Chapter XXXI: The Federal Reserve System (3)

We come, finally, to the third need which emergency elasticity is supposed to meet, that is, a prompt and great contraction of the circulation when the panic has passed and the inevitable business depression consequent upon such a panic has set in. Here, again, though not in the same degree as in the last case, if the new law proves as successful as many conservative students expect, the need in question will be little, if at all, experienced. We shall usually escape the extreme business inflation of the antepanic period; the panic itself will be much abated, if not completely eliminated; and, in consequence, the trade reaction which naturally follows a panic will be much diminished in intensity. If this turns out to be true, the circulation will never again show such an extraordinary glut as characterized the winter of 1893-94. Nevertheless, it can hardly be doubted that, after even an incipient panic, there will be some reaction, and consequently a more or less plethoric condition of the currency will follow. Will the new issue have sufficient contractility to meet this need? Earlier in this paper we have seen that the conditions attached to the new issue are in general not favorable to contractility, in that they do not provide for either the prompt driving home or the prompt drawing home of the notes when the necessity for their issue is past. Outsiders lack adequate motives for sending the notes home; issuers lack adequate motives for calling them home. The case for emergency contractility, however, is somewhat better than the case for ordinary contractility. First, it is probable that the homing power of the note will prove greater at such a time than in an ordinary year, for, at such a time, outside banks will not be able to find investments for their funds, since speculative trading will disappear altogether and business generally will be at a very low ebb. Again, it seems certain that the issuing bank will, in this case, have more than the usual motive for bringing about a contraction of the circulation. The chief reason why such a bank may not be eager in ordinary times to hasten the retirement of its notes is the fact that, provided the notes do not accumulate in its own vaults, such a bank will gain more by using the funds in its possession to make loans than it would by using them to retire notes, assuming that the interest charge made by the Federal Reserve Board is not placed excessively high. But it is practically certain that, in the depression which follows a panic, no reserve bank will have opportunities for keeping all of its funds busy; and since, in that case, the interest charge, however small, will be a dead loss, the bank will have adequate motive for effecting, as promptly as possible, an adequate contraction of its note liabilities. This motive would be still further strengthened should the glut prove sufficient to cause a decided drain of gold, since, in that case, the reserve banks will find difficulty in maintaining the required 40 per cent. reserve. On the whole, then, we seem warranted in affirming that, as respects emergency elasticity, the new notes will give no serious disappointment.

Finally, as respects elasticity in general, though the note issue, viewed by itself, does not seem quite fitted to satisfy the tests which an old-fashioned advocate of elasticity is inclined to impose upon it, yet, when we take the new law as a whole, it seems not unreasonable to affirm that it promises to accomplish, directly or indirectly, most of the ends which we had hoped to attain through elasticity and hence promises to give us a system which in essentials is truly and adequately elastic.

NOTES PRINTED AND ISSUED

[300]During the year 1915 the circulation of Federal Reserve notes has increased to $188,817,000 as of December 31, 1915. Believing that the country should be prepared against any contingency, the Board had authorized the printing of about $700,000,000 of these notes. Almost one-quarter of the total supply printed has been placed in circulation. On December 31, 1915, however, only $16,675,000 of notes secured by commercial paper pledged with the Federal Reserve Agents was outstanding as an obligation of the Federal Reserve Banks. The liability of the Federal Reserve Banks as to the remainder has been discharged by the deposit with the Federal Reserve Agents of a like amount of gold and lawful money. This result has been achieved by the Federal Reserve Banks in responding to requirements, for currency by issuing Federal Reserve notes rather than by parting with gold. While the gold pledged with the Federal Reserve Agents represents a very valuable protection in case of a substantial demand for gold, it must be observed that the process is expensive without, at the same time, giving to the Federal Reserve Banks that additional strength and lending power which they would secure in case the law were amended so that the Federal Reserve Banks would remain liable for the outstanding notes, but, on the other hand, would retain property title to the gold delivered to the federal reserve agents, which, in that case, would not be paid in to extinguish the liability upon the notes but would be deposited as collateral security against them.

IMPOUNDING GOLD

[301]On November 16, 1914, the first shipment of Federal Reserve notes was received by the Federal Reserve Agent [of the Federal Reserve Bank of New York] from the Comptroller of the Currency. On November 19 the bank pledged with the Federal Reserve Agent $500,000 of commercial paper rediscounted by member banks and received from him a similar amount of Federal Reserve Notes. These notes were not required by the banks which made the rediscounts, as they had already withdrawn by checks the credits so established. They were taken by this bank for its general use. The issue of Federal Reserve notes gave the reserve bank the opportunity of affording to its member banks complete interchangeability between book and note credits. The bank therefore established the policy of issuing Federal Reserve notes freely to any member bank desiring them whether the credit thus withdrawn was established by it through rediscounting, or the deposit of checks, or the deposit of gold or lawful money. In practice, however, most credits withdrawn by notes have been established by the deposit of checks which have been collected by this bank in gold or lawful money through the clearing house. Accordingly, the accumulation of cover in the hands of the Federal Reserve Agent has been mainly gold, with but a small amount of rediscounts. The processes provided by the act for the issue of Federal Reserve notes to the reserve bank permit complete interchangeability between gold and rediscounts held by the agent. Gold may be substituted for rediscounts and rediscounts for gold, in accordance with the requirements of the reserve bank. During the entire period its requirements have been for notes with which it might exercise its statutory right to "exchange federal reserve notes for gold, gold coin, or gold certificates."

The policy of the Federal Reserve Bank has resulted in greatly strengthening its gold position and its ability to assist its member banks or other Federal Reserve Banks should they at any future time seek credit in order to withdraw gold for domestic or foreign uses. Through this policy also it has been able potentially, at least, to retard the expansion of credit by impounding in the hands of the agent a large volume of gold which might otherwise have found its way into bank reserves already superabundant.

Furthermore, through this policy it has been able to take the first step toward accomplishing one of the purposes of the act set forth in its title, _e. g._, "to furnish an elastic currency." There are two forms of elasticity, one of _quantity_ and the other of _quality_, both provided for in the act.

From the point of view of cover, the gold certificate is completely inelastic. It stands at one extreme of our currency, with a dollar of gold set aside behind each dollar of paper. At the other extreme stands the national-bank note, with only 5 cents of gold set aside behind each dollar of paper. The assets of the issuing bank make it good, but its elasticity is nullified by the requirement that it must be secured dollar for dollar by government bonds.

Between these two extremes the Federal Reserve note, a new form of currency, has been introduced. For each dollar of this paper there is set aside from 40 cents to $1 of gold. As in the case of the national-bank note, the obligation of the United States and the assets of the issuing bank secure it.

The process in which this and other Federal Reserve Banks have been engaged is the substitution, as a circulating medium, of a note which is elastic in quality for the inelastic gold certificate. Gold is the most uneconomical medium of hand-to-hand circulation since, when held in bank reserves, it will support a volume of credit equal to four or five times its own volume. What the reserve bank does in accumulating gold behind its Federal Reserve notes is to establish with the holder of each note a credit which may be availed of whenever the occasion requires. With this credit established it can convert at will its gold-covered notes into notes covered partly by gold and partly by commercial paper. In times when credit is becoming strained and bank reserves need strengthening or when gold must be exported, this conversion will take place, and after the strain is over the gold cover will be restored through the repayment of the rediscounts substituted for it. In this way elasticity of quality in our currency is obtainable. But it should not be construed as in any way a deterioration of the currency contemplated by the act. Quite the reverse is true. The act provides for the issue of Federal Reserve notes in unlimited amounts, with 40 cents of gold behind each dollar of paper. This is elasticity of quantity and it becomes operative with the minimum of gold cover. Elasticity of quality, on the other hand, operates with a gold cover always above the 40 per cent. minimum and ranging as high as 100 per cent.

In order to be prepared for any currency demands which might be made upon it, the Federal Reserve Bank of New York in the spring of 1915 adopted the policy of having printed and keeping constantly on hand a supply of Federal Reserve notes substantially in excess of the amount of emergency currency which, experience shows, this district might be called upon to supply. The maintenance of this policy and of the policy of issuing Federal Reserve notes freely has entailed a heavy cost upon this bank. Unissued Federal Reserve notes are carried at cost on the books of the bank, and at the end of each month the amount of notes issued to the bank during the month is charged off at cost. The shipment of notes unfit for circulation to the Comptroller of the Currency at Washington for cancellation and destruction is a further item of expense in connection with the maintenance of these policies. The directors and officers of the bank, however, feel that the results accomplished amply justify the expense incurred, and consider that the added strength furnished the bank by the gold thus accumulated is perhaps the most important result of the operations of the period.

Some reduction has already been made in the cost of printing Federal Reserve notes, and it is to be hoped that further experience and study will enable other substantial reductions to be made in the cost of preparing for issue what has already become an important element of the circulating medium of the country. The act provides that all expenses in connection with the issue and redemption of Federal Reserve notes shall be borne by the Federal Reserve Banks, and in view of the service the banks are performing in accumulating gold through the medium of these notes, the feeling is quite general among their officers that the notes should be furnished to them at the lowest possible cost consistent with the high quality of workmanship required.

The design of the notes is not altogether satisfactory for efficient handling. In sorting notes it is necessary to be able readily to distinguish between notes of this bank and notes of other reserve banks. This would be greatly facilitated if the printing of the distinctive number and letter of each bank were made more general on the face of the note.

THE FINANCIAL POLICY OF THE FEDERAL RESERVE BANKS[302]

It seems clear that the cardinal principle in the management of the Federal Reserve Banks will be to disregard the course which will lead to maximum profits, following instead the path which will lead to the greatest safety and which will permit these banks to be of the greatest service to the nation. Large reserves should be maintained, and these should consist chiefly of gold. The payment of interest upon bankers' deposits and government deposits should be avoided, if possible, for the reason that the payment of interest will force the keeping of smaller reserves, if the cumulative dividend is to be earned. The banks should be managed, not from the standpoint of profit, but from the standpoint of safety.

Yet this is but one side of the policy of the Federal Reserve Banks. Their power and influence can be made to extend much farther than would result solely from the wise management of their own affairs. These banks are the financial trustees of the nation. The country will look to them to see that they exercise over the member banks a closer supervision and discipline than has been possible in the past. Supplementing a negative control by the bank examiners, who are powerless so long as the letter of the law is observed, the federal reserve banks will be a great positive force. The Federal Reserve Banks, with the approval of the Federal Reserve Agent or the Federal Reserve Board, may conduct examinations of a member bank, both for the purpose of ascertaining its condition, and, what will be of equal importance, for the purpose of determining the lines of credit which are being extended by it.

In the long run, the greatest work which the Federal Reserve Banks can do for the business men of this country is to improve and standardize the methods of commercial borrowing. I believe it is possible for these banks, with the approval of the Federal Reserve Board, under the power just quoted, to establish a comprehensive credit information clearing service through which the aggregate loans of all large borrowers can be known by any bank official and through which excessive borrowing or the lending of money to concerns pursuing unwise financial policies can be checked before disaster overtakes them. This is one of the greatest needs of our banking system....

RELATIONS OF FEDERAL RESERVE BANKS WITH MEMBER BANKS[303]

The aim of this bank [Federal Reserve Bank of New York] at all times has been to maintain frank and friendly relations with its member banks. At every meeting of the New York or New Jersey Bankers' Associations, or of their groups, to which invitations have been received, one or more of the directors or officers have been present and discussed the development of the various functions of the system.

When the establishment of an intradistrict collection system was under consideration, the directors and officers invited representative member bankers from all parts of the district to confer with them at the office of the bank. The plan finally adopted was thoroughly discussed in all its aspects and a consensus of opinion seemed to prevail that it was a fair and reasonable plan.

When the conditions under which State banks should be admitted to the reserve system were under consideration three conferences were held by the directors and officers of the bank, one with national bankers, one with State bankers, and one with trust company officers, from various parts of the district, to ascertain their views upon the question at issue. In every case the policy has been pursued of dealing frankly with those present, in order that they might understand fully how the action under consideration would affect them.

The officers have expressed themselves at all times as desirous of establishing personal relations with officers of member banks and have invited them to call at the bank when in New York City. Yet a year has gone by and officers of probably not over 15 per cent. of the member banks have done so. Many of them still have the feeling that the bank is a branch of the Government. Their experience with the Government consists principally of the statutory and supervisory relationship which exists between them and the Comptroller's office. The conception of the relation of this institution with them as co-operative makes headway slowly. The fact that the national banks were practically compelled to join the system naturally retards the development of the co-operative idea. The change of attitude, upon which the success of the system will ultimately depend, will probably come slowly, but there are already signs, as we enter upon the second year of the system, that the banks are getting more accustomed to it and appreciate the results it has already accomplished. It is hoped that during the coming year, with organization pressure somewhat lessened, more time can be devoted by the officers to developing personal relations with the officers of member banks.

The present attitude of the member banks toward the reserve bank may be summarized as follows:

The New York City banks, upon which the strain of all crises first and chiefly falls, fully understand the value and benefits of the system. While regretting the loss of bank deposits which will probably be drawn from them (estimated to be as high as $250,000,000), they are nevertheless hearty supporters of the system, at all times co-operative in their attitude.

Many of the banks in other large cities are unable to take full advantage of the lowered reserve requirements, but in spite of the loss of interest on their reserve balance, most of them understand what the system in its larger aspects means for American banking and generally give it their support.

While the same may be said of many of the country banks, yet it is among the country banks as a class that most of the apathy and hostility to the federal reserve system which still persists is found. Their opportunities and earnings are relatively small, and in order to live they must figure closely. They feel the loss of interest on reserve deposits; the absence, as yet, of dividends on their capital contribution; and the prospective loss or decrease of the exchange they generally charge on remitting for checks drawn upon them. Many banks in industrial centres are precluded by the activity of their business from taking advantage of the reduction in the required reserve. They believe that they will, in fact, be required to carry an even larger reserve than heretofore in order to obtain collection service for notes, drafts, and non-member bank checks and the various other services now rendered by their reserve agents, but not yet undertaken, by the reserve banks. It is very natural that they should view with reluctance the termination or diminution of long-standing business associations with their reserve agents. Few of them, as yet, conceive of the reserve bank as their active reserve agent, performing all the services which go with the relationship. The dormant accounts most of the banks maintain with the reserve bank are, perhaps, indicative of their attitude toward it. Relatively few banks of this district are borrowers; in good times and bad they have been able when necessary to borrow from their city correspondents on bonds or on the indorsement of their directors, two avenues which are now to be closed to them. The rediscounting privilege has been little availed of and the larger functions of the Federal Reserve System, such as influencing domestic rates and international gold movements through the development of a discount market and by dealing in foreign bills, appear remote from their spheres of activity. They feel that the system has few advantages to offer in return for the cost it entails upon them.

All of these points will be felt with increasing acuteness by the country banker as his reserve transfers approach completion and as reduced balances result in reduced service from his city correspondent. His point of view is outlined thus frankly in order that the difficulties he sees may be clearly recognized and steps taken gradually to remove them. The development of a more satisfied relationship requires progress on the part of the reserve bank and a willingness to co-operate on the part of the country banker.

The reserve bank should organize a complete collection system embracing the handling of notes, drafts, and items on non-member banks, which eventually will bring all the members into daily active relations with the bank. It must be ready to act for member banks in the purchase, sale, and custody of securities; to supply credit information on names whose paper is offered by brokers; to give its members information concerning methods of developing the new functions which the act authorizes them to exercise; to perform the services now rendered by their reserve agents; and generally to assist them in every reasonable way.

The member banks should look upon the reserve bank not as an alien but as their own institution. They own all its capital and most of its resources, and they control its management through the directors they elect, subject always to the supervision of the Reserve Board. At the reserve bank they may borrow as a standing right and not as a favor which may be cut off. They no longer have to buy or carry bonds to serve as security for loans; the paper of their own customers, large or small, will now serve as their security. While panics in the past may not have affected them, they have been disastrous to the business interests of the country, who are their customers; and their contributions to the reserve bank should be recognized as a form of insurance not merely for themselves but for their customers as well. If this insurance is expensive and makes some changes in the nature of their business, the act should be carefully studied with a view to making the most of the new functions it provides. New avenues of activity should be looked for. The banks which will get the most out of membership are those which are the first to see and develop the opportunities it provides and to educate their customers to the protection and facilities they will enjoy through the system. The occasion is a favorable one also for the correction of abuses. Customers will do things in the name of the Federal Reserve System which they have never done before. The experience of banks in using the forms provided by the reserve bank to get statements from their borrowers is evidence of this. The occasion should be seized also to increase the balances of depositors who carry unprofitable accounts. To assist member banks in studying their accounts this bank has had under preparation by chartered public accountants a reasonably simple form for analyzing accounts which may be obtained by banks desiring to use it.

It is the duty of the directors and officers to understand not only the problems of the reserve bank but those of the member banks as well; and it has been their endeavor during the past year to give special study to those of the country bank. Several suggestions for the relief of the country bank have come to their notice.

One of these, which the American Bankers' Association at its 1915 Seattle convention favored, was to permit the 3 per cent. of reserve which the member bank may carry either in its vaults or in the reserve bank, to be deposited with member banks not more than 300 miles distant and count as reserve. This seems to be contrary to the spirit and intent of the act, which is primarily to centralize reserves in Federal Reserve Banks.

Another suggestion which seems more worthy of consideration is that the percentage of reserve required for country banks should be somewhat further reduced. When the reserve transfers are completed checks in transit can no longer count as reserves. It is clear, therefore, that the reserve reduction contemplated by the act will not be realized in practice. A further reduction in the reserve requirements would, in the case of many banks, result in a reserve less than the amount their business actually required, and would enable them to carry the amount thus freed wherever it would best serve their particular business, and, if they so desired, to maintain some relations with present city correspondents. It would lead away from the present rigidity of bank reserves toward greater flexibility and a better understanding of their meaning and purpose.

RELATIONS BETWEEN THE FEDERAL RESERVE BANK OF MINNEAPOLIS AND ITS MEMBERS

[304]The Ninth Federal Reserve Bank has sought to make the Federal Reserve Act fully operative within its district. During the spring of 1915 it had opportunity to demonstrate its effectiveness in meeting the requirements of agriculture in the Northwest during the planting season, and rediscounted liberally for member banks, in order to enable them to better satisfy the requirements of farmers. It relieved local pressure at a number of points where manufacturing enterprises and general business were depressed because of war conditions, and had opportunity to show that it can efficiently meet the demands of industry. Again, in the fall of the year, when an adverse season had created large amounts of immature corn, it was able to perform a very valuable service in assisting member banks to meet the requirements of farmers who were suddenly compelled to make provision for utilizing a valuable forage crop. During the prevalence of the foot-and-mouth disease it was able to come to the assistance of many banks in the western part of its territory, which had applications for loans from numerous stockmen who had cattle ready for market, but were unable to ship on account of quarantine conditions. The service above indicated, while not perhaps of notable consequence in any single case, consists in the aggregate of a very valuable degree of assistance, which would not have been available except for the Federal Reserve Bank, and without which, portions of the district would have encountered considerable hardships.

RELATIONS BETWEEN THE FEDERAL RESERVE BANK OF BOSTON AND ITS MEMBER BANKS

[305]Owing to the unusual conditions existing in the money market, and to the fact that the reserve city banks offer facilities to the country banks which this bank has not yet developed, more particularly in connection with the collection of checks and other items, the latter banks have carried only their minimum reserve requirements with this bank and have used its facilities only to a limited extent. The relations between country bank officials and the officials of this bank have been most cordial. While many of the banks in this district are borrowing, most of them find it much more convenient to go to their correspondent bank and borrow, either in the form of a demand loan, with or without collateral, or against a certificate of deposit.

The Comptroller's calls on the several dates show the total borrowings of member banks in the district as compared with their rediscounts with this bank, as follows:

_Total _Borrowed,
Borrowed._ F.R.B._
Dec. 31, 1914 $4,738,416 $105,000
Mar. 4, 1915 4,047,708 234,531
May 1, 1915 3,969,796 410,723
June 23, 1915 4,284,445 270,441
Sept. 2, 1915 3,398,856 190,849
Nov. 10, 1915 2,985,406 131,725

The officials of the city banks on the other hand are apparently satisfied with the progress made in the development of this bank's functions. While but few of the Boston banks have rediscounted with us, almost all have intimated that should occasion arise they would do so. Furthermore, several Boston banks have entered into the acceptance business to a large extent, and the assistance that this bank has given in the matter of rates and market for acceptances has done much to bring it into favor with those banks. The Boston banks have also used this bank to a large extent in exchange transactions, and the services offered by the gold settlement fund have been used almost exclusively by those banks.

Thus far Boston banks have received more benefits from this bank than have the other banks in this district. A possible exception to this is in Aroostook County, Me., where, owing to an unusual situation surrounding the principal industry, the potato crop, banks have relied on this bank to a considerable extent to carry them through a trying period. The moral effect of having the Federal Reserve Bank of Boston stand behind them was not only appreciated by those banks, but enabled them to handle their business much more satisfactorily and to finance themselves without having to call upon this bank to an undue extent for rediscounts or without embarrassing their customers.

FEDERAL RESERVE BANKS AND THE ACCEPTANCE MARKET

[306]The right to accept drafts was conferred on New York State banking institutions by the act of April 16, 1914. Shortly afterwards a few acceptances were reported, principally against securities. It was not until the derangement of international credit facilities at the opening of the European war that American bankers' acceptances, especially those relating to foreign commerce, came into existence in substantial volume. At that time some of the trust companies with foreign connections extended credits freely to their customers to replace credits formerly granted by European banks which had been either withdrawn or reduced; they also accepted drafts in large volume. On and after May 18, 1914, member banks were authorized also to accept drafts drawn upon them involving the importation or exportation of goods....

The monthly purchases of acceptances by this bank [the Federal Reserve Bank of New York] in the New York market have been:

1915 _Number_ _Number_
_of pieces._ _Amount._ _of pieces._ _Amount._

_For itself._ _For other reserve banks._ February 41 1,659,740.21 86 1,263,871.25 March 140 3,343,143.17 250 3,799,809.42 April 86 1,272,694.36 84 1,700,396.57 May 46 867,420.18 48 1,305,873.80 June 132 3,083,261.75 34 602,558.89 July 106 2,496,865.67 147 2,348,050.89 August 103 1,597,630.63 89 1,910,417.47 September 89 1,769,880.50 172 1,948,243.05 October 68 2,199,679.95 163 2,028,098.36 November 115 1,899,606.56 246 2,594,951.04 December 310 5,648,708.78 313 2,809,823.59

Total 1,236 25,833,631.76 1,632 22,312,094.33

The policy pursued by this bank thus far has been to purchase good acceptances whether or not the acceptor was a member bank....

The reserve bank and the market rate for the discount of such bills in New York has been for nearly a year, and is now, lower than the rate for similar bills in London. The relatively small volume of such credits which American banks have succeeded in making operative even under the unusually favorable opportunity which the war presents for their extension, is evidence of the difficulty which will be encountered in developing the acceptance business in the United States. Some of the fundamental difficulties are:

(1) The disinclination to break old banking connections.

(2) The difficulty of educating handlers of bills in distant places as to American credits.

(3) The lack of bill buyers in foreign countries who will quote as low rates on dollar as on sterling bills.

(4) The natural prejudice of bill buyers in foreign countries in favor of a bill of known currency and against a bill of as yet unknown currency.

(5) The lack of men trained to exercise the judgment and financial responsibility required of them as managers of branches or agencies which American banks might establish in foreign countries.

(6) The inferior communications for both goods and mail between the United States and foreign countries as compared with those between Great Britain and foreign countries.

Only time, experience, and patient effort will remove these handicaps to the elevation of dollar exchange to its proper position in international finance. The business, however, is developing and will continue to grow as our banking machinery and connections extend throughout the world.

The Act permits member banks to accept an amount of bills not exceeding 50 per cent. of their capital and surplus. By the amendment of March 3, 1915, under certain conditions they may be authorized by the Federal Reserve Board to accept up to 100 per cent. of the capital and surplus. The following banks in this district have received such authorization:

_Amount of capital and surplus._ Bank of New York, New York $6,000,000 Mechanics & Metals National Bank, New York 12,000,000 Atlantic National Bank, New York 1,600,000 American Exchange National Bank, New York 8,000,000

As this bank has probably been the largest single purchaser of bankers' acceptances, it has been able, as it gained experience, to exert some influence toward standardizing practice and form....

The amended regulation[307] issued September 7, 1915, considerably broadened the field of acceptances eligible for purchase and encouraged an increased volume of these instruments. The further amended regulation issued December 4, 1915, covering the purchase of bankers' acceptances arising out of domestic transactions relates to a class of bills which national banks are not authorized to accept. When accepted by institutions of high credit they have a ready market, though at a fractionally higher rate than acceptances based on foreign transactions.

[308]New England imports a large volume of hides and wool from South America and cotton and jute from the Orient and other sections of the world. These shipments in the past have been financed through credits drawn on European centers. Since the opening of the Federal Reserve Banks these foreign trade transactions have been financed to a large extent through dollar credits drawn on this country and the acceptances arising there from have found a ready market in the Federal Reserve Banks. Several of the member banks in this district have entered this new field of finance and the Federal Reserve Bank of Boston has used every effort to further and develop that business, not only by buying a large amount of that class of paper, but also through furnishing favorable forward discount rates to assist in protecting its member banks. The following member banks have entered this field:

1. First National Bank, Boston, Mass.
2. Fourth-Atlantic National Bank, Boston, Mass.
3. Merchants National Bank, Boston, Mass.
4. National Shawmut Bank, Boston, Mass.
5. Old Colony Trust Co., Boston, Mass.
6. Second National Bank, Boston, Mass.
7. Merchants National Bank, Worcester, Mass.

Under special permission of the Federal Reserve Board the First National Bank, of Boston, and the National Shawmut Bank, of Boston, have been given authority to accept up to 100 per cent. of their capital and surplus. It is of interest to note that the former bank has reported the largest amount of acceptances of any member bank of the Federal Reserve System.

CLEARINGS AND COLLECTIONS IN PRACTICE

[309]Section 16 of the Federal Reserve Act made general provision for the establishment of a system of clearance of checks throughout the United States, each Federal Reserve Bank being required to act as a clearing house for its members if directed by the Federal Reserve Board, while the Federal Reserve Board was authorized to clear for the reserve banks themselves.

The Board had from the first recognized its duty to make this provision of the law effective as fully and at as early a date as conditions would permit; and in its first report spoke of this as "one of the most important responsibilities with which it is charged under the Act." So, regarding its duty in this particular, it undertook early in 1915 the preparation of a general circular and regulations intended to provide for the clearing of checks within the several Federal Reserve districts, while it also took under advisement the establishment of a gold settlement fund at Washington for the purpose of clearing obligations between Federal Reserve Banks. The latter undertaking has been carried to a successful conclusion and the gold settlement fund has been in full and satisfactory operation since about the first of June. The Board, however, had not advanced far with its work relating to the intradistrict branch of the clearance system before technical and other difficulties began to make their appearance. Many banks, both city and country, throughout the system were opposed to the enforcement of the provisions of the law because of the loss of exchange charges which would thereby be entailed upon them. Legal questions were also raised, it being argued that there is no power to compel a member bank not located in a Federal Reserve city to pay or have charged to its account at the Federal Reserve Bank of its district a check which it had not seen and approved prior to the time of presentation at its own counter. For the purpose of ascertaining the Board's powers in this connection the opinion of the Attorney General has been requested.

While the Board was not inclined to attach undue importance to objections based upon self-interest, it felt that it must take cognizance of all legal objections, and it recognized that the clearing question was essentially a reserve problem rather than a technical question or a mere matter of administration. Inasmuch as the Federal Reserve Act had granted a period of three years within which to effect the final transfer of reserves to Federal Reserve Banks (balances with correspondents counting as reserves in the meantime), there was a certain ground for objection to the immediate introduction of complete clearance at Federal Reserve Banks. As is well known, reserve balances in some reserve cities have heretofore been used for the purpose of providing for exchange and collection operations, and so long as this function on the part of city correspondents continued there was some argument in favor of deferring any compulsory application of par clearance at the reserve banks. Study of the problem, moreover, shows that, pending the time when state banks enter the system in larger numbers, it may be necessary for some member banks to collect and clear through their correspondents in reserve cities.

So complex was the situation and so serious the difficulty involved in the compulsory application of any system, however carefully conceived, that the Board felt it would be well if member banks could be brought to recognize of their own free will the advantages of a general and nation-wide clearing system--advantages which would inure not only to the benefit of the public at large, but ultimately to the direct benefit of the member banks themselves from the purely business standpoint. It therefore took under favorable consideration the question of a voluntary clearing system. Both the difficulties of a compulsory plan and the probable merits of a voluntary system had been strongly represented to the Board by the governors of the respective Federal Reserve Banks who at various meetings had thoroughly canvassed the whole situation. Under a plan, proposed by the governors, which in most districts became effective during June, 1915, provision was made for the acceptance at par by the Federal Reserve Bank of each district of checks drawn upon any member bank of that district which had previously assented to the provisions of the scheme. It was hoped that a very large number of member banks would promptly affiliate themselves with the new system of clearing and that the natural force of economic competition would ultimately attract to it those who at first might hesitate.

This system, as already stated, became operative in most districts during June, 1915. Prior to this whole discussion, however, two districts had already undertaken the application of the clearing provision of the law. Early in December, 1914, district No. 10 and district No. 8 (Kansas City and St. Louis) had sought and obtained permission to apply to their members a complete system of required clearing. This system had been in full operation in both districts prior to the general application of the voluntary system. Upon the inauguration of the latter the directors of the Federal Reserve Bank of St. Louis deemed it wise to offer to their member banks the option of withdrawing from the clearance system if they so desired; but so successful had been the working of the plan that comparatively few retired, about 80 per cent. of all continuing their membership. The Federal Reserve Bank of Kansas City continued its required system as before for the benefit of all its member banks, numbering 950. As about 365 banks continued their membership in the St. Louis district, a total of approximately 1,300 was included in the clearing system of the two districts in question. Outside of these two districts about 1,100 member banks voluntarily affiliated themselves with the clearing system within a short time after its inauguration, and there was a subsequent net inward movement of about 50 additional members, making approximately 1,150 banks which of their own free will have assented to the voluntary clearing plan. This is considerably less than 25 per cent, of the institutions eligible for membership, and the proportion has been so small as to prove a severe disappointment to those who had confidently expected that the foresight and enlightened self-interest of the member banks would speedily accomplish the desired result. Some progress has been made through the action of the banks, both member and non-member, in improving exchange conditions and in providing for the clearance of country checks at points where this practice has never before prevailed; but in the main comparatively small advance has thus far been made in rendering effective the provisions of the law requiring the standardization of exchange and clearance practices. This slowness is largely due to the failure of jobbers and merchants to appreciate the advantages of the clearance system and to enlarge its membership by insisting that their own banks join and co-operate in the plan. The subject has recently been reopened at the conferences between the governors of the Federal Reserve Banks, the Federal Reserve Agents, the transit managers of the reserve banks, and the Board itself, with a view to extending the present system not only in the several districts themselves but as between the various districts. For many years it has been lawful for banks to count as reserves deposits with other banks. It was never the intention of the Federal Reserve Act that member banks should continue the maintenance of these reserve accounts. On the contrary, the full meaning of the act is manifestly opposed to such an idea. It is the plain conception of the Act that the reserve banks should, to a very large extent, if not entirely, perform the work that is now being done by correspondent banks in this respect. This means that the reserve balances to be carried in the future by the reserve banks instead of by the correspondent banks should serve as the basis for a system of clearing and collecting the exchanges of the country. Whatever can be done to bring about the prompt and effective use of this new system of bank settlement will be done.

BRANCHES AND AGENCIES

[310]The question of branches of federal reserve banks has received careful attention during the past year. There has been intimation from several quarters that the establishment of a branch at a given point would be acceptable to the banks of that place. Only in one instance--that of New Orleans--did the Board receive a definite request from a Federal Reserve Bank to establish a branch. Believing that New Orleans and the adjacent territory could make advantageous use of this additional banking machinery, the Board authorized the establishment of a branch of the Federal Reserve Bank of Atlanta to be located in New Orleans, and this branch was opened for business on September 10. Operations at the New Orleans branch have proceeded satisfactorily, and the institution has been of considerable use to the local banks. The branch is already more than self-supporting.

Investigation and experience have seemed to show that, at least for some years to come, the organization of branches with completely equipped offices, vaults, and the like, and with a full staff of salaried officials, will be too heavy an expense for most of the reserve banks, yet, that valuable service could be performed by local offices of the several banks in not a few places. The Board has, therefore, had under consideration the question whether establishing local agencies might not meet the requirements of the case better than the more fully organized branch office. Competent legal opinion is to the effect that the creation of such local offices is permissible under the terms of the law, and the Board believes that it may prove practicable to meet banking necessities in many sections of the country by this means.

PROPOSED AMENDMENTS TO FEDERAL RESERVE ACT[311]

A year's experience in the operation of the Federal Reserve Act has confirmed the Board in its profound conviction that the act has been one of the most beneficial pieces of legislation ever adopted by Congress. Not only have its fundamental principles been fully vindicated but in most details the working of the measure has been successful. The act, however, is a progressive piece of legislation and creates new conditions as the result of its own operation. Modification in its terms growing in part out of these new conditions will subsequently be required from time to time.

For the present the Board presents the following suggestions for amendments to the act:

(1) In addition to powers now possessed in this connection by Federal Reserve Banks and national banks, the latter should be permitted to subscribe for and hold stock in banks organized for the special purpose of doing a banking business in foreign countries.

(2) With the approval of the Federal Reserve Board the issue of Federal Reserve notes to Federal Reserve Banks should be permitted either against the deposit of an equal amount, face value, of notes, drafts, bills of exchange, and bankers' acceptances acquired by Federal Reserve Banks under sections 13 and 14 of the Act, or of gold, or of both, provided, however, that gold so deposited with a Federal Reserve Agent shall count as part of the reserve required by the Act to be maintained by the bank against such notes outstanding.

(3) The acceptance system, provision for which is made in foreign trade operations by the Federal Reserve Act, should be extended to the domestic trade in so far as relates to documentary acceptances secured by shipping documents or warehouse receipts, covering readily marketable commodities or against the pledge of goods actually sold.

There can be but little question of the safety of such acceptances, and their use will tend to equalize interest rates the country over and help to broaden the discount market.

(4) Permission should be granted to national banks to establish branch offices within the city, or within the county, in which they are located.

(5) In order to enable member banks to obtain prompt and economical accommodations for periods not to exceed fifteen days, the Federal Reserve Banks should be permitted to make advances to member banks against their promissory notes secured by such notes, drafts, bills of exchange, and bankers' acceptances as the law at present permits to be rediscounted or purchased; or against the deposit or pledge of United States Government bonds, the purchase of which is now permitted under the law.

(6) The Board furthermore recommends that the power of national banks to make loans on farm lands as provided in section 24 be extended so as to permit any national bank not situated in a central reserve city to make loans secured by improved and unencumbered farm land situated within its Federal Reserve district, or within a radius of 100 miles from the place in which such bank is located, irrespective of district lines. It also recommends that the powers of national banks be further extended to permit any such bank to make loans on any improved and unencumbered real estate located within 100 miles of the place in which such bank is located, irrespective of district lines; provided, however, that the aggregate of farm land loans and other real estate loans made by any national bank shall not exceed 25 per centum of its capital and surplus or one-third of its time deposits; and provided further, that no such real estate loan, as distinguished from a farm land loan, shall exceed a period of one year nor exceed 50 per centum of the actual value of the property offered as security.

It is believed that the enactment of these amendments will, besides enlarging the usefulness of the national banks, result in greatly strengthening the operation of the Federal Reserve Act, and more completely realize the purposes of its framers. The text of the amendments designed to carry out these recommendations will be submitted by the Board at an early date. The Board has under consideration other suggestions for amendments to the Federal Reserve Act concerning which no conclusions have yet been reached, and regarding which the Board will take occasion to submit its views to the Congress at an appropriate time in the future.

STATEMENT OF CONDITION OF FEDERAL RESERVE BANKS.[312]

_Combined resources and liabilities of all Federal Reserve Banks as at close of business on the last Friday of each month during 1915._

RESOURCES. [In thousands of dollars.] ---------------------------+---------+---------+---------+---------+---------+ | Dec. | Jan. | Feb. | Mar. | Apr. | | 31. | 29. | 26. | 26. | 30. | | 1914. | | | | | ---------------------------+---------+---------+---------+---------+---------+ Gold coins and certificates| | | | | | in vault | 228,641 | 235,417 | 248,256 | 241,344 | 237,278 | Gold settlement fund | | | | | | Gold redemption fund | 428 | 488 | 653 | 824 | 950 | +---------+---------+---------+---------+---------+ Total gold reserve | 229,069 | 235,905 | 248,909 | 242,168 | 238,228 | Legal tender notes, silver,| | | | | | etc. | 26,578 | 20,882 | 29,085 | 23,098 | 26,518 | +---------+---------+---------+---------+---------+ Total reserve | 255,647 | 256,787 | 277,994 | 265,266 | 264,746 | Commercial paper | 9,909 | 13,955 | 18,577 | 22,001 | 22,774 | Bankers' acceptances | | | 1,892 | 9,682 | 13,812 | United States Bonds | 205 | 2,015 | 5,406 | 6,639 | 6,813 | Municipal warrants | 734 | 11,165 | 12,011 | 14,940 | 18,656 | Federal Reserve notes, | | | | | | net assets | 5,418 | 3,179 | 3,215 | 6,091 | 6,909 | Due from other Federal | | | | | | Reserve Banks, net | 7,930 | 7,421 | 8,088 | 5,573 | 9,468 | All other resources | 5,931 | 7,712 | 4,550 | 3,019 | 4,425 | +---------+---------+---------+---------+---------+ Total resources | 285,774 | 302,234 | 331,733 | 333,211 | 347,603 | ---------------------------+---------+---------+---------+---------+---------+ LIABILITIES. ---------------------------+---------+---------+---------+---------+---------+ | Dec. | Jan. | Feb. | Mar. | Apr. | | 31. | 29. | 26. | 26. | 30. | | 1914. | | | | | ---------------------------+---------+---------+---------+---------+---------+ Capital paid in | 18,051 | 20,440 | 36,069 | 36,105 | 39,669 | Government deposits | | | | | | Reserve deposits, net | 263,948 | 279,516 | 290,336 | 288,217 | 294,832 | Federal Reserve notes, | | | | | | net liability | 3,775 | 2,278 | 5,328 | 8,889 | 11,038 | All other liabilities | | | | | 2,064 | +---------+---------+---------+---------+---------+ Total liabilities | 285,774 | 302,234 | 331,733 | 333,211 | 347,603 | ---------------------------+---------+---------+---------+---------+---------+