nearly 6,000 State banks were not

eligible for conversion into national banks under present provisions
of the National Bank Act.
No doubt the soundest principle with resoect to the two outstanding problems of capital requirements and par clearance would be to reauire
all commercial banks to meet the standards of the Federal system.
of the high mortality among banks with capital of less than




In view

$50,000,

nixgL'it "be more in the public interest if all such banks were

required to increase their ce,pital* go out of business, or be taken over
as branches of larger institutions within a reasonable period of time*
It has been suggested that the problem of capital requirements
might be simplified if the present provision of Federal law were repealed and a provision substituted to require capital which appeared
adequate to the supervisory authorities, who would take into consideration the deposit liabilities of the bank and other corporate responsibilities*

It is quite possible that the Federal authorities would find

many banks whose capital is low in amount and yet sufficient in relartion to deposits and other factors to warrant their being converted to
Federal charter or admitted to Federal Reserve membership*
mum capital, however, should be required®




Some mini-

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COMFULSORY FEDERAL RESERVE MEMBERSHIP
Tiie First Alternative to Compulsory Federal Charters. - If it appears inexpedient to press for Federal charters in the near term, compulsory membership in the Federal Reserve System might nevertheless be
attained.

This method of unification would avoid the necessity of

destroying at one stroke the powers of the States in the commercial
banking field®

It would, therefore, be likely to encounter less

opposition from State bank supervisors and others interested in the
preservation of the State banking systems*

It would also avoid some

of the difficult problems which would be associated with transferring
the commercial business of some large trust companies to Federal charter*
This degree of -unification would make it possible for the first time in
the history of American banking to prescribe some standards from which
no commercial bank could escape*
Just as the establishment of the national banking system was intended by its sponsors to eliminate State institutions from the commercial banking field, so in 1913 it was hoped that the Federal Reserve
System would provide a means of unification of commercial banks operating nnder national and State charters*

Even the urgent proposals of

President Wilson during the war days, that State banks join the Federal
Reserve System as a patriotic measure, brought in relatively a small
number of the State banks and trust companies, though practically all
those of large size did become members*

The last two decades have amply

demonstrated that it is idle to hope for unification by any voluntary
method*
The safety record of State bank members of the Federal Reserve
System during the past 15 years was substantially as good as the record



- 19

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of national "banks and better than that of nonmember banks.

This was part-

ly the result of the fact that member banks were stronger and larger institutions on the average than nonmember banks,

Nevertheless the whole

commercial banking structure would have been in a better position to
meet the banking crisis of 1933 if all State banks had been members of
the Federal Reserve System.
Many of the advantages which would result from compulsory Federal
charters would result from compulsory membership in the Federal Reserve
System if broad powers to prescribe and enforce sound banking standards
were conferred.

The division of responsibility with State authorities,

however, would continue.

The disadvantages of continuing State powers,

pointed out in the discussion of compulsory charters, are serious enough
to suggest definitely that the plan of compulsory Federal charters is
much to be preferred.
The Chief Advantages. - An advantage of conpulsory Federal Reserve membership as contrasted with compulsory deposit insurance is the fact that all
banks would automatically become subject to a number of sound provisions to
which member banks are now subject but insured banks are not.
A vital thing that compulsory membership in the Federal Reserve System
would accomplish which would not be attained by compulsory participation in
Federal deposit insurance concerns the power of the Board of Governors to
influence credit conditions by making the reserve position of barf.es easier
or tighter.

If some commercial banks do not carry their reserves with Fed-

eral Reserve banks, the policy actions of the System affect nonmember commercial banks indirectly rather than directly as is the case with member
banles.
It is true that members of the Federal Reserve System had $28,000,000,000




of demand deposits on December 31, 1935 > while banks outside the System had
only $3,100,000,000 of such deposits, ]J

However, as long as membership in

the Federal Reserve System is voluntary, the danger exists that the Board's
power to influence monetary conditions through altering the reserve position
of member banks may be nullified or rendered ineffective by withdrawals from
the System or by the possibility of such withdrawals.
creased greatly as reserve requirements are raised*

This danger is inIt is unfortunate for

decisions with respect to altering the reserve position of banks to be influenced by considerations as to whether action will affect voluntary membership in the System*
Nonmember banks usually hold their reserves in the form of deposits
with other banks*

One of the most important purposes of the Federal Re-

serve Act was to lessen this condition known as pyramiding of reserves,
which can result in a large volume of deposits to the public being supported by almost no real reserves*

The existence of numerous nonmember

banks perpetuates these unsound possibilities, which unfortunately may
become more serious if changes in reserve requirements, now an important
instrument of national monetary control, result in withdrawals from the
Federal Reserve System.
Aside from the matter of credit policies, a distinct advantage would
accrue to small banks in carrying their reserve balances with Federal Reserve banks instead of with city correspondents*

The State-wide banking

holidays declared in several States in early 1933 a r e traceable to the difficulties of small banks which resulted from the freezing of their reserve
balances held by their city correspondents which had been forced to suspend
if

Time deposits excluded since compulsory Federal Reserve membership lias
not been suggested for mutual savings banks having about $10,000,000,000
of such deposits*




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21

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payments.
While it would not be as easy to do as -under a system of compulsory
Federal charters, compulsory Federal Reserve membership would make it
possible gradually to work toward substantial uniformity of standards
with respect to charters, examinations, supervision, loan and investment
policies, etc0; to inaugurate a policy for improvement in bank management;
and to take other measures which cannot be made fully effective now because
of the possibility of withdrawals from Federal Reserve membership®
Favorable Opinion, - Numerous men of affairs and responsible business
groups have time and again recommended that all commercial banks be coi>pelled to operate as members of the Federal Reserve System, One of the
countryts leading industrialists and financiers made a recommendation of
this character at a Congressional hearing in 1931®

At the sane time, he

indicated that in the long run he hoped that all commercial banks would
operate under Federal charter, though he did not think this move should
be pressed as a first step© 1,1 The Banking Board of the State of New York
in 1933 recommended compulsory membership in the Federal Reserve System
for all banks and trust companies of that State, 2./

A report of a com-

mittee of the Chamber of Commerce of the United States recommended that
every bank doing a commercial banking business should ultimately be made
a part of the Federal Reserve System.

The report stated that "Bringing

all commercial bank deposits into a single unified system under Federal
regulation will result in (l) effective control over the principal circulating medium of the country; (2) effective influence upon the volume and,

1/ U. S# Congress, Jlst,
3rd Session, S. Res, 71, Part 2, Feb. H, I93I,
PP. 353 ff*
2/ Report on Banks of Deposit and Discount, Annual Report of the Supt. of
Banks of N. Y., 1933, p. kl.




-

22

-

to some extent, upon the directions of use of hank credit; (3) more uniformity of commercial hanking policy and practice; and (k) an opportunity to
concentrate effort on measures to secure the safer operation of banks*H 1J
The California Bankers Association, 2/ the Reserve City Bankers Association, 3/
and others could he similarly cited*
Obstacles to Compulsory Federal Reserve Membership* - Many of the
practical considerations which are obstacles to compulsory Federal charters are also obstacles to compulsory Federal Reserve membership*

Some

of these obstacles might be removed by granting the Federal supervisory
authority power to waive statutory requirements under appropriate conditions*

This could be done somewhat more readily under a program for

compulsory Federal Reserve membership, because some of the restrictions
now applicable to national banks do not apply to State bank members of
the Federal Reserve System*
Among the obstacles to Federal Reserve membership as well as to Federal
charters are the reluctance of small banks to forego remittance charges, the
lack of sufficient capital among small banks to meet the requirements prescribed for membership, and the inexpediency of lowering Federal Reserve
standards in order to admit banks to membership*

Other such objections in-

clude the fear of increased reserve requirements, the absence of need for Federal Reserve rediscount accommodations, the requirements with respect to

l/ Banking Legislation, Chamber of Commerce of the U* S*, March 1933, p. k.
2/ The California Banker, June 1933, p# 26g#
3/ Summary of Arguments on Title II of the Banking Bill of 1935, prepared
by the Commission on Banking Law and Practice, Association of Reserve
City Bankers, May 20, 1935, pp* k0~kl.




-

23

-

reports of affiliates, the restrictions on loan and investment policies,
and the heavy capital requirements in certain circumstances in connection with the establishment of branches.
Some of these objections night Well be cited as good reasons why
commercial banks should be compelled to be members of the Federal Reserve
System.

So long as a large number of State banks is allowed to operate

under lower standards than those implicit in the matters just referred
to, the weakening effects upon the Federal system growing out of competition in laxity will not be obviated.
The strength of the opposition to compulsory Federal Reserve membership is illustrated by the experience of recent legislative history
with respect to permitting banks not members of the Federal Reserve
System to participate in Federal deposit insurance.

The original pro-

visions in this connection, passed June l6, 1933» contemplated that
after the lapse of a short period all banks enjoying the protection of
the Insurance Fund should become members of the Federal Reserve System.
Opposition to this provision in Congress has been such as to modify it
substantially.

By the terms of the Banking Act of 1935 "the present

stipulation is that compulsory membership in the Federal Reserve System
will be required after July 1, 19^2, only for insured State banks with
deposits aggregating $1,000,000 or more.

Only one out of 7 °f the ap-

proximately 8,500 commercial banks which do not belong to the Federal
Reserve System had as much as $1,000,000 of deposits at the end of 1935.
When the modification described above ?/as in process of enactment,
its supporters in the House of Representatives clearly indicated that
they were unwilling to sponsor unification through membership in the




-

Federal Reserve System.

24

-

This position has "been reiterated in the interim®

The Chairman of the Banking and Currency Committee of the House of Representatives in addressing the convention of State "bank supervisors in
Detroit in September 1936 affirmed the attitude in this connection of the
element which he represents, l/

The public opinion which thus registers

itself in Congress has been indicated by numerous resolutions of meetings
of State bank supervisors and State bankers associations as well* 2/
On the matter of lowering Federal Reserve standards in order to admit banks to membership, one group of responsible bankers has said:

,!

To

many, instead of lowering the Federal Reserve standards, it would seem
preferable to give the Federal Deposit Insurance Corporation power to
work with the large number of small banks which have survived the depression and which are rendering a useful service, until such time as they can
conform to the standards of a nation-wide banking system*

Then and only

then is it likely that this country will have a banking structure which
will survive in bad times as well as in good*ff j/

It might be noted

in this connection, however, that the large banks of the cities have
sometimes been accused of having no enthusiasm for seeing their country
correspondents join the Federal Reserve System because it would result
in reducing some of the lucrative relationships of the city banks.

1/ American Banker, September 21, 1936, p* 15*
2/ Proceedings of the 3^rd Annual Convention of'the National Association
of Supervisors of State Banks (193*0* P«
Also Report of Committee
on Resolutions of the Missouri Bankers Association in 1935«
3/ Summary of Arguments on Title II of the Banking. Bill of
prepared
by the Commission on Banking Law and Practice, Association of Reserve
City Bankers, May 20, I935, pp*




-

25

-

COMPULSORY DEPOSIT INSURANCE

If it appears inexpedient to press for compulsory Federal charters
or membership in the Federal Reserve System for all commercial banks, the
commercial banking system could nevertheless be strengthened considerably
through requiring all commercial banks to participate in Federal deposit
insurance and gradually to conform to as many as possible of the sound
pro visions to which member bariKS are now subject.

A program of this

character would, make it easier to avoid such obstacles as par clearance and minimum capital requirements and at the same time preserve the
existing standards of Federal Reserve membership.
Federal authority over insured State banks would not, of course, be
nearly as strong or effective as in the case of a single system of banks
operating under Federal charter, nor even as effective as it would be if
all commercial banks were required to be members of the Federal Reserve
System.

Nevertheless the bringing together of all national and State com-

mercial banks under some form of coordinated supervision Tvould be a distinct improvement over the present situation, under which banks may at
will remove themselves entirely from Federal jurisdiction.

Compulsory

Federal deposit insurance would provide the nucleus for a completely
effective control of commercial banks in the long term.

Indeed some

proponents of the plan of compulsory Federal charters would much prefer
to bring about such a result step by step rather than at a single stroke.
Present Participation in Deposit Insurance. - The Deposit Insurance
System already comprehends nearly 95 percent of the number and 98 percent




- 26 -

of the deposits of all commercial banks*

The following tabulation shows

that at the end of 1935 there were 9$505 commercial banks with deposits
of $20,300,000,000 outside of the national system, and 2,507 banks with
nearly $6,700,000,000 of deposits did not even belong to the Federal Reserve System*

Only 836 commercial banks, however, with deposits of

$1,200,000,000. were not participating in Federal deposit insurance.

Commercial Banks, December 3I, 1935
(Each with some demand deposits)

Class of bank

Number

Deposits
(millions of dollars)

S30

1,15s

Insured banks not
members of the
Federal Reserve
System

7,671

5,523

National

5,326

2M02

231

l3,6Hg

1/ 1 M 9 1

^5.131

Non-insured

State member
Total

l/ Includes 95 Morris Plan, industrial, and private banks reporting
some demand deposits, and 39 cash depositories (all in South
Carolina); excludes 5^7 mutual savings banks, 70 other banking
institutions without demand deposits, 32 banking institutions
without any deposits, and 253 banking institutions for which
figures on deposits are not available*
Many banks which are not on the Federal Reserve par list are nevertheless participants in Federal deposit insurance*

For example, in the 10

States, Minnesota, North Dakota, Wisconsin, Nebraska, Tennessee, Mississippi,
Georgia, North Carolina, Louisiana, and Alabama, where sentiment for remit-




-

27

-

tance charges is strong, there were on December 31, 1935, about 1,600 nonmember banks that haci not agreed to remit at par but had become members of
the Federal Deposit Insurance Corporation.

There were, however, in these

States 1,566 member and nonmemb~r banks on tne par list, any one of which
could have withdrawn from Federal Reserve membership or from the par listit if had found par remittance too burdensome.
Compulsory vs. Voluntary Insurance Participation. -

It is well known

that compulsory membership in the Federal Reserve System is generally
opposed by the supervisors of banking in the various States.

On the other

hand, many such authorities favor Federal deposit insurance and give it
much credit for

restabilizing the banking system.

One supervisor had gone

so far as to say that banks which do not belong to the insurance fund
should be regarded as leeches upon the other banics that support the fund,
which may be given credit for restoring tne confidence of the people in the
banking system of the country.i/
There were many persons, such as Senator Glass, "ho accented deposit insurance in the Banking Act of 1933 because it was hoped that i t
might serve to bring all commercial b^nks under a single authority.
Senator Glass stated that the only excuse for deposit insurance was
as an agency to bring about a unified system through membership in the
Federal Reserve System and that the president and the then Secretary of
the Treasury

had felt the same way.

All of them had be.ai persuaded

to go along with tne insurance principle for that reason.2J

Many

students of banking doubt whether voluntary participation in Federal

1/ Superintendent of Banks of Iowa, Proceedings ox t~ne Thirty-fourth
Annual Convention of the National Association of Supervisors of State
Banks, November 7-9, 1935, p. 33.
2/ U. S. Congress, 74th, 1st Session, Hearings on S. 1715 and H. R.
7617, April 1935, p. 35-




deposit insurance will ever result in a unification of the banking
system.

The possibility of a'bunk's doing a successful business as an

uninsured bonk exists, as trie tabulation given above indicates.
It would not be any great hardship to require the few hundred
uninsured commercial banks to become insured, and they should not be
permitted to profit from the stability which insurance has brought to
the banking business without supporting tne principle.

Experience has

amply demonstrated that no single authority will ever gain complete
jurisdiction over the commercial banking system through indirection and
enticements.

This end must be attained by Federal legislation.

The friends of Federal deposit insurance compose the elements which
have always been able in tne past to prevent unification through Federal
charter or membership in the Federal Reserve System,

These elements

might find persuasive an argument that everything should be done to preserve Federal deposit insurance.

However, they have not had occasion to

express themselves on a definite proposal for compulsory deposit insurance.

Their friendliness for the insurance principle might not extend

to a measure which would run counter to some of their own desires by
curtailing competition in laxity and weakening the influence of the State
authorities,,
If creation of the Federal Deposit Insurance Corporation was constitutional, presumably Congress has the power under McOulloch v. Maryland to clo whatever is necessary to preserve it.

The principle of in-

suring the deposits of commercial banks can be kept sound only by giving the insuring authority the power to impose sound banking principles
upon the entire commercial banking system,




~

13

-

Since it is possible for a commercial bank to operate outside of
the insurance system, insured banks which do not wish to submit to
principles of sound operation may withdraw from the insurance system*
Lax banking practices which could obtain among uninsured banks could
undermine the business of the insured banks*

For example, Federal

legislation prohibits an insured bank from paying interest on demand
deposits*

It does not appear equitable, nor would it be sound from the

standpoint of the insurance system, to allow commercial banks to escape
this regulation by staying out of or withdrawing from the insurance system amd drawing off deposits of insured banks by paying interest on demand deposits*

The success of Federal deposit insurance could be best

secured by providing for compulsory insurance for all commercial banks*
Greater Power for Insurance Authorities* - To be effective compulsory participation by commercial banks in Federal deposit insurance
would have to be accompanied by a. strengthening of powers of the Federal
supervisory authorities*

They should be given the power to impose sound

banking principles on all insured banks*

They should have the power to

remove incompetent managements and the power and funds to recapitalize a
bank before all of its capital is exhausted*

They already have power over

the establishment of branch banking offices by the various classes of insured banks, and compulsory insurance would give them the power to veto
the granting of a charter by State authorities to a bank if there were
no sound basis for its organization*

As many as possible of the other

provisions that apply to member banks should gradually be made applicable




-

30

-

to insured banks, for example, the provisions regarding security affiliates,
purchasing and dealing in securities, excessive investment in bank premises,
excessively large boards of directors, and loans to executive officers.
An arrangement of this character might work in the direction of the
abandonment by States of their supervisory activities with respect to commercial banks.

In this connection there may be cited the agitation which

has existed in North Carolina in the past year or two for the practical
abandonment of State supervision of banks.
Competition in laxity would not end completely because there 750uId
still be Ay different systems clothed with the power to charter and supervise banks and to appoint receivers (or to fail to appoint them) when
banks became insolvent.

All the difficulties which have previously been

mentioned in connection with the retention of State charters and State
supervision would remain? and to the extent that member bank provisions
named above were not made applicable to insured banks, other difficulties
would remain.
Wisdom of Extending the Insurance Principle.

There are some who

would like to dispense with the insurance principle as soon as possible
since they regard it as unsound,

To such persons a program of forcing

non-insured banks to participate in Federal insurance would appear to
be progress in the wrong direction.

Whatever the opposition may be to

deposit insurance from the point of view of sound banking principles, however,
it has strong friends.

They believe that it was a necessity when enacted

and has made distinct contributions to stabilizing banking conditions.




The

-

31

-

sponsorship which put it through Congress clearly had popular support
at the time of enactment-.

The evidence would indicate that this sup-

port has strengthened in the interval rather than weakened.
Recently the American Bank Depositors Association was formed under
the chairmanship of a national banker,

He has said that his organiza-

tion proposes to campaign against any movement directed toward the
emasculation of the Federal deposit insurance principle and expects
political leaders to make clear where they stand on the issue.

The

association holds that it is wholly American for the Government to
promote the continuation and the success of the Insurance Corporation
which has made all banits safe depositories for the money of the people,
protecting them against losses from bank failures, and accounting for
an unprecedented increase in bank deposits.2/
If the banking structure can be so improved that failures are
insignificant, as appears to be the case in certain other English speaking countries, deposit insurance may be dispensed with as unnecessary at
some future date.

On the other hand, if the banking structure is not

progressively improved, it may degenerate progressively and the principle of deposit insurance might disappear through its own insolvency.
Supervisory authorities should, be interested in bringing all commercial
banks under a single aegis so that experience will work toward the first
condition rather than the second.

1/ American Banker, July 18, 1936.




SAVINGS INSTITUTIONS

Non-commercial Banks.

The tabulation presented in earlier para-

graphs brought out the number of banks as of December 31, 1935, that
can be identified as in whole or in part commercials that is, at least
some of the deposits of each are demand deposits, which in general are
subject to circulation by check.

Official figures as of the end of

1935 accounted for the following other banking institutionss

Mutual savings
Insured
Non-insured
Others having no demand deposits
Having no deposits at all (mostly
trust companies)
Distribution of demand and time
deposits indeterminable
Total

Number

Deposits
(millions)

57
510
70

$1,067
8,888
108

82

—

1/253

108

972

10,171

1/ Includes the following non-insured institutions: 172 commercial banks, 63 small private banks, 16 Morris Plan and
industrial banks, and 2 branches of foreign banks.
The 567 mutual savings banks, having deposits of approximately
$10,000,000,000 and located almost wholly in New York and New England,
would be the only important class of banks which would not be compelled
to join a unified system if the definition of banks for inclusion be
"commercial banks."
It has been the general feeling in the Federal Reserve System for
years that it would serve little useful purpose for these mutual saving
institutions to be members of tne System.




They are not monetary banks

facilitating the exchange of goods and services as commercial banks are
but deal with the accumulated wealth of their depositors,
The Insurance of Savings Accounts* - In view of some of the objectives which influenced the enactment of Federal deposit insurance, the
question can readily be raised as to why compulsory participation in
insurance should be required of only such banks as have demand deposits,
omitting pure savings institutions*
Since no depositor is insured in a sum in excess of $5,000, the
holder of small deposits is more fully protected than the holder of
large ones*

The statistical evidence clearly indicates that among

insured banks the weight of large uninsured deposits is demand deposits while the savings deposits are insured to a much larger extent*

This situation is no doubt in keeping with two of the princi-

pal objectives of the framers of the insurance act*

The first of these

was to protect the savings of small savers against loss; the second,
to protect banks from hysterical runs for which small savings depositors
are often responsible.

It would appear clear that the authors of the

act have not been much concerned with protecting large demand depositors
who by and large represent business interests capable of taking care of
themselves*
On the other hand, it has worked out under voluntary participation
in deposit insurance that the major fraction of deposits no portion of
which is insured is held by the more than 500 mutual savings banks which
do nov belong to the Federal Deposit Insurance Corporation.

Other ap-

parently satisfactory arrangements have, however, been made for the pro-




tection of mutual savings banks and their depositors in at least two
principal States in which they operate*

In New York, for example,

where half of all mutual savings deposits are concentrated, a special
trust company has been organized to act as a liquifying agent for
mutuals*

In Massachusetts a special system for insuring deposits of

mutuals, the deposits of which in that State aggregate $2,000,000,000,
is in operation as well as a rediscount organization*

Similar arrange-

ments exist in some other States where mutual savings banks operate*
The protection already provided for mutual savings banks and their
depositors perhaps is adequate in view of the special character and
stability of these institutions*

Mutual savings bank deposits cannot

be circulated by check and the depositor must appear at the banfe^'c
window to get his funds.

The aggregate of funds which may be accepted

from one depositor is usually limited to an amount such as $5>000, $7,500,
or $10,000*

All of their deposits (with possible minor exceptions in in-

dividual cases) are time deposits and the contracts under which they are
accepted specify that notice may be required before they are surrendered*
It is true that in ordinary times mutual savings banks have not required
that the notice be given, but following the banking holiday they had 110
difficulty in enforcing the requirement of notice and in restricting
withdrawals*

On the other hand, an ordinary commercial bank, which has

not been requiring notice for withdrawal of savings accounts, cannot
begin to do so without casting suspicion on its position and starting
a run in its demand department.




-

35

-

Building and Loan Associations, Credit Unions, etc. ~ If mutual
savings banks were to be included in a unified system of deposit banks,
the question might well be raised as to why other groups of savings institutions should not also be included®
Building and loan associations by and large have functions similar
to the mutual savings banks, since they bring together the savings of
the people and invest them, not in liquid resources, but in the capital
assets of the country, principally mortgages on urban real estate*

They

do not facilitate, as do the commercial banks, the exchange of goods and
services by means of checking deposits*

There are in the country about

10,600 building and loan associations with assets of $5,900,000,000* l/
It is true that the claims of savers on building and loan associations
are generally in the form of shares of stock, but as a matter of practice many building and loan associations stand ready to meet claims
upon the associations on demand or short notice*
Credit unions also represent a class of financial institution
which deals with savings, returning them upon comparatively short
notice*

Policyholders in life insurance companies have savings

claims which are subject to withdrawal upon short notice*

The cash

surrender value of life insurance policies in this country at the
present time is said to approximate the life insurance reserves of
the companies, a figure not far from $20,000,000,000*
The broadness of the field comprehended by savings institutions
suggests caution in invading it by compulsory unification*

There are

also certain constitutional arguments, based on the Federal Government's

l/ Latest available figures - Federal Home Loan, Bank Review, October 1936*




monetary powers, which support compulsory unification of commercial banks
but would not apply to compulsory unification of savings institutions*
Moreover, from a political point of view it has often been argued that
in a program of unification good strategy recommends leaving something
to the States*
Savings. Deposits in Commercial Banks* - The group of about 15,000
commercial banks which would be brought into a unified banking system
under any plan of compulsion includes only 5^2 banks which had no time
deposits on December 31, 1935*

Eke remainder had some such deposits,

aggregating $13,000,000,000 for all banks*

Their demand deposits aggre-

gated $32,000,000,000•
However, there is considerable difference between subjecting time
deposits in commercial banks to this incidental compulsory unification
and attempting to compel purely savings institutions to enter a unified
system.

The existence of these time deposits in commercial banks does

not alter the necessity for compulsory unification of commercial banks*
Problems arising out of operating both a demand and savings deposit
business xvithin the same institution are the subject of considerable
current discussion*

Some leading bankers suggest the possibility of

changing the nature of the contract with respect to savings funds*

One

suggestion contemplates the issue of short-term debentures to savers in
lieu of a deposit credit*

It is argued that an arrangement of this sort

would mitigate the evils connected with attempting to liquidate longterm assets caused by savings depositors1 demanding the banks to pay
them on short notice*

Some students go so far as to suggest that a

thoroughgoing reform of the American banking system would look toward




-

37 -

the separation into specialized institutions of the two types of business.
Under such a reform there would be two classes of institutions, on the one
hand pure savings banks, and on the other pure commercial banks*

Whether

this is an ideal objective or not it cannot be realistically suggested
as part of a near-term program*

There is, for one thing, too large a

school which does not find persuasive the argument that the two businesses cannot be soundly operated in one institution*

Those who are con-

vinced of the unsoundness of the mixture of the two businesses are
stumped by the practical problem of unscrambling the existing situation*