-32 may hold their reserves in the form of vault cash, correspondent balances at other banks, U.S. government securities, state and local government securities, federal funds sold, cash items in process of collection, and 12/ certificates of deposit. The vast majority of small to medium size banks, principally nonmember banks, need the services of a correspondent. To obtain these services, a respondent bank places deposits with a correspondent bank which supplies check clearing, loan participation aid in asset management, domestic and foreign currency, computer facility, bond purchase, etc., services. All fifty states allow non-member banks to hold their reserves at certain correspondent banks. Therefore, non-member bank reserves in all fifty states can be used to buy correspondent services. On the other hand, small and medium size member banks must draw down their earning assets to purchase correspondent services. Member banks cannot use their required reserves at the Federal Reserve banks to buy these services. Thus non-member banks have a lower opportunity cost than member banks in buying correspondent services. From this it follows that the banking laws, which allow non-member banks to hold their reserves as correspondent balances, result in non-member banks having a lower ratio of non-earning assets to total assets than do member banks. For example, the ratio of cash assets to all assets for non-member and member banks was 9.1 and 15.7 13/ percent respectively on June 30, 1974. 12/ For a detailed breakdown of the nature of non-member bank reserve assets see: Robert E. Knight, "Reserve Requirements", Federal Reserve Bank of Kansas City, Monthly Review, April 1974, Appendix, pp. 15-20; and Joseph M. Prinzinger, Op. cit., Chapter 2. Federal Reserve Bulletin, December 1974, p. A-16. In addition to permitting non-member banks to hold their reserves in the form of cash or correspondent balances, some 25 states allow non-member banks to hold reserves in a manner that yields an explicit return. U.S. . government securities are the most common form of interest earning assets that are allowed to serve as reserves for non-member banks. Overall, however, there is a great diversity in the form in which nonmember banks may hold their reserves, as the preceding paragraph has already indicated. In Georgia, for example, certificates of deposit of other Georgia banks, both of member and non-member banks, may be held as part of reserves. Apparently the variety of interest earning or service providing assets in which non-member banks may hold their reserves is more than sufficient to cancel out the negative aspects of high reserve requirements in some states for non-member banks. It is this item, the composition of nonmember bank reserves, which we believe to be the key to the general desire of small and medium size banks to remain or become non-member banks. A low ratio of non-earning assets to total assets and its concomitant high profit potential are strong incentives for the growth in numbers of non-member banks. Other legal differences between member and non-member banks such as capital requirements and par status could also be analyzed. On balance, however, these differences are features of bank membership status that are relatively unimportant in light of the incentive which the composition of non-member bank reserve assets gives to non-membership status. -34 c) Summary and recommendations The more important results of this analysis of non-member banks and monetary policy can be summarized as follows: (1) Non-member banks have grown relative to all banks in numbers, assets, loans, investments, and deposits since 1947. (2) The relative growth of non-member bank assets is usually expansion accompanied by monetary restriction. (3) The relative growth of non-member bank demand deposits is economic expansion accompanied by monetary restriction. (4) Commercial banks generally move toward high yield risk assets be the result of Federal Reserve policy actions, however. banks may respond to macroeconomic variables more procyclically than member banks. (7) Reserve requirements for non-member banks are not typically lower than those of member banks. (8) Non-member banks, in contrast to member banks, may often hold their reserves in correspondent balances and/or interest These observations demonstrate that an increasing portion of our "means of payment money", demand deposits, are being created by non-member -35 banks. Since these banks are not directly under the control of the Federal Reserve, it follows that, as non-member banks continue their growth, the efforts of the Fed to regulate the economy will ultimately become more difficult. Under such circumstances, the Fed would have to increase its direct control over its member banks in order to bring about a desired change in the money stock. This would be a process that, hypothetically, could induce a further withdrawal of banks from Federal Reserve membership. The more attractive form in which non-member banks may hold their reserves, I feel, is the source of the relative decline in System membership. To resolve the problems created for monetary policy by the ever increasing importance of non-member banks, I recommend that non-member banks be made subject to the same reserve requirements as comparable size member banks. This could probably be most expeditiously brought about by requiring that all commercial banks be member banks. Over the years, the Federal Reserve itself has made such recommendations. frequently disagree with Federal Reserve policy actions, but on the matter of uniform reserve requirements I wholeheartedly approve of the Fed's recommendations. I do not agree with one economist who recently I argued that "The Fed's continued interest in universal reserve requiretraces both to its desire to eliminate the problem of eroding ments ... System membership and to its hunger for greater regulatory dominion."14/ 14/ Edward J. Kane, "All for the Best: The Federal Reserve Board's 60th Annual Report." American Economic Review, December 1974, p. 844. 52-221 O 75 15 -36 2. Bank Asset and Liability Management Their Relationship to Monetary Policy This section examines the relationship between monetary policy and the various forms of bank asset and liability management. We shall touch upon asset and liability management in general and then look at specific forms such as Euro-dollar borrowings, commercial paper sales of bank holding company affiliates, loan commitments to corporate customers, and the competition with non-bank financial institutions for savings funds. Some of this material has already been touched on in section (1) when we dealt with the loans and investments of all banks. Additionally bank asset and liability management in so far as it relates to the economy in general is a means of competing for reserve funds and is primarily of importance during periods of economic expansion, monetary restriction, and disintermediation. During recession, reserve funds are ample and banks can concentrate on obtaining an asset portfolio which maximizes return and minimizes risk. For these reasons we can be somewhat terser than we were in section (1) and concentrate on the logic of asset and liability management rather than directly observe the behavior of banks in all phases of the cycle.15/ a) General analysis of bank asset and liability management and the economy The dilemma for banks. Commercial banks, like other businesses, are private, profit seeking corporations. They can be expected to maximize profits, hopefully in a manner that is consistent with bank safety. Το し raise earnings, banks must grant more loans and make more investments, and 15/ Portions of the discussion which follows are based upon my book, Money and The Economy, 3d edition, Harcourt, Brace & Jovanovich Inc., 1974, pp. 74-83, and 91-93. |