-42 acquisition of reserve funds. This enhances the lending ability of those banks successful in their quest for funds, but reduces that of all other banks. No change in the total of bank reserves generally occurs. All these activities redistribute a given volume of reserves among the commercial banks. c) Competition with nonbank financial institutions the search for time deposits Theoretically, the yield on one type of liquid asset relative to yields on other types influences the demand for that asset. For example, should the yield on time deposits rise relative to yields on competing financial assets, the volume of time deposits demanded will rise and the demand for other liquid assets will decline. Because the higher yield on time deposits makes them a more attractive savings form more of these deposits will be demanded and fewer other liquid assets will be purchased. Conversely, a relative decline in yield on a financial asset will decrease the demand for that asset. Hence it can be argued that the demand for a liquid asset is an increasing function of its own yield and a decreasing function of other yields. Should the yield on competing liquid assets remain the same relative to the yield on time deposits, we would expect little substitution to occur. The presumed objective of the Federal Reserve's use of Regulation Q has been just this namely, to allow time deposit rates to keep pace with yields on other liquid assets. this policy has not been successful. However, The period ending around 1960 was one of relative decline for commercial banks as direct contributors to the pecuniary assets of the economy. This decline can be partly attributed to the failure of the Federal Reserve to adjust ceilings payable on time deposits under Regulation Q. -43 Other lending institutions such as savings and loan associations offered substantially higher yields on time deposits than commercial banks. These nonbank financial institutions successfully competed with commercial banks for idle cash and deposits of individuals in the economy. When one borrows from a lender other than a commercial bank, money is not created. These financial institutions lend funds directly, usually in the form of demand deposits at commercial banks. As a result, the dollar volume of loans and investments made by commercial banks decreases in relation to those of other institutions, although for the economy as a whole there is an increase in economic activity. The total of the money stock is unchanged but there has been an increase in its turnover. In other words, the velocity with which the money stock changes hands in the economy has increased. Surprisingly, commercial bank reserves are unchanged, but the activity in their deposit liability turnover has expanded because of nonbank financial institution increased lending operations. The relative growth of commercial bank assets increased sharply in the 1960's and 1970's. This is partly attributable to a change in Federal Reserve policy. The Federal Reserve along with other federal regulatory agencies has increasingly used Regulation Q in such a way as to raise the rates payable on time deposits by commercial banks relative to those paid by mutual savings banks and savings and loan associations. The result has been a marked increase in outstanding certificates of deposit issued by commercial banks. Many members of the public increased their rate of purchase of CDs issued by commercial banks and decreased their rate of purchase of CDs issued by nonbank financial institutions. 0 -44 Effects on bank reserves from the sale of CDs. When a bank sells a CD to a new depositor, the bank creates a new time deposit liability and receives an increase in its reserves. The increase in the bank's reserves occurs because the purchase of the CD will have been made with checks drawn on other commercial banks. If, for example, the funds came from savings and loan share accounts, then the checks were drawn on the commercial bank used by the savings and loan association. Or if the CD had been purchased by a business, then the business would have used idle demand deposits, quite probably from accounts originating in other commercial banks. The net effect will be a change in the ownership of bank reserves away from some commercial banks that have not been successful in competing for funds. There is no change in the total of reserves in the banking system as this competitive process takes place. There is, however, some change in the level of required reserves. Since time deposits have a lower reserve requirement than demand deposits, bank required reserves will have decreased and excess reserves increased. This enables the banking system as a whole to expand its loans somewhat. The extent of the expansion depends upon the relative magnitude of the reserve requirements on demand versus time deposit accounts. How are the nonbank financial institutions affected by a loss of savings and loan share accounts and other comparable time deposits? Dramatically! The nonbank financial institutuions redeem their liabilities with their holdings of commercial bank demand deposits. Since these deposits serve as cash reserves of the nonbank financial institutions, any reduction constitutes a decrease in their reserves and thus in their lending ability. -45 0 d) Disintermediation Disintermediation occurs when interest yields on such forms of liquid wealth as treasury bills and paper issued by businesses rise above the interest rates paid by financial intermediaries on their liabilities. This process typically occurs in periods of credit restraint; 1966, 1969, and 1973 provide the most recent examples. When people at such times decide to reduce their savings deposits at nonbank financial institutions, they acquire funds that were serving as reserves for those institutions and thereby force a contraction in lending activity. Subsequently, the money acquired is used to purchase such financial assets as treasury bills. The housing industry, which needs mortgage funds provided by such nonbank financial institutions as savings and loan associations, is severely hampered. Businesses and individuals may also decide to redeem certificates of deposit issued by commercial banks and purchase treasury bills or commercial paper issued by other businesses instead. This action reduces bank time deposits and increases demand deposits which require higher levels of reserves. The effect is a reduction in bank lending activity. These contractionary forces may cool an economic boom, but they create serious adjustment problems for banks, other savings institutions, and the housing industry. e) Summary and discussion of legislative recommendations The more important implications of the relationship of bank asset and liability management to national economic health during periods of economic expansion and monetary restriction can be summarized as follows: -46 (1) Commercial bank asset management increases inflationary pressures by increasing the velocity of money and the demand for goods. (2) Commercial bank liability management increases inflationary pressures by increasing a) the velocity of money, b) the growth (3) Special forms of liability management have developed in recent (4) Both asset and liability management normally result in a changed distribution of reserve assets among banks without there being any change in the total of bank reserves. The recently developed special forms of liability management tend to shift the ownership of bank reserves away from small member to large member banks. This in turn can be viewed as a force that induces small member banks to leave Reserve System membership. (5) The recent uses of Regulation Q have resulted in periodic dis intermediation for non-bank finanacial institutions and chaos in the housing industry. (6) The Regulation Q ceilings have also resulted in some disintermediation for commercial banks, primarily because of an induced change in the composition of bank liabilities away from time deposits toward the higher reserve requirement demand deposits. |