Readings in Money and Banking / Selected and Adapted

by Chester Arthur Phillips

There will always be wide differences between the capital and other resources of the various Federal Reserve Banks. Neither the capital nor the resources of existing banks can be made the basis for dividing the country into Federal Reserve districts. Geographical consideration will necessarily require the creation of a number of districts in sparsely settled parts of the country, in which banking resources are comparatively small. No Federal Reserve Bank may, however, be established until it has a subscribed capital stock of at least four million dollars. It would, therefore, seem to follow that the organization committee is precluded from forming any district in which 6 per cent. of the capital and surplus of the national and state banks is less than this minimum amount. There are indeed provisions in the act designed to meet the contingency of failure by banks to subscribe in sufficient numbers to provide a minimum capital; but they would not seem to authorize the organization committee to create districts in which resort to these provisions would be inevitable.[291]

Whether the capital of the Federal Reserve Banks is large or small is a matter of no great importance. Subscriptions to capital provide a comparatively small part of the resources of banks. The capital is an indication that those conducting a bank have something at stake, and is also a margin of safety against loss to depositors. These Federal Reserve Banks are, however, to accept deposits from banks only, and are ordinarily to confine their dealings to the banks. In these circumstances, there is practically no difference between the funds which the federal reserve banks will secure from member banks in payment of subscriptions to capital stock, and the funds which will be deposited with them by member banks. The depositors are the stockholders and, therefore, there is no separate interest to be protected by a margin of safety.

Shareholders in the reserve banks are entitled to a cumulative dividend of 6 per cent. A limited dividend is obviously wise, since it tends to eliminate the profit-making motive in the management. Whether all the Federal Reserve Banks will regularly earn the 6 per cent. dividend is, of course, not certain; but it seems highly probable, since the danger of serious losses is remote, and interest will presumably not be paid to the member banks on their balances. All earnings in excess of the dividend are to be paid to the Government of the United States as a franchise tax; but half of these surplus earnings are to be paid into a surplus fund until it has become 40 per cent. of the capital stock. Whatever is received by the Government from the Federal Reserve Banks is to be used at the discretion of the Secretary of the Treasury, either to increase the gold reserve against United States notes or for the reduction of the interest-bearing debt.

The federal reserve banks will doubtless secure very large resources through the deposit with them of the moneys held in the general fund of the Treasury of the United States, although no power over the disposition which shall be made of these funds is granted either to the Federal Reserve Banks or to the Federal Reserve Board. Entire discretion remains with the Secretary of the Treasury. He may continue the independent treasury system without change; he may continue to deposit funds with member banks, just as hitherto he has placed deposits with national banks; and finally he may deposit with any or all of the Federal Reserve Banks, using them as government fiscal agencies. The responsibility of the Secretary of the Treasury is in no way changed. Almost certainly in practice, however, the bulk of the free funds of the Government will be placed with the Federal Reserve Banks, and doubtless the opinion of the Federal Reserve Board will determine the distribution of these funds between the various banks.

The lion's share of the cash resources of the Federal Reserve Banks will come from the reserves and working balances deposited with them by member banks. Under the terms of the act, part of the required reserves of member banks must be placed with Federal Reserve Banks. This is a novelty in central banking legislation, but is based upon sound principle, and is especially to be commended for this country where, on account of the absence of branch banking, the number of banks to be served by the regional banks will be very great. It makes certain some increase in the resources of the Federal Reserve Banks, along with the expansion of the credit liabilities of the member banks. It also lessens somewhat the danger of unnecessary withdrawals of funds from the reserve banks in emergencies.

Reserve requirements of the national banking law are radically changed. In addition to the requirement that a part of the reserve of the banks be kept with the Federal Reserve Banks, the reserve ratio is reduced for all classes of banks: the practice of keeping a part of the reserve of country and reserve city banks with reserve agents is to be discontinued; and a distinction for reserve purposes is made between time and demand deposits. Some of these changes become effective as soon as the new system is established; others are to be made in a succession of steps and completed three years after the passage of the act.

Time deposits are to comprise deposits payable after thirty days, and are to include certificates of deposit and savings accounts subject to thirty days' notice. A reserve of 5 per cent. is required against these deposits, and no distinction is made between country and city banks. This low reserve requirement will certainly lead the banks to encourage the conversion of demand obligations into time obligations. A relatively large part of the deposits of banks in most European countries is payable at notice. It is obviously an arrangement which shields the banks somewhat from the effects of sudden waves of distrust.

Against demand deposits the ratio of reserves is also to be reduced at once; but the existing classification of banks is to be retained. The required ratio for country banks is reduced from 15 to 12 per cent., for reserve city banks, from 25 to 15 per cent., and for central reserve city banks from 25 to 18 per cent. A provision in the bill excluding from reserves the 5 per cent. fund held in Washington against outstanding circulation is a slight offset to this reduction in reserve ratios.

As regards the banks in central reserve cities, the initial arrangement regarding the disposition to be made of their reserve is also the final arrangement. They must hold 6/18 of their reserve in vault, 7/18 in their Federal Reserve Bank, and the remaining 5/18 either in vault or with their federal reserve bank. Other banks are allowed a period of transition. Reserve city banks for three years must hold 6/15 of their reserve in vault, thereafter 5/15; for twelve months they must keep with their Federal Reserve Bank 3/15, adding an additional 1/15 every six months; so that at the end of two years they will have a deposit of 6/15. During the three year period the remainder of the reserve may be deposited with reserve agent banks in a central reserve city, or by what would seem to be an inadvertent extension of existing practice with those in reserve cities; but thereafter it must be either in vault or with a Federal Reserve Bank. Country banks must hold in vault 5/12 of their reserve for three years, thereafter 4/12; for twelve months must deposit with their Federal Reserve Bank 2/12, and an additional 1/12 every six months until 5/12 are deposited at the end of two years. The remainder of the reserve may be kept for three years with reserve agent banks, but at the end of that period must be either in vault or in a Federal Reserve Bank.

Whether these changes in reserves, together with payments by the banks of subscriptions to the capital stock of the reserve banks, will make necessary any considerable amount of loan contraction, cannot be precisely determined. If numbers of state banking institutions enter the system at the beginning, some strain may be occasioned, since, although these requirements are less than those to which the national banks have been subject, they exceed those imposed upon banks by the law of many of the states. In order to enable the banks to avoid contraction, the act contains a provision under which one-half of each instalment of reserve to be placed in reserve banks may be received in the form of the kinds of commercial bills of exchange which the reserve banks may purchase in the open market. It is, however, most unlikely that the banks will be able to make much use of this arrangement, because of the scanty amount of such paper available.