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Changing liquidity patterns in the American banking system

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Title:
Changing liquidity patterns in the American banking system
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Lee, Jerry Wayne, 1944-
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English
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vii, 167 leaves : illus. ; 28 cm.

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Subjects / Keywords:
Assets ( jstor )
Bankers ( jstor )
Banking ( jstor )
Cash ( jstor )
Commercial banks ( jstor )
Demand loans ( jstor )
Federal Reserve Bank ( jstor )
Investment banking ( jstor )
Liquid assets ( jstor )
Liquidity ( jstor )
Bank reserves -- Florida ( lcsh )
Dissertations, Academic -- Finance, Insurance, and Real Estate -- UF
Finance, Insurance, and Real Estate thesis Ph. D
Liquidity (Economics) ( lcsh )
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bibliography ( marcgt )
non-fiction ( marcgt )

Notes

Thesis:
Thesis - University of Florida.
Bibliography:
Bibliography: leaves 158-167.
General Note:
Manuscript copy.
General Note:
Vita.

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This item is presumed in the public domain according to the terms of the Retrospective Dissertation Scanning (RDS) policy, which may be viewed at http://ufdc.ufl.edu/AA00007596/00001. The University of Florida George A. Smathers Libraries respect the intellectual property rights of others and do not claim any copyright interest in this item. Users of this work have responsibility for determining copyright status prior to reusing, publishing or reproducing this item for purposes other than what is allowed by fair use or other copyright exemptions. Any reuse of this item in excess of fair use or other copyright exemptions requires permission of the copyright holder. The Smathers Libraries would like to learn more about this item and invite individuals or organizations to contact the RDS coordinator(ufdissertations@uflib.ufl.edu) with any additional information they can provide.
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CHANGING LIQUIDITY PATTERNS IN THE AMERICAN BANKING SYSTEM














By
JERRY WAYNE LEE













A DISSERTATION PRESENTED TO THE GRADUATE COUNCIL OF THE UNIVERSITY OF FLORIDA
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE
DEGREE OF DOCTOR OF PHILOSOPHY














UNIVERSITY OF FLORIDA 1969










,A.CT7McLEDGREJN


T'h' e r r T"he -ox.prsi' - :0 :., T
018tion_ -o the ._e-, r- .. r.. ... . o, .,f ;- s ._ s , p er"viso r/ ,co.m..i.t, ee,' "

Dr C. A. Mates phimn Dr. L.. Eoge an . ,h . Jes. Tht writer espeoiall.y ..ihes to rhak .:. "7j.e7 , n curiy for :hs idance in preparing this stud:, but al3o for his ivice ani enon to this rit.r over the past four yars. The :'ri'e also skes to thank Mr. ,edrd J. Lee, Deputy lnkin Ccommissione-, of the State of I o;ida, r his assistance ii su7rp1ying -'sa for tis " u



ia hoas .ro.n co1san ncouaeet a-.A ,s'oecil :.;t? ",." tihun s IS <~t r. o m-:, vrass.iaance in the wrr'ti:;g an pr -aration of -.itheiSo
















ACKNCOELEDG:ENTS . . . LIST OF TALES . . . LIST OF FIGUE S . . . TLIST OF EHITITS . INTRODUCTION . . .

Introduction . .
Purpose, :ethod,


. . . . . . . . . . . . , V1






S� �ope . . . . . . , 5 * *5
S OrJ ,


I. THE: SECOCDARIY RES TE IN THEORY .

Definition of Secondary Reserve .
Functions o the Secondary Resetre
Secondary deserves and Dapital Fund
Determining! Liquitdity irements Lquid ity Etandards .......
Other B.k Assets and Liqi.ty
Secondary Reserve Assets .....


I. T E INDUSTRY TRENJDS: 1953-196 .


The Liquidity of' the System . . ..
The Challence of Com~etition . . . .
The Certif'cate- of D-p-o sit . . .
Bank Debentures an Capital . . . .
The Need for Liqudity . .
Conclusions . . . . . . . . , , ,

II I TEE SECC 'TY .ESE:7VD I ALITY 1 v

The Sannle . . . . . . . . . . .
Classification of Data . .....
Secondary Reserve Chateristics of
Sample Banks .... , , , , . .

IV. F !AL CONCLUSIONS . . . . . . .

BIDLIOGRA Y . . . . . . . . . . .


5 9 * .


i ii


C S


* S
* 5
* S
* ,
* 8

* S


. . 59


S



U


* S S

* S S
* 9 5


* 5 8

* S S


60
78
85
92 99
102


116

117
1,%0


152

157


. . . . . . . . . . . .

. . . . . . . . . . . .














ab'e Page

1. U.S. G iovernment o e12 Hele o c Ba ,' 1O 95l -196q ,-- . ." .'} . : . . ".,. . . "


195 8 9
19 5> 9�:

3. To-t l A t All Cor :1 ecial O- SO.
195- - 1 . . . . . . . **7

8. Chne in Pr en oD Sai cr fE eod
in an: n avn Loans, 19
through lIj . . . . . . . . . . . . . . . 79

. elSc o, cletee Lonr-Tr e cri t:, 1955- 5 . .. . . . . . . . a . .

e. Percent o ?ir a As- oI o.ia Caegi at Y-an Und, '3lcr -ted Yers .

7. ld-" 0 f Seco "arey -SeS a h y Lag Str a lks atereI in .r i3' 3
1967- 96 . . . .

8. Toldirn o Se'na srv orty Florica, 1 -.... , . . . . . . . . . . a 12t

9 _li n- of -oary serves o f
Fcor-I ve ': -1L Sat Bn s Chart cr -1
in -lori7s, 1967-19 1 . . . . . . . . . . 123

10. S "z e ... 7 ee o 7-1c tuition
CharacTeristics oi' Se;zndry 2e'orve' of
aThirty t a S e an. Ca.- r ere 1i
lorida, 19?7 1 - . . . . a . . . . . . . 132

11. Size anf D-r of :'luctu tion
Characteristic a condAry Reserves ot .orty ei r-- - p aSta an:s Chatered
n lri, TP7-1 3Inr a I . ' " � . . . . . � �











Table Page

12. Size and degree of Fluctuationri
Ciarateri Tics 3f Seccuiary Reserves
of Forty-ive S:-all Stte Banks Chartered
- ", -- - C '-- " ) '
in 7lorid-a, 1..7-1. 9. . . . . . . . . . . 1,4

1, isztribAution of .ai zs , for >are Eanks


14., : itrLution of 7-t ins for c 'iunm-Sized
Eanks in l . . . . . . 44

15. 2-,rb-to a ains for S 'all anks
i n S a-.le TD . .e

lI istri' ution of Ratings for A l IaJ:s in
Sample . . . . . * . . . . . . . . . . . 148




















2.C- '1
1 U ~'~ I71

-,~ ~ ~~~ o O ~ I, sn~~
4 ~ , 0 & 75 5 5 5















ollLo -a

1-7


Pa -1-
















Introduction


During the first few years of this decade (the 1960's) a number of significant changes occurred in the American Commercial Banking Industry. In the first half of 1961 several large money-market commercial banks in New York City began to issue negotiable time certificates of deposit (CDs). 1 This was a radical departure from past banking practice, which emphasized asset management and assumed that the composition of bank liabilities was more or less beyond the control of individual banks. The change was accepted, however, both by the regulatory authorities and by the banking community as a hole, and the practice of issuing C s spread rapidly. The total volume of CDs outstanding rose steadily from almost zero in early 1961 to more than 19,000,000,000 in June of 1968, and represented an important source of'

funds for the bankiing system during this period.

Anoth-er significant ch:n e occurred in December of 1962 ;hern the Com:troller of the Currency approved the issuance of capital notes and detentures by commercial banks which could be included in their










capital accounts, as long as such notes were s. bordinated to deposits. Commercial banks were quick to take advantage of this, ard sold more than $1,500,000,000 worth of' these securities during the following three years. This represented 47 of the increase In new capital funds raised by the banking system during this period.

The decade of the 1960's also brought changes in the composition of commercial bank assets. Between 1961 and 1966 commercial bank holdings of U.S. Government securities decreased by about 17", while loans increased by 799 and holdinGs of other securities (mainly municipal securities) increased by 11LL. The decline in the holdings of U.S. Government securities occurred at a time when the money supply (currency and demand deposits) was growing at an annual rate of h4. which included a 20% increase in total demand deposits. Over the same period -- 1961 to 1966 -- time deposits increased by 9. Thus, according to traditional measures, there was a significant decline in commercial bank liouidity during this period. The loan to deposit ratio rose from .52 in August of 1961 to .67 in August of 1966, while the ratio of cash and government securities to total assets declined from .42 to .29 over the same period.










Many of these changes were the natural result of increased comoetition inr the banking industry, both among individual commercial banks and between commercial banks and other financial institutions. It has been necessary for commercial banks to aggressively seek new sources of liability funds and invest them even more aggressively to simply maintain their competitive position with non-bank financial institutions. However, these changes did result in a substantial drop in commercial bank liquidity if such liquidity is measured by the amount of "liquid" assets held relative to total assets. Ey the end of 1968

commercial bank holdings of U.S. Government securities had fallen belo.i 144 of total assets. This co-pared with a percentage in excess of 35% in i95L*.

This suggests that perh-aps commercial barks did not need to hold so many liquid assets in the first place -- that perhaps commercial banks meet their liquidity needs in ways other than relying on secondary reserves. Perhaps commercial banks maintain a certain level of secondary reserves (liquid assets) because it is the "traditional" and "conservative" thing to do. Perhaps the regulatory authorities "encourage" commercial banks to maintain a certain "average" or










"normal" level of liquid assets to conform to "sound banking practice." Since the existence of the Federal Deposit Insurance Corporation and the increased knowledge and sophistication of the banking authorities have almost eliminated the possibility of widespread bank failure because of a liquidity crisis, this would mean that banks tend to hold an excessive amount of liquid assets which are not needed to meet the reasonable demands made on a bank. This is the hypothesis of this paper.

Hypothesis: Ccmmercial banks in the United

States, because of unnecessarily conservative banking practices and overstrict supeavision, tend to maintain an excessive amount of their assets in a highly liquid form (the secondary resere) at the sacrifice of additional income. Furthermore, the secondary reserves of most commercial banks are not related to the true liquidity needs of these banks as the sizes of most bank's secondary reserves are determined by an informal, system-.,wide standard -- the industry average.


Purpose, Method, Scooe


The purpose of this study is to examine the

banking literature, the banking industry as a whole,










ann a ....l of cooerciRal banks to !-'rmi.e wetheor not cotlmm-'yrcil bsns .u.ly de :t eir own 7iuau i~y ne.c; -are -'i thy -ina.n their secondary reserves in accorance w it their neeis. This study ill fcr -h ost par b ~ oic presentation based on sttistical analysis, eri:"i g awS, andv rofessioal opinion.

This paner is divT into four ajor pa't or chapters. he first chonter is conceded wit the theoreti-cal sti fication for t maintenan - of a secondary rcsrve in a o.:.arcil bnk. An atte.-t is made to determine uhbat a secrnia r. reerve s its f uncios are, a :, t; siz is eterin e, a~nC hat 1.t sources of a bank's Iluidity are.

In Cpr II the industry trends in -ank assets and liabilites sInce 19 3 ar- eaminxa . Special .attention is -venr to th~ chn that occrre efter i960. In particur, the t+!e certificate of erosit and the subordineted debent'uire cre e..ined, and a attempt. is male to determine their role in tcay:'s bankr'in system. The th-eory of 'cilities maa ement (as a replacement for the se.orla -y r-serve) is analyzeA, anJ its wek points , as well as its strong points, arc pointed out,











In c pter i th- ass ets of a sr.-ofle of 115 state banks chartered in ?o'ida wil be examined, The analysis w ill ate pt,. to show wether or not coercoai banks ten-, to maintain their seconIary reserves close to the .y ere or at soe minimum level, whether secoonary reserves _ flutctatc or remain firy steady, a-nd .hether the size of a bank affects econiary reserve policy. A:i at; ePt is also male to brin,- out the differences and similarities between the seccniary reserve policies of the diffe-ent banks.

The conc.l sions that can be dm ot'fro an a aly:i of this sale must neces-riy2 be limitef because of the n...ture ana tmje scan of ti'e sariTple (ss c.pla-n"-: in Ch, ter TT. Never-...., th'e samle is suf icie 4 to rov e for some meaninafui conclusions, which can found in Chaoter TV.

It is hoed that this study "will shed sore 1 ht on hor commercial banks actually determine their policies in reard to l dity, and how these policis are affected 'by traditional thought re-latory supervision, an chan-es in Iohtiion. Tn discussinliquidity t1is paper is cri-;rily concen r w ithu the liquidity of inividual 'ars',s as opnose to the liquidity of te s-ste-- as a who e. Althouh lboth










types of liquidity are closely related, and one type cannot really be discussed Iithout at least implicit consideration of the other, each type calls for a

different method of analysis. For example, an individual bak may increase its secondary reserves by purchasing short-tern U.S. Government securities from another bank, and 'the liquidity of the system does not change. In the same light, the liquidity of the sytem may increase through Federal Reserve action whilee some banks lose secondary reserves because of local considerations. This paper will emphasize :be iLquidity of individual banks.

Ths study ray be quite useful to the managers of some banks (especially small banks) in evaluating their -olicies and practices ap-ainst the policies and practices of the sample banks in this paper. The regulatory authorities may also find this work of

scme small use in formulating future policies. In any case, it is hoped that this thesis will help other students of money 3nd banking more clearly understand the forces that shaed commercial bank policies durin the decade of the 1960's.














Notes


I. W. H. Baughn and C. E. Walker, The
Bankers' Handbook (Homewood, Illinois: Dow JonesIrwin, Inc., 1966), 610.

2. G. Walter Woodworth, "Bank Liquidity
Management: Theories and Techniques," The Bankers Magazine, 150, No. 4 (Autumn, 1967), 76.


3. Table 1 in Chapter II.

































CHAPTER I

THE SE'-CONiRY RESERVE IN THEORY














Definition of Secondary Reserve


The phrase "secondary reserve" is somewhat of a loose term in the American Benking Industry. Bankers differ widely in their opinions as to exactly what a "secondary reserve" consists of. The term cannot be found in any of the various bank acts, and it apparently does not have any official status.

A study of the history of American Banking

indicates that secondary reserve accounts of commercial banks in most cases "just g-rew." ?unds that were not needed by commercial banks for Toans and .iscc~in ,ts became available at certain times and were invested in short-term liquid assets such as commercial paper and Treasury Bills. The purpose of these acquisitions ",as to have on hand a number of assets that could be sold quickly when the demand for loans increased. Paul M. Atkins summed up the bankers' motives in The Bankers Magazine of August, 1930, in the following way:


The principal attention of the banker
when buying these "secondary reserve
assets" was not focused on the organization of a secondary reserve, but rather on the selection of assets which were safe and which could be sold or disposed of in some other










way at his own discretion. His eye was on the credit position of these
assets, and he was interested in
whether they would pass the
inspection of the bank examiner
rather than on their adaptability
to meet the needs of a secondary
reserve.


Thus, the term "secondary reserve" is not subject to a precise definition, as it has never been legally defined. Of course that does not mean that every banker has a different opinion as to what a secondary reserve is. On the contrary, there is a fairly uniform consensus of opinion as to what a secondary reserve is. There is, however, as will be brought out later in this thesis, some difference of opinion as to what assets should be included in the secondary reserve.

Textbooks dpaling with corImercial banking will almost always have a section or two dealing with secondary reserves, although in many cases the author will avoid trying to define the term "secondary reserves" directly. They generally prefer to describe which type of assets might be included in a secondary reserve and why there is a need for such a reserve. Where a definition can be found the language used is usually of a general, unspecific nature. In 1938, for example, the Bank Management Commission of the American Bankers Association issued a Statement of Principles and










Standards of Investments for Commercial Banks in which

it defined secondary reserves in the following way:


Secondary reserves consist of short-term,
readily marketable investments which normally may be converted into cash through sale without material loss.
They ordinarily include bankers'
acceptances, treasury blls and other
short-term Governments, prime commercial paper, and other short securities of the3 highest quality and broad marketability.


Other definitions emphasize the use to which a

secondary reserve should be put -- that is, as a

potential source of cash to replenish the primary

reserve when that reserve declines for some reason.

J. H. Wilkinson, Jr., for example, defined a secondary

reserve in this way:


The secondary reserve can be defined
as the first line of defense ,Thich
will be employed to replenish the
primary reserve whenever that reserve
needs to be replenished because of
withdrawals of deposits or an increase
in loan demand. If, then, the outstandirn-g characteristic of the secondary reserve is that it be
available for transition into primary
reserve without other than an
inconsequential loss, it logically follows that only prime securities with short maturities -- not more
than four years -- are eligible for
such an account.


These two definitions, by reason of their length,

are probably the exception rather than the rule. Some










authors define secondary reserves in a sentence or less and move on to other matters. A typical definition would be: "By 'secondary' reserves are meant highly liquid earning assets that may be converted into cash with little or no delay and at practically no loss."5 Other authors, although they may deal with secondary reserves at length,
6
offer no direct definition of the term. The most meaningful "definition" which this author found was in a monograph prepared by the American Bankers Association for the Commission on Money and Credit. In this book also no "direct" definition is offered, but the authors are able to define "secondary reserves" quite adequately using arn indirect method. They state:


Since a bank's cash assets can be
counted onlyr to a very limited extent
among liquidity assets Cprimary reserves
must be maintained at a minimum level ,
a secondary reserve of short-term, readily
marketable, high quality assets must be
maintained. This provides the bank with
its real source of liquidity. The
secondary reserve is used in an
accordionlike fashion, expanding to
take up the slack when deposits increase
faster than lending opportunities and
contracting as necessary to meet deposit
withdrawals or loan increases.?


The authors go on to explain what they mean by "short-term, readily marketable, high quality assets," and what assets










can be included in this category. They say that any U.S. Government bonds with maturities of up to five years can be included in this category, but any other assets, regardless of quality, should mature within a maximum of two years to be eligible. "Other" assets eligible to be counted as part of the secondary reserve would ordinarily include money market loans, Federal Funds sold, Government securities bought undsr repurchase agreements with Government security dealers and other banks, bankers' acceptances held, cal] loans to security brokers and
8
dealers, and open-market commercial paper. At this

point it is sufficient for our purposes to say that a secondary reserve consists of short-term, readily marketable, high quality assets.


Functions of the Secondary Reserve


There is some differences of opinion amcng

students of money and banking as to what functions a secondary reserve serves in a commercial bank, However, almost all agree on at least two of the functions of a secondary reserve. The first of these functions is to provide a bank with a source

of funds with which to meet deposit drains. The second function is to provide for funds with which










to meet increased loan demand. These two functions

will be considered together as they are closely

related and are at the core of the rationale for

the maintenance of a secondary reserve of

highly-liquid assets. Thus, according to The

Bankers Handbook:


In the use of funds supplied to
the bank, the changing volume of
deposits coupled wTith the nature of
the community's credit needs
produces basically four functional
asset categories; (1) cash, (2)
liquidity reserves, (37 customer
loans, ana .4 residual investments. ..
The liquidity reserve category is
made up of a wide range of income
producing assets where Ethe: primary function is to provide the bank with
a source of funds, through conversion
of these assets, to meet deposit
drains or loan demand. This is the
immediate source of liquidity for the9
bank in its normal banking operation.


These same sentiments, in one form or another,

can be found expressed in almost any text that deals

with secondary reserves (or "liquidity" reserves) to

any extent. James 3. Duesenberry, although he devotes

only one chapter to commercial bank operations in

Money and Credit: Im-oact and Control, mentions that

most banks try to prepare for deposit withdrawals by

investin- in securities which can be readily sold

with no risk of loss, such as short-term Government









10
bonds.10 Another author says that it is clear that

a bank should carry enouch licuiid assets to meet the "seasonal demands of depositors," which can be forecast from experience, as well as to meet the "cyclical variations in deposits," taking measures

to increase liquidity during times of prosperity.11

These two functions of a secondary reserve are

clearly identified in a text prepared by the American Bankers Association for the Commission on Money and Credit entitled The Commercial Banking Industry. 12
-. - je - a *- y

The text points out that the greater Dart of commercial bank liabilities by far is in the form of demand deposits, and tlhus adequate liqutidity is required to meet anticipated withdrawals of these depoits and to provide a margin of safety for the unforeseeable. Adequate liquidity is also needed to satisfy the legitimate credit needs of its customers and to provide portfolio flexibility should a rise in

interest rates make available attractive investment opportunities. "The part of the bank's investment portfolio that constitutes its secondary reserve

(liquidity account) is the prime source of such liquidity ,"13

Roland I. Robinson, in The Mana ement- of Bank

Funds, discusses these two basic reasons for protective










liquidity in some detail.14 He holds that there are two great reasons for the protective liquidity of commercial banks. First of all, banks must meet their legal obligation to convert demand deposits into currency on demand without fail. Secondly, although there is no legal responsibility to do so, any bank which vrants to enjoy good profits, to perform its expected function in the community, and to attract customers must be prepared to meet all legitimate loan demands. He states: "There are two ways in which a bank can prepare for these needs: by holding cash and by havirg7 investments which can be co-nverted into cash quickly, in sizable amounts and within negligible loss." ~ach inf�vidual banker, of course, is interested in the circumstances that cause deposit variations, The principal factors involved are changes in the aggregate of bank loans and investments and changes among individual banks in the distribution of deposits. These variations are of several kinds, which Robinson lists in t'.e following way:


1. Business fluctuations, which
cause the demand for bank loans to
go up or down. This, in turn, affects
the level of deposits.
2. Seasonal variations in the demand
for bafnk credit and for currency to
put into circulation cause bark deposits
to fluctuate.










3. Relative population changes among
areas -- some -parts of the country grow
rapidly, others hardly at all.
4. Competitive shifts in which some
banks grow at the ex-pense of others,
5. Changes due to shifts in the
relative prosperity of various
depositors; for exa.ample, when there
Is farm prosperity, agricultural
banks gain deposits more gapidly than
do other types of banks.1


The author points out that seasonal movements of both loans and deposits can be fairly well anticipated as to when they will occur and approximately how large they will be. However, there are some deposit movements which cannot be accounted for -- random movements. The banker must take these movements into account as well: "Recognition cf random movement is, perhaps, a sort of clumsy effort at preparing for the unknown future. It is a guard against the unexpected; ... v7

Besides seasonal and random factors, the

individual bank should provide for some Drotection against the movement of what might be called "unstable" accounts. An example of this type of deposit might be amounts "due to banks," Also, "public funds" may also be highly variable, as their placement depends on who holds political pow-er at the time. The accounts of "uninvested trust funds," "investment trusts," and "rich investors" may also be subject to wide variation,










And of course, the "'big" account in the "little" bank presents another illustration. A bank should always be prepared to lose its biggest single account. "While every bank has reason to welcome deposit accounts and particularly the big ones, the small banker should never make himself slavishly beholden to one big account."18

In the establishment of a secondary reserve, it is important that a distinction be made between the demand and time deposits of a bank. Demand deposits are payable at sight whenever they are demanded during

the regular banking hours. Time deposits, on the other hand, are payable only on some specified future date or after the lapse of a determined length of time, upon notice. At the serime time, banks psy a relatively high rate of interest on time deposits, while interest payments on demand deposits are prohibited. Thus, the return that a bank must earn on time deposits must necessarily be higher than the return it must earn on demand deposits.19 Thus, a bank would be expected to keep a high percentage of the funds it derives from time deposits invested in high-earnir assets. This leaves demand deposits to supply funds for the secondary reserve. Therefore, the dependence of the










secondary reserve upon the deposits of a bank takes effect in three ways:


1. The amount of the deposits and
their distribution between demand and
time deposits.
2. The fluctuations in the amount
of these two classes of deposits.
3. The distribution of the size
of the deposit accounts.20


A conscientious banker must, of course, be

sensitive to changes that occur outside of the bank as well as to changes that occur within the bank. Individual communities are subject to economic factors that are peculiar to a particular region, The danger of relying on one major industry or customer has already been mentioned. Change,3 in the industrial components of a community or population changes may call for an ad.justment in bank strategy. These and any other "local" considerations all play a part in 21
the operations of a commercial bank.21

In addition to local considerations, national economic conditions must be taken into account by the individual banker. The more widely diversified a bank's service area, the greater the probability that

national conditions will be reflected in the bank's business. Treasury and Federal Reserve policy especially must be watched closely.










A secondary reserve may have other functions

apart from the two that we have mentioned. Some

authors maintain that secondary reserves are a

bank's protection against panic withdrawals during

periods of crisis and depression. Raymond P. Kent,

for example, states that:


... it is a generally accepted
doctrine of good bank management that
the secondary reserve pltIs the
primary reserves should always be
sufficient to enable a bank to r.eet
even the anirc withdrawals that may occur in periods of economic crisis
and depression. The idea is, of
course, that the bank must always
be in a position to protect its
solvency; and it rust be in such a
position even when, as in periods
of prosperity, times of econ-mic
crisis and difficultv appear to be
exceedingly remote.#?


This function of a secondary reserve, however.

is not as generally accepted as Mr. Kent would have

us believe. In fact, his statement is anything but

a "generally accented doctrine of good bank management."

Donald R. Hodgman, for example, in Commercial Bank Loan

and Investment Policy, stands in direct opposition to

Mr. Kent. He states:


I shall assume common acceptance of the proposition that in time of a perverse
liquidity crisis only prompt and powerful
action of the central bank to monetize





23



assets of the commercial banks can
provide the bankiing system .:with enough
liquidity to go around. In such a
cataclysm the survival of even a well-managed bank may depend more
upon the policy of the central bank
than on that of its own management

He goes on to say that in a general liquidation crisis

the central bank alone can provide adequate liquidity,

No individual bank can safeguard its own position by

holding saleable assets, since no one w,,ill be willing

to purchase them in a liquidity crisis. He concludes:


Therefore, the task of management is
to antici-ate those deposit drains which, while exce ding the amounts that can be met by borrowing at the
Federal Peserve Bank, have P good probability of occurrence without
involvi-g the entire banking system
and thus forcing a liberalization of central bank policy. The size
of such drains determines the
"rock bottom" for the investment
portfo io.2h


This latter view would seem to hold more water

than the view expressed by Mr. Kent. The correctness

of this position stems from the fact that it is

impossible for the whole banking system to possess

any large degree of liquidity. It is quite clear

that the liquidity of any particular bank's assets depends upon the willingness of the other parts of

the banking system to lend or invest freely. Of










course, commercial banks mray shift the burden of

providing liquidity upon the central bank, but any

wholesale attemt on the part of the system to

liquidate its loans and investments must fail.25

It should be noted that the emperical evidence

provided by the experiences of the 1930's supports

this view. C, A. Wright, in a study conducted for

"The Bankers i'agazine," stated the following:


Figures published by the Federal
Reserve Board indicate that there
w,,as no dearth of eligible paper in
the Federal Reserve System as a
whole during the crisis of 1931-32.
Nevertheless, the general widespread demand for liquidi*yr necessitated by the emotional behavior of depositors
led to the exhaustion of primary reserves by many otherwise sound banks, and to the liquidation of
secondary reserves on a scale great
enough to demoralize the security markets; the possibility that this demoralization was occasioned by a
general desire for relatively liquid
forms of wealth would seem to be
confirmed by the extension of pri e
declines to the commodity market.
It therefore seems reasonable to
conclude that, during a period
characterized by rapid liquidation,
it is impossible for the banking system to alter within itself the
distribution of its credit resources
so as to maintain a safe position.
In different terminology, "shiftability" of assets is no longer
sufficient to maintain the liquidity
of large po-tions of the bankt-r
mechanism.26










The author goes on to conclude that:


The existence of eligible paper
In 1931-32, the situattion was the same in 1933, was insufficient to prevent widespread bank closings,
and a resort to "shiftability"
through the market also failed.
It seems evident that the preservation of banking liquidity in time of crisis involves the absorption
by the public of assets formerly
held by the banking system; ...
in other words, the public must exchange its quick deposits for
slow assets just when it is
unwilling to do so.27


This position is further substantiated by a

banker by the name of Eugene H-. Burris who in the

last part of 1931, while president of the Oregon

Bank and Trust Company, wrote an article which

appeared in "The Bankers Magazine." His article

was concerned with whether or nrot it was desirable

to rely on bonds (any kind of bonds) for liquidity

during a crisis. He stated that his bank had met

all of its liquidity requirements through note

collections rather than through the sale of any

assets. He further stated:


Shall we bankers not face the facts?
Bonds have acted no differently in
this depression than in every previous
depression. In every former depression,
without exception, for at least fifty
years, bonds as secondary reserves





26




have been a frail staff to lean upon.
We may point to them with pr de. He may advertise 3hen, Bt ,we dare not
sell them.28


From this discussion then, we shall conclude that commercial banks cannot protect themselves by maintaining sufficient liquidity to meet excessive withdrawals brought on by a liquidity crisis. Only during T "normal" times can a commercial bank obtain liquidity (cash) through the sale of assets.


Secondary Reserves and Capital Funds


There is another function of the secondary

reserve, however, which is considered most important by many bankers. This function has to do with the amount of capital funds in a comi:ercial bank and the degree of risk entailed in a bank's lending and investing of funds, Almost all colummercial banks are capitalized. at less than ten percent of total assets. This means that a commercial bank cannot afford to expose itself to a very large degree of risk as it

cannot afford to lose very much.

There are two types of risks that can result in losses for a bank. The first type of risk is the credit risk, which depends on the quality of a bank's assets (the risk of a loan going bad or of default as










to interest or principal on a bond or note). The second type of risk is market risk, which results from changes in the interest rate structure.

From the standpoint of capital adequacy, market

risk is not particularly important unless the secondary reserves of the bank are inadequate to meet the potential needs for liquidity. Tf this is the case, then the banker runs the risk of having to dispcse of a. long-term bond (or other asset) at a Price which may be very much below what was paid for it. Thus, even though the asset soll might have a negligible credit risk, capital backing would be required. This diversion of capital to cover investment market risks results in less capital to cover credit risks, and the bank's lending function would be impaired 29 According to one author:


At the present time, because of the
existence of central banks, the dangers
of nonliquidity are minor conmpsoared to the dancers of impairment of capital.
Therefore, bank management is giving more attention to this problem than
was true in the past. Em-hasis on
solvency is synonymous with emphasis
on the quality of assets.30


The American Bankers Association, in The Comnercial Banking Industry, had the following to say on this subject:









Enough assets involving no credit
risk should be included among the
bank's investments at all times to
hold within reasonable bounds its overall risk exposure -- including risks assumed in loans. To provide
proper balance for a bank's total assets, for example, it may need
to hold a larJer volume of
U.S. Government securities than
would be needed solely to provide
liquidity.31


Determining Liquidity Requirements


We are now in a position to say something about the size or magnitude of the secondary reserve for a commercial bank. J. H. Wilkinson, Jr. feels that there are four basic factors that should determine the size of a secondary reserve for any commercial

bank.32 These factors include the nature of the deposits of the bank, the size and condition of the

bank's capital account, the condition of the loan and discount portfolio, and the position of the business cycle. Charles L. Prather lists these same four factors as the determinants of the size of the secondary reserve.33 Paul M. Atkins, in an article prepared for "The Bankers Magazine," listed nine factors that determine the size of the secondary reserve. They are:


1. The larger the volume of deposits
the larger should be the secondary reserve.










2. The larger the proportion of
demand deposits to total deposits, the larger proportionately should
the secondary reserve be since demand deposits require a relatively larger
reserve than do time deposits,
3. The less the stability of
deposits the larger should be the
secondary reserve.
4. The higher the rapidity of
fluctuation of deposits, the larger
should be the secondary reserve.
5. The smaller the ratio of total
surplus to deposits, the larger should
be the secondary reserve0
6. The less liquid the funds in
which the net worth is invested, the
larger should be the secondary reserve.
7. The smaller the proportion of the
local loans and discounts eligible for
rediscount at a Federal Reserve bank,
the larger should be a secondary reserves
8. The larger the proportion of the
earning assets invested in local loans
and discounts and in local. mortgages,
the larger should be the secondary
reserve.
9. The smaller the primary reserve
(within limits) the larger should be the
secondary reserve,3


Although this list would seem to be quite exhaustive,

a second readin w'ill show that it is also quite general

and unspecific. The author is aware of this, and states:

"Like so many other instances in the field of practical

economics, this is a case where gcod judgment based on

experience rm ust be applied."35 This still tells us

nothing about how a bank should determine the size of

its own particular secondary reserve, and it is to this


subject that we now turn.









In order for an individual banker to determine his liquidity requirements he must begin with an analysis of past deposit activity to determine whether there are any repetitive, predictable performance patterns.6 The study should go back at least five years and encompass a full business cycle if possible. Data may be for aggregate deposits, or they may be divided into types of

deposit categories. The data should be in terms of daily figures, or at least weekly averages.

These data may then be plotted on a 12-month

graph, with each year superimposed on the preceding

year's plotting. This will permit the banker to see more clearly the nature of seasonal patterns in deposit or loan activity for future reference. The same data should then be plotted on a graph covering the full historical period being revie,ed. This will provide the banker with a rough picture of his growth pattern and is the basis for establishing a program for the employment of funds. By inspection, a hard core line might then be drawn so that it roughly parallels the deposit trend, but is sufficiently below the deposit plot. so that at no time does the graph for actual deposits fall below. the hard core line (except for any extremely unusual









and temporary deposit loss). The volume of deposits falling below bha hard core i ne represents the "stable" portion of the bank's deposits, to be used in cash, customer loans, and the residual investment area, with the exception of providing for loan liquidity, as discussed below. The volume of deposits exceeding the hard core line represents the volatile area which should be employed in liquidity reserve assets,

To the extent that deposits decline, a portion of the legal reserve cash funds are released and may be used to supplement the liquidity reserve function. Whether the individual banker wishes to take this into account in determining the size of the liquidity reserve, or whether he wishes to ignore it and tus look upon such funds as providing him with a margin of protection ag-ainst unforeseen demands, is a matter of choice.

In the plotting of loans to help determine

liquidity needs, the banker is primarily interested in how high loan demand might go. Therefore, he should plot a loan ceiling line co appear above the plot of actual loans in the same manner that he plotted a hard core line for deposits. The difference between the actual loan level and the loan ceiling line at any given time represents the









amount of liquidity he should wish to retain in his liquidity reserve for loan demands. Since this liquidity is in addition to the amount of protective, cr deposit, liquidity being maintained, the equivalent of the loan liquidity assets must be established at the expense of the residual investment area.

The next step is to project the hard core line, or loan ceiling line, into the future period, for example, into the next 12-month period. Finally, he superimposes on this projection, for each monthly period, the average derived monthly liquidity need for that future month. The result is a projection of anticipated actual deposits (or loans) for the next 12-month period, and the diversion of these funds between hard core, or stable deposits, and those requiring offsetting employment in the liquidity reserve.

These estimates, of course, are based solelyr upon historical performance and adjustments in projections to current conditions should be made if warranted. In any case, until it can be established that any differences are attributable to basic (or temporary) factors, a conservative tack should be followed. If the differences are temporary, which implies a self-correcting movement, no chanZes need be made in the forecasts.









Of course, the method just described is not

the only approach that can be used, anr.! there are

undoubtedly many variations of this method.

However, the statistical method, in whatever

form, can be used by an informed banker to more

adequately estimate his own liquidity needs.

These sentiments can be found expressed by any

number of respected authors, although the method

may be different from that described above.

Roland i. Robinson, in The Menar7ement of Ea k

Funds, states:


Although there are a number of
ways in which seasonal influences are felt in banks, for the purpose
of ro,-h estimation the main forms of influence are two: (1) fluc;iuations in short-'term .oen demand,
and (2) fluctuations in demand
deposits. ..
The effects of these two major
factors in terms of cash demand
are opposite. The -rowth of loans
gives rise to cash demands, the
decline of deposits gives rise to
a cash demand. ...
Because the whole estimation of
seasonal fluctuations has the sole
purpose of figuring out the share and size of expected cash demands, these two factors have to be used in reverse; the seasonal highs of
loans and the seasonal lows of deposits are added to find the
cash demand.37











The American Aankers Association, in The

Commercial Barkin- Inrlustry, describes a statistical

method for estimating loan highs and deposit lows

and goes on to say:


Once estimates have been made of
the probable deposit floor and loan
ceiling, the size of the secondary
reserve can .e determined in the
followring manner.

1) Cor.mpute the difference between
current deposits and the estimated
deposit floor, and the difference
between current loans and the
estimated loan ceiling. The sum
of these differences, plus whatever
extra rnargin of safety is decided
uon, represents the total potential
loss of funds for which provision
must be made in the secondary reserve.
) Fro 'is total subtract any deposits
with the Federal Reserve Eank or correspondent banks in excess of
leg-al requirements and minimum acceptable balances. A further substraction can be made for the
amount of legal reserves that would be released by a decline in deposits to the estimated deposit floor. The
resulting balance is the ar-ount required
in the liquidity account.38


The list could go on,39 but the examples cited

acove are representative and sufficient for our purposes.

The major point to be made here is that each bank must

determine its ow n liquidity needs as reflected in a

study of its pest history. Each bank should determine

ow h igh its loan demand might go and how low its










deposits vcht go (perhaps taking ino 3 account the adjustments mentioned above) in order to determine how minch l iqui ity _it woul need under adverse (but not crisis) conditions. The effect of risk exposure (capital adequacy) on the size of the secondary reserve will also vary among individual -banks.


Liauidity Standards


A subject that should be brought up at this point is the supposed existence of "formulas" or "ratios" for determinir.- th proper size of a secondary reserve. I. Laurence clb, or use th-e folcin; formula whiile at the Elmira Ean> and Trust Cmpany in Ne York:
omo.v New Yr.:


Secondary Reserve shall consist
of prime ommercial paper, call
loans, Cankers accepbances and prime bonds and noces maturing
within -our years. These reserves shall not be less than (a) 24<. of all Time and Demand Deoosit. plus
(b) 5C' of Public Deposits. '


Donald R. z-c gan, in Commercial Bank Loan and Investment Polic7, makes mention of bank "ratios" such as the "total investments to total assets" ratio and the governmentt bonds to total assets" ratio, Charles L. Prather also men-tions these









ratios in his Voney and anin. Euene H. Buris, in an article espouising "S3lentific Lanagement Policies" for commercial banks, stated:


From banking experience it has
been concluded that, generally speaking, 35 per cent of demand
deposits and 10 uer cent of time
deposits represent proper
proportions to be invested in
quick assets readily convertible
on occasion *o meet ordinary
withdrawals. 3


These references see.m to hint that there are certain minimum "liquidity ratios" that a bank should or must adhere to. The fact that the banking industry is heavily regulated would seem to support this vie- Towever, this author was not able to find any evidence which woulf lend support to this proposition. There are certainly

no legal requirements for commercial banks to maintain some minimum liquidity ratic (aside from

primary reserves). In response to this author's inquiries on this subject, Mr. Frederic Solomon, Director of the Division of Supervision and Regulation of the Federal Reserve System, had

the following to say:


The loan-to-deposir ratio to which
you refer has been used for many years
by bankers and bank supervisors to










demontrate the e:teni bo wicoh a bankhas used it-s available resources 'o acoomodate tbo it needs' of its custoeIers. Tu'e resu4tion is t!at
th .i deposits, .he lss ,tle a ban ill.
be to eet a oal ci c n r! ' d

sus-aine , i.or :n7ely Ini (h ratio
7ay' re -an i prolo.ed and oontinuots oorro.n i, a auestienl e practice for

There is no s andred loAn-to-decoast
rati a lie1 universally by bank:
su~r io rS a~ h " jea O Y ition for cn; "en ank. The overa-e rati(
for all icmrcial bets.. s omtio
us as a 'ui~ s ~'i ra o ranzin .2 oo far' beyorj "he a.Yrage are~


.- o' ca. A ratin J, say, 7?



;.77 Oq : r7i7 "s -,' n t , 7,t _ -'-l' 0 o l L; - ol. i l .:t .
M ~ '0r '.r , -] 0.11 ' . 2 rUIT '.- 4 ,


f,:l. h- ^ sh - , Cri p,
isOclerly "eno i t'he.ac",r o f


other ; ato Ksllo rev an s

ro i ......t. n.C rule of thumb can e
esta~bTi s.hed, to :measure allI b~ank_. ...,
e to of cash ssets and n

cconern:rt e ut0i .CS tal e....
to :'ich yo: refeNr la only infrequentlyr
se!by back outeorvisors,
... To arraise th- l*1i.tty require::ents of '-n individual Uank on. .e . to
know"te-endosly acr#e about-' the tn
ihan 1ite' of >xee -. a0.tLios, o" y
other ratios, cam l-,


n rot,. t e fore];oan o " i "ion thi ato. ay rion c o n cl u l e.. t h a t ?-. e r e a r e nio " S t a n i a r" l i qu"i t r a t i










in the American banking system. if any such standard exists, it is an informal ore. Actually, it is quite reasonable to suspect that there moy ell be an informal liquidity standard in the system in the form of the "industry average." It is quite likely that most bankers would hesitate to deviate too far from the industry averages in their loan and investment policies, either through fear of disapproval by the regulatory authorities or through aderence to "conservative" banking practices. Discussion of this subject, however, is put off until a later chapter.45


Other Bank Assets Pr Liuidity


At this point one might ask the question: Why should a commercial bank' plan on meeting all of its liquidity requirements from the seecnlary reserve? Certainly there are other assets held by a bank that generate some liquidity (see Exhibit 1). The repayment of loans comes immediately to mind. We will consider this subject by looking at each of the different types of assets held by a commercial

bank in turn.

Banks carry accounts with correspondents for a number of different reasons, such as to provide clearing facilities for customers, to have the










EXHIIT 1

CONSOLIDATED BALANCE SEEET OF LARGE EABER
COMMERCIAL BANKS, DEEMBER 24, 1968

(In millions of dollars)


Assets


Lo-ans
Commercial and Irndustrial
Agricultural
For Purchasing or Carrying Securities To Financial Institutions Real Estate
Consumer Instalment Foreign Governmzents All Other
Valuation Reserves
Total Loa-ns Investments
U.S. Government Securities
State and ,uniipal Securities
Other Bonds, Stocks, and Securities
Total Investments Cash Assets
Reserves with F.R. Banks
Other Cash Assets
Total Cash Assets All Other Assets
Total Assets


Liabilities


Demand Deposits Time Deposits Borrowing s
From F.R. Banks prom Others Other Liabilities Capital Accounts Total Liabilities and Capital Accounts


, 73, C'0
2,017
8,577
17, 646
3" 2,9Lh.
18,567
1,125
14,058
3,237
.66, 995
29,160
3L,517



16,602
3/5,767
4 52,39
10,8 67
3295,115



$112, 21 111,854

24h
11,214 17,808
21,8L2
7295,115


Source: Federal Reserve Bulletin.









services of the corresondent in the form of execution of buy and sell orders in LUe securities markets, and to obtain custodial and safe-keeoing services for securities. The bank which provides these services incurs costs in doing so, and will either charge for them directly or require that the benefitting bank keep a sufficient average minimum balance to provide an opportunity for the correspondent to hold enough earning assets to provide commensurate compensation. These balances held with correspondents can be used

to provide liquidity to meet a loss of funds. Usually, however, such balances are held at levels commensurate

with services rendered and offer only a very limited source of liquidity.,46

Cash in vault is sterile as it earns no return, and commercial banks generally try to hold it to minimum levels. Excess stocks of vault cash are costly to a bank because of the greater need for protective measures and insurance to which they give rise, and because of the income lost through failure to invest the funds. In a comprehensive study it was found that: "The interviews suggest that without exception barnkers were currently attempting to hold only that amount of cash which they regarded as sufficient to meet minimum operating requirements."47









As a result, there is virtually no usable liquidity in most banks' holdings of vault cash. By the same token, cash items in process of collection are also keDt at a minimum, and are not a source of planned liquidity.

Required reserve balances at the Federal Reserve Bank obviously can not be used for liquidity purposes. However, excess reserve balances represent free cash and so are available for liquidity needs. Usually, however, banks will try to keep t-heir excess reserves
48
at a minimum.

The cash flow which arises from the repayment

of loans at maturity is one aspect of loan portfolio

liquidity. This cash flow is a function not only of the maturity composition of the loan portfolio but also of the borrowers' intentions to repay loans at scheduled Taturity dates.49 This depe s on a

customer's abilities to repay, tacit understandings with the bank, and other intangibles. According to one banker:


The liquidity of loans depends on
the pay-out prospects of the individual borrowers. We have 60-day notes which are renewed continuously so that their
actual maturity is longer than some
term loans, The maturity composition of the loan portfolio is important for public relations because it is used by
many analysts, but it is of little
practical significance for liquidity ,50










Apoa rt from hi "unre aliy f soe oan Mq ourit ies, it must be renmembered th,;t l.oan behavior has already been included in the calculation of liquidity nee.s. An expansion of' total loan vo]umc does increase the need for limqutiity and a conrac.I ion does decrease it, but this has alrea-!y been taken into account. Therefore, while it is -appropriate to include a projected loa1 decline as a source o' liquidity to reet deoosit with'draw..al s, it is not arnpropriate to consider Icn runoff as a source of funds for loan pension.

On the other han, an individual ban: could possibly refuse to 2reme a io t-at is uS Hoever, this wold be a desperate mea'sre E .oul not be emplcye chort op a :enuine risis in t'e life of a "ban. Alsc, uch action is aLost ce-rain co be 7n ineffective e ,su-e if at-cempt.e. uin a general liquidity crisis. Th maturity composi.ion of a bank's lo-n portfolio is an important factor,

however, in deterr:iin- the eligibility of loans for redisccunt. "his Iould appear to be the primary con, tributin of short 71 oan aturities .to a corercial bank's liquidity.

Traditionally the >oldi nr: of call loans repayable upon a bank:'s demanf has been regarded as a source o liquidity in the loan po'-tf'o 51 re are two










types of loans which bankers customarily write on a demand basis at the present time: loans iT4th securities as collateral and loans on receivables, In Donald R. Hodgnan's study of commercial banks52 it was found that in general, the reason bankers give for making these two types of loans on a demand basis is not to preserve the liquidity of the bank:, but to protect the bank against a sudden increase in risk resulting from a deterioration in the borrower's position or a sharp drop in the mrrarket value of the collateral. None of the bankers interviewed in the study regarded security loans to customers as callable simply to meet liquidity needs, ani only a few thought of loans to brokers and dealers as callble at the bank's convenience. We conclude, therefcre, that loans written on a demanl besis do not in general constitute a source of liquidity for a commercial bank.

In the same study bankers were interviewed to determine whether they considered the sale of loans as a possible source of cash to meet liquidity needs.-)' Among the banks interviewed (18 major banks in San Francisco, Few York, and Chicago) only three

regarded the outrigh,t sale of loans to another bank or financial institution (other than the federall










Reserve Bank) as a device to gain liquidity. Even these three eareed that such sale was considered highly unusual, The author concludes:


On balance the banks in the survey
do not look to the sale of loans as a
potential source of liquidity other than in the sense of gaining "elbow room" through narticipations. Even
here, there is the important qualification that these participations may intensify the major banks' liquidity problem in time of a liquidity crush rather than easte it. ... Accordin-ly, it appears th-at the sale of loans to
gain liquidity is a weak reed for any
bank to rely upor.S#


We may conclude, then, that since cash assets

tend to be held at a minimum, and since the loan portfolio's contribution to all but last-ditch

liquidity is insignificant, the bank must turn elsewhere for liquidity. In other words, the banlk must maintain a secondary reserve of highly liquid assets to provide for deposit withdrawals, increased loan demands, and unnecessary risk exposure,

This conclusion, however, ignores one important fact: a bank is not necessarily restricted to the asset side of the ledger in meeting its liquidity

needs. There is a certain amount of flexibility in managing the liability side of the balance sheet as well. An individual bank, for example, may aggressively









try to attract time certificates of deposit. The individual bank can also use various forms of borrowing. These include the purchase of federal funds, the sale of securities under repurchase agreements, borrowing from correspondent banks,

borrowing from the Federal Reserve, and borrow:ing through the issuance of unsecured notes.55 The management of liabilities can be an important

factor in a commercial bank's operations. In fact, the management of liabilities has come to play a very important role in the American BankIn~

Industry i.n the last ten years. We will not examine this role, however, until the next chapter, so for the present we wil assume that the management of liabilities does not- greatly affect an individual bank's liquidity position.56


Secondary Reserve Assets


As was mentioned previously,57 a secondary reserve

should consist of short-term, readily marketable, high quality assets. The commercial banker must, of course, determine what assets meet these criteria. There is no formula that can be applied to decide exactly what assets should be included in the secondary reserve. There is general agreement, however, as to what type of assets can be included in the secondary reserve.










The Bankers' Handbook, for example, states the following :


Typically, the liquidity account
includes U.S. 'reasury b l2s and
other Treasury and federal agency
securities of short (less than
one- or twio-year) maturities,
short-term high quality municipal
obligations rith broad market
acceptance, commercial and finance
paper, bankers' acceptances, broker
and dealer loans, Federal funds sold,
and securities purchased under
repurchase agreement (RPs).58


Lists similar to this can be found in a number of other references.59 r ost of these authors agree on the general type of assets that may be included in the

secondary reserve with perhaps oe exception. There is some disagreement as to whether medium-term and long-term U.S. overn:ent securities should be considered as part of the secondary reserve or as part of the investment (residual) account.

Some authors feel that medium-term and long-term U.S. Government bonds should never be included in the secondary reserve. The definition above, for example, excludes all securities that have maturities of longer than two years. J. Harvie W'ilkinson, Jr,, states that only prime securities with short maturities -- no: more than four years -- are eligible for the secondary reserve. Ke further states that all medium-termn arn long-term U.S. Covernrent obli-ations will automratically











be excluded from the secondary reserve since they have 6o
maturities of more than four years. Raymond P. Kent is in complete agreement with this view, and states:


Treasury bonds are not generally
reared a s includable among secondary reserves at the tie of their original
sale or when, in any case, they have
several years to run to maturity.
They are not liquid in the sense of
early assured repayment of the
principal, an2 their markl:etability
is in cuestion -- in the sense ... 61
of salability at no appreciable loss.


Cther authors feel that the 'hole concept of using long-term Government bonds as part of the secondary reserve i's in violation of every principle of a well organized banking structure.

The logic behind these pronouncements is that the market values of long-term bon s -- including U.S. Government bonls -- fluctuate widely. Thus, even though U.S. Government bonds are essentially riskless as to default, changes in the interest rate structure can result in wife fluctuations in their prices. In a period of rising interest rates (and fallin- bond prices) a commercial bank would not be ,willir to sell its lcng-term U.S. Government bonds, for to do so would result. in a capital loss on the bon-s (assuming they were purchased when prices were hih).










This is not the only side of the scory, ho-.ever.

There are other authors who feel that all U.S. Government

bonds should be included in the secondary reserve. The

reason is that U.S. Government obligations are excellent

collateral for loans at a Federal Reserve bank (or at any

other financial institution for that matter). Existing

regulations provide that U.S. Government bonds shall be

accepted as collateral at all Federal Reserve banks at

par regardless of what the market price may happen to

be. 62 This means that, in effect, there is a lower

level below which the collateral value of U.S. Government
6'3
bonds cannot fall, 63 Dr. Paul M. Atkins, in a:n article

for The ankers v.:az n,- had the following bo say about

the suitability of long-ter-D U.S. Governmen-' bonds for

the secondary reserve:


... United States Government securities
are also desirable for a secondary reserve. ... -e~ long term issues,
however, are very sensitive to fluctuations in interest rates and hence are likely to fall rapidly in price ;with a rise in interest rates. They are, nevertheless, very suitab-le for tihe secondary reserve of a bank because
all United States Government issues -lor and short term alike -- are eligible
to secure loans at the Federal Reserve
bank.s. They are, moreover, the only
securities which are eligible. Their
possession, therefore, adds substaytially to the liquidity of a ban'.,









It is impossible to say which of the twc views

presented above is correct, or even which view is more correct than the other. It all depends on hcw you want to look at it. For the purposes of this study, however, the latter view must prevail.

There are tree reasons for accepting this view. First of all, as was mentioned, all U.S. Government securities are excellent collateral for loars at the Federal Reserve banks and other financial institutions. Since these securities are eligible to be discounted at par at the Federal Reserve banks, any banker may use them to obtain funds at no loss regardless of what the market price of such securities might happen to be, Hnowever, since orrow. at Federal Reserve banks is considered to be a privilege to be exercised only for short periods of time,65 using such securities as collateral for loans at the Fed is not an appropriate source of liquidity for long-term loan expansion. Nevertheless, this source of liquidity is very well suited to the seasonal needs of many commercial banks. For example, an individual commercial bank may find that it is pressed for cash because of deposit withdrawals or heavy loan derands at a time when the market value of its long-tern U.S. Government securities is lower than the price that was paid for










them. At such a time the bank might Cell prefer using

these securities as collateral for a loan until the

pressure subsides, waiting for a more opportune time

to dispose of the securities. Also, in times of dire

need, the Fei uould certainly accept such collateral

for as long as was necessary.

Secondly, Florida ls' states that commercial banks

operating under a State charter must keep a primary

reserve (cash reserve) amounting to at least 20%

of the a7gregate amount of its deposits in the form

of cash and/or bonds and securities of the United

States and bonds and securities guaran4.eed as to
/
principal and intc-rest by the United States. The

wording of the statute is as follows:


Every bank shall at all times have
available in cash an amount equal to
at least t-enty per cent of the
aggregate amount of its deposits.
Such portion of said r-serve as the bank may desire :-y bp invested in bonds and securities of the United
States and bones and securities guaranteed as to principal and
interest by the Unitet States, owned and unpledged by the bank, or which arE in e-cess of the total deposits
,which they are pled7eA to secure,
and balances payahble on demand, due to t.he company from banks with whom
such coIpny may keen its current
account. O


1f al'l U.S. Gover.nm-nt bonds can be counted a "art of

a bank's primary reserve (in ' lorida), then such bonds










are certainly good enou-h to be counted as ,pari; of a bank's secondary rese-rve.,

The third reason (,zhich is actually an extension

of the second) is that the one-hundred fifteen co-nmercial banks which form tIe sa ple used in CThater TII of this study are all state banks chartered in Flcrida,


Conclus i o s


We are no-,, in a position to dra: some conclusions

about commercial bank secondary reserve accounts. first of all, "secondary reserve" is not a rec ise tern, an' has never been lea2ly defined. NIevertheless, there is general agreement in the inustisry Tha a eccnar reserve causists of short,-er-, readivy markIs abe, hi.h qual ity assets.

Second, a seconlary servee -srver Lhree -ain functions: (1~) to provide a bank with a source of funds with which to meet deposit drains; (2) to p:oovide a bank w a- a source of funds it"l hich to meet incressea lcan .ea); (3) o OreveenT capital impairment th ru.. the forced sale of assets at below-coSt -rias nd provide for a satisfactory level of risk e,:osure. Protection against depression is nob a function of a seconiary reserve as it is impossible for co-mercial banks to maintain su-'fficIent









liquidity to meet excessive withra:als brought on by a liquidity crisis.

Third, the size of a bank's secondary reserve depends on the nature of the deposits of the bank, the size and condition o- the loan aCY discount portfolio, and the position of the business cycle. Each individual banker must determine his own

liquidity requirements by anlyzing hic bank's past history and the environienl ..ithin which his bank operates. This analysis should include a stat-istical analysis of past aeoosit and loan act.ivityr with a projection of thiee data into the future, in the finel anal73is, this is a case where good judgment btsed on e~nerience mu t be app lied.

Fourth, it is possible that .mIerican banks adhere to an informal liquidity standard in the form of the industry average, if this is so, it means that most banks do not determine their own liquidity needs, but rather rely on the industry average (and perhaps regulatory prodding) to tell them how lar-e their secondary reser-ves should be. This subject is discussed in Chapter III,

Fifth, the secoonary reserve is a bank's

primary source of liquidity as none of a ban>'s









other assets -- including loans -- can be exoece. to contribute anything but an in significant amount to a bank's liquidity.

Sixth, it is possible that a bank may obtain some decree of liquidity through the effective management of its liabilities. This subject is discussed in Chapter II.

Seventh, for the purposes of this study all U.S. Government bonds will be counted as part of a bank's secondary reserve.










Notes


1. Paul M. Atkins, "The Scientific Organization of a Secondary Reserve," T .ankers aazi, CXXT, No. 2 (August, 1930), 217.

2. Ibid.

3. Paul 7. Atkins, "Secondary Reserve Policies and P ogra-s," Th --ank rs . azine, CXX IX, No. (December, 1939), 679.

.4, J. Harvie W"'lkinson, Jr., Investment Policies cr Comri...al >ans (Hew, York: Harper and Brothers, 193~3), 13.

5. Charles L, Prather, moneyy and ~okinr (Chicac o: Richard D. Irvin, TInc., 19 49), 327,

6. For e a-ole, see Dor'ald R. Hod-man, omerci-l Bank oan Iv Fset olricy (Chamnaign: Univers 4 of Illinois, Io), .0-b;: cland I, Robinson, ..e IM-ana e z'ement of en- . ..s < Tw Y -orks � Gra- ill, ' 162) 23-92; and -. ark;r ,ilis, . r.C. i a . kin (hie.:.: . LaSalle Extension ,Univrs, ty, 191, 1--76.

7. The A:-er:ican Bankers .ssocat ior, Te Corercl Eank - I...., ldus-rv.. ( En woodd Cliffs , ,.J : Pren- i - _-, ll
1 i719 T7_ s,.*
Inc., 1962), 2, -,

9. A more d e iied discussion of the es of
assets found in the secon ary reserve can be foun in a later section of this chapter.

9. Baugan and ,,alk'~r, o. cit., -2.

10. Ta-res S. Duesener.y, money and Creci,:
Ioact- anr' Con.tol (E~e ood Cliffs, N.J.: ren1, tice-eall, Inc., 1967), T2.

.1. Rollin . Thor as, Our modernn 7ankin ad :one ary System (Yev Yor,-: Frentice-Hal1, Inc., 1950), 21,4.

12. The A-erican Bankers Issociation, op. cit., 271.

13. Ibid.


14. See Robinson, o. 0. , 23-40.










15. Ibid,, 23.

16. Ibid,, 26-27.

17. Ibid., 60.

18. Ibid., 63.

19. Otherwise, time deposits would not be
profitable, given the low rate of return on total assets in the banking industry.

20. Paul '. Atkins, "The YIeletion of Deposits to Secondary Rserv_," The B~nlkers Macazine, CXXI, No. 4 (October, 1930), L79.

21. For a more detailed discussion of this, see Baughn and Walker, o. it., 568-72.

22. Raymond P. -eit, moneyy and anin (ew York: Holt, Rinehart and W'.4int,0cn--, 297.

23. od an, o . -L., 57.

24. ibi(d. ?b.

25. or a re detailed dis.s.o. cf t.s s4c, see Thomas, o. cit., 220-27

26. Char les Ash'ley Tr.It, "EL Liquidi and he Eccles Bill," The akers a azine, NotX, N. 5 (Nay, 1935) , 52P-29.

27. Ibid., 533.

28. Eugene H. Burris, "Do arn- Secondary Reserve Theories Need Revisin:?," The Bankers Eaazine, CXXII, No. 6 (Decenber, 1931), 736.

29. See -augthn and' '!alker, on. t. 562-77.

30. Prather, on. ci., 324.

31. The American Bankers Association, co. cit., 271.


32. See '!ilkinson, on. cit., 17-23.









33. Prather, on. cit,., 328.

34. Paul M1. Atkins, "Seconlary Reserve Policies and Programs (Part I!)," T.he an rs Ma:aine, CXL, No. 1 'January, 1i940), 7-5.

35. IMS., R.
36. The following method is a synopsis of the approach described in Baughn and W;alker, on. cit., 572-77.

37. Robinson, o. cit., 64-65.
38. The American 2arnkers Association, o. cit., 278-79.

3,. For exampe, see Hodcan, on. r it., 46-53, or L. Sumner Pruyne, "Framin: a Flexib'le Banik Investment Program," Eurroughs Clearin cuse, 35, No. 1s (January, 1951), 32-33.
40. J. Laurence IKolb, "Setting Up a Bond Account Formula," Eurrou -h arin s, 25, No. 2; (January, 1941), 13.

412. Hodg,.an, o. Cit., 0

42. Prather, oc. cit., 277.

43. Eug-ene -. 3urris, "oa's Bank Investment, Program," The Bankers Ma Lzine, CXX, No. 1 (January, 1930), 14.(
44. From a personal letter to the author from Mr. Solomon.
45. See Chapter III.

273. 46. The American Bankers Association, onp cit., 273.

47. :-odgman, on. cit., 56.

273 S. The American Eankers Association, onr,. cit., 273.


49. Hodgman, o. cit., 57-58.









50. Ibid., 58.

51. Ibd., 59-60.

52. Ibid., 59.
53. Ibm., 60-61.
54. Ibid., 61.
55. Baughn and 7alker, o. cit., 581.
56. There is a good reason for making this assumption as will be made clear in Chanter 7I.

57. See page 15.
58. Baughn and Walker, on, cit., 581.

59. ?or eianple, see Paul M. Atkins, "Secondary Reserve Policies and Pro-raas (Part II)," The Bankers Magazine, CXL, "'o. 1 (January, 194 0): ilkinson, on. cit., 13; m'he American Eankers Association, or. cit., 27'4-75; Paul i. Atkins, "Te 3 c entific Organzation of a Secondary Resrve," The Bankers 'arazine CXXI, No. 2 (August, 1930): Fau . Atkis, "Secnar Rseve Program," The ankers Taazane, CXL, No, 2 (Webruary, 1940); and Richard 7. Stern, "Comrcn Errors in Portfolio Management," The pariker: eanzine, CXXXVII, Nc. 1 (January, 1939).

60. Wilkinson, o. i'., 13.
61. Kent, op. cit., 305.
62. See Board of Governors of the Federal Reserve System, "Regulation A: Advances and Discounts by Federal Reserve B nks," Code of ederl Re- 'ilations, Title 12, Chapter II, Part 201,
63. Paul 1. Atkins, "Secondary Reserve Program," The Bankers Tacezine, CXL, No. 2 (February, 1940), 109.
64. Paul M. Atkins, "Difference Eetween Bank
Secondary Reserve and Investment Accounts," The bankers Magazine, CXXI, No. 3 (September, 1930), 345. Also see Paul M. Atkins, "Liouid Assets for the Secondary Reserve," The Bankers 7azazine, CXXIII, No. 3 (September, 1931), 341-42.





58



65. See Chapter i'.
66. Fred O. Dickinson, Jr., Comptrolle2 and
State Comrmissioner of Bankng, Laws of the State of Florida, Banki g Code, Second Part, Paragraph 6~5.6 (Tallahassee: 1968), 71-72.





























C FAPTER TI I
THE INDUSTRY 'T"EE1DS: 1953-196S














T Li l "ir of tIe YS Ctem


In order to determine thie chan:7es in the liquidity of the American banking industry over a period of time it would be desirable to tabulate the secondary reerves held by the system for a number of years. In crier to do this it would be necessary to nave a detailed breakdown of the assets held by the baking industry. Unfortunately, such informati i is not available. 1 The Federal. serve does report t -e principal asses and iab1 cities of a- - commercial bar-ks on a monthly
2
basis, divid ed into four g-roups: loans, U.S. Covernenisecur iCes, other securities, and cash assets (ciroed reserves an s rese-ve ). ,rince U.S. Government securities account for mcre than niner.cy percent of the liquid assets of all commercial banks, total U.S. Government securities hel are used in this chapter as a substitute for secondary reserve and as a measure of the liquidity of the banking system.

The amount -of U.S. Government securities held by commercial banks, as a percentage of total assets on a mont.ly basis for the years 195 t hrouh 196, is presented in Table 1. These same data are -resented on a quarterly'. basis in graphic form in Figure I.

60









TALE 1

U.S. GOVEENKENT LCNDS rEL BY CCM:ERCIALAKS, 1953-1968
(As a Lercentage of total assets)



1953 1958 19 55 1956 1957 1953 1959

January 35.1 34.7 34. 4 30.0 26.9 27.1 29.0 ebr ary 3- 4.6 34. " 33.7 29.3 27.3 27.2 23.'
ach 34.1 3, 32.8 28.8 26.9 27,6 27.
::,arch 34+.1 t . April 33.5 3.9 33. 0 2.6 27.3 28.2 27.3 "ay 33.3 3. 9q 28.2 27.2 22.6 26.9 June -- 3 .3 ?1 . 27.5 27.2 .2 26.2 Julv 25.1 3.0 1.9 97.7 24. 22.6 26.1

A3' v3t.3 31. 3 2" -r 26 293 2.
Au ust b,, 35. ' 1, -2. -2-. * Sept:mbr S,. 319.? 30.9 27.5 26.6 28.7 25.0 October 3". 35.5 31-1 27.5 26.4 28.9 25.2 November 38.5 35.1 30.1 27.7 26. 29.0 24.6 December 33. 34.0 29.2 26.9 26.1 27.8 24.2












TABLE 1 (Continued)


1960 1961 1962 1963 1964 1965 1966 1967 196k 24.6 25.1 25.1 23.2 20.3 18.1- 16.2 !L.4 14.2 25.1 24.5 24.6 22.7 20.1 18.0 15.6 14.L 1L. 23.3 24.3 24.2 22.5 19.9 17.2 15.0 1i.6 I. 23.6 24.4 2",0 22.2 19.3 17.0 14.8 14.0 13,6 23.4 24.5 23.9 21.'7 19.0 16.7 14.4 13.7 13.7 22.8 24.6 23.5 21.2 18,4 16.0 13.9 13.2 12.8 23.7 25.4 23.6 21.1 18.5 16.3 13.9 13.8 13.2 23.6 25.3 73.4 20.8 18.6 1,.0 -i.1 18.4 13.5 23.8 25.3 23.1 20.6 18.5 15.8 1L.1 14.3 13,4 24.6 25.4 23.0 20.5 19.8 16.3 14,0 1L.8 13.7 24.4 25.1 23.1 20.2 18.8 16.2 14.0 14.8 13.1 23.7 24.2 22.7 20.1 18.2 15.7 14.0 14.1 13.0


Source: Derived from Federal Reserve Bulletin.










FTGUEZ I

U.S. GC0ERNE ONDS HELD EL CO.CITAL EAX S, 1953-196
(As a percentae o total assets)



Percent Percen 40 40 38 38 36 36
34.._- 34 32 32 30 30 22 28 26 - _ 26 2. - _--_ 24 22 - --_ 22 20 20

18 _- 18 16 16

l6 1 12 12 10 5 10
1953 5 5 56 5 58 5 0 6 62" . 6,













FIGURE I (Continued)


Percent Perce nt

40 40 38 38 36 36

34 34
32 32 30 30
28 28

26 26 24 24 22 22 20 20 18 18 16 -- 16

14 --- - 14

12 12

10 10
1965 66 67 68 69 70 71 72 73 74 75 76 Source: Derived from Federa2 Reserve Bulletin.










The data for the years 1955 throh 196 1 show that there was a series of peaks an- troughs in the relative amount of U.S Gover.ment sc.urities ked by the baring system. as a whole. These rises and falls are quite easily identified wit :-ajor monetary polir changes intied y te Fed eral e.rve.

-he period 1953 through 195U, for example, witnessed a recession durin which rember bank reserve requirements were reduce several tie, proucinr a b- increase in the expa,1-sor. of reserves and roney. !'Tis brought about a peak in the amount of liquid asIet- he. by the ban:kinsystem, as U.S. overnment scsurit ies held increae, to 35.5" of totel assets i' Dooer of 1.5. _D.rin the recovery tRo followed ban loans increased and reThtv h' n; of lic ui2 ses .eased. This trend was scentuat.ed during the upsuing in 1955-1957 as the Fe. was quick to implement a restrictive policy, virtually f.reezi both the amount of bank reserves and the reserve requirements. The result was that the growth in the money sunply :, was almost corletely halted. 3e',,tween the second quarter cf 1955 and the second quarter of 1957, monetary growth was slightly under 9,0O-00',000,. Banks responded to this by selling securities in order to expand loans. During





66



1955 and 1956, banks' holdings- of securities were reduced by ,13,000,000,000, and loan- grew by $20,000,000,000. As a result, bank h1oldin?,s of U.S. Governmer nt securities declined to around 263 of total assets during 19576

Beginning in late 1957 the Federal Reserv e

again reversed its policy as it because evident that a recession was well under way. Discount rates were cut repeatedly, from a peak rate of

3.5% in Cctober of 1957 to a low of 1.75 in the spring of 1958. Three rounds of cuts in reserve requirements came in Febr ary, .arch, ard April of 1958. Once again, commerce bank hcldin~s of U.S. Government securities rose, re cin~ pea of 29.3 in Au:u-'+, of 1958.

The subsequent recovery saw: the return to a

restrictive policy, and the reserve base actually declined in the last quarter of 1959. Bank holding's of liquid assets again declined, falling to less than 235 of total assets in m id-1960. However, once recession was clearly identI'fIed, Federal Reserve policy undertook a number of expansionary steps. Discount rates, raised to 4% in September of 1959, were cut in June and again in Auust of 1960, Vault cash became eligible to be counted as part of










member banks' required rese res. The reserve base expanded, and bank holdings of U.S. Governmrent securities again increased until the end of 1961.

Thus, throughout the period 1953-1961 changes in com-mercial banks' relative holdings of U.S. Government t- securities can be largely explained by changes in Federal Reserve monetary policy. The overall -tendency of a decline in relative holdings of U.S. Government securities during this period (from a peak of more than 354 in 1954 to a peal, of about 25, in 1961) is explained by

the fact that commercial birlks were in general unloading e:ces U.S. Gcvernmericnt securities they had inherited from World Is? II an, the overly-liqui,
5
economy of the irmediate ost-war eriod.5 Commercial banks were employin their fnds more profita2bly, as loans accouned for about 35' of thie total assets of the system at the end of 1951 - and about 455 of assets
6
at the end of 1961.

From 1961 on, however, changes in commercial bank holdings of U.S. Government securities cannot be so easily identified with. monetary policy. Be ginni ng in late 1961 and continuing through 1965 there' was a steady and rather steep decline in commercial banks' holdings of liquid assets. At the same time, this was









.7
a period of relative monetary ease and expansion. After 1965 fluctuations in banr holI r-'s of U.S. Government securities aain correspond to changes in monetary policy with lols associated with monetary restriction (Stummer of 1966 and Sprinl of 1963), and high.s associated with monetary ease (2,: r of 1967 and Summer of 1968). Nevertheless, the total volume of U.S. Government securities held by the baenkin system remained relatively low throughout this period. W'Je must look elsewhere for an explanation of the rapid decline in commercial bank "liquidity" that took place in the 1960's.

Part of the ans;,er is revealed by an analysis of the liabilities of commercial baks cver the period 195-196 , Time deposits held by coiercial banks, as a percentage of total assets, are tabulated in Table 2 on a monthly basis throughout this period. As was the case with U.S. Government securities, these data are also presented in graphic form in Figure 2. It can be seen from these data that time deposits have become increasingly important as a

source of funds to the banking system. At the end of 1956 time deposits accounted for slightly more than 23, of total commercial bank resources. By the end of arch, 1968, time deposits represented










TABLE 2

TITIE DEPOSITS !ELD BY COr 2ERCIAL 3AN KS, 1953-1968


(As a percentage of


total assets)


1953

January 23.0 February 23.1 March 23, 4 April 23.9 May 24. O June 23.8 July 23,6 Aui- ust 23. September 23.6 October 23.8 November 23.4 December 23.1


195 1955 1956 1957 1958 1959


23.8 24.1 24.5

24.5 2?4.7

24. i


24.4 24.2

23.8

23.3 23.3


23.6 23.9 24.3 24.0 24.2

24.2


24,2
2' , 2

24.0 23.6 23.1


24.0

24. 2 24.2 24.2

24. 3 2.
,-. 1, I
21.

2 .6 24.3

24.3 23.8 23.8


24.9 25.1

25.5

25.3

25.7 25.9 25,.
2 r, . *


26.1

26.2 26.1 25.3


26.7 27.0 27.2 27.0 27.6 27.1

2 "
2?.0 27.9

2?3.0 27.3 26.9 26.6


27. 27.7" 28.1

27.2

28.1
28.3
28.0 2< . 0


27.

27.3 27.4

27.1












TABLE 2 (Continued)


1960 1961 1962 1963 196h 1965 1966 2967 1968 27.8 29.2 31.6 34.8 37.3 38.8 40.3 41.6 '2.3 28.0 29.4 32.1 3.9 37.5 39.0 40.4 '1.9 42.9 28.5 30.3 33.0 35.6 37.5 389 L1.0 42.4 43.3 28.1 30.2 33.0 35.8 37.8 39.3 ho. 42.2 42.9 28.4 31.1 37.5 36,0 38.0 39.6 41.4 42.3 b2. 28.5 31.3 33.4 35.3 37.2 38.8 40.2 22 41.5 28.5 31. 34.0 36.0 38.3 40.1 41.3 42.6 42.1 28.8 31. 34.3 36 .8 38.4 0. 1 83.3 42.8 28.7 31.1 33.8 36.1 37,3 40.1 41,2 42.6 42.2 28,5 31.2 33.5 36.5 38.0 40.2 41.0 -2.7 42.3 28.4 30.9 33. 7 36.0 37.4 40.0 0.2 42.6 42.1 27.8 29.9 33.4 35,6 37.0 39.2 39.7 41.0 40.7 Source: Derived from ?ederal Reserve uet n.










'TC URE 2


(As a fercen ze cf total assets)


Percen

50

48 ' 6 46


42


38


!YD]~0 -'- - :
f5"-5;1 5 3 56 57 5�59 606 ! %263


Percent

5o 0 L6













FiCUEE 2 (Continued)


Percent Percent

50 50


1965 6- 67 68 69 70 71 72 73 74 75 76 Source: erived from Federal Reserve Buietin.









TABL S 3
TOTAL ASSETS 3O ALL C0,ERC IAL .ANKS, 1953-1968


(In millions of


, dollars)


1953 1954 1955 1956 1957 1958 1959 January 179 185 200 203 207 213 232 February 179 18L 198 202 208 214 231 March 178 183 196 203 207 217 229 April 175 183 199 203 210 223 233 May 175 184- 197 203 210 221 232 June 179 191 199 206 208 228 232 July 180 190 200 203 211 224 234 Auus.t 10( 191 200 204 211 226 234 September 183 193 200 207 211 225 237 October 183 198 202 208 212 228 236 November 185 200 204 210 214 232 237 December 190 202 211 21~ 223 239 242











TABLE 3 (Continul)


1960 1961 1962 1963 1964 1965 1966 1967 1968 235. 24? 267 285 305 334 367 390 437 23 250 269 288 306 336 368 392 435 233 2264 266 288 309 342 369 395 435 237 249 269 289 311 342 374 401 42n 235 251 269 291 312 343 373 6 237 252 273 300 322 355 385 ,-12 57 239 255 272 29, 315 3L6 330 41 4.7 240 2'L 272 293 316 3 8 3'1 2 4,6 243 261 27S 300 32 354 381 9 465 246 262 285 301 326 358 382 b22 472 247 264 283' 307 331 362 387 425 479 258 274 290 312 340 372 398 Lhb3 492


Sour-ce: Federal Eser' ulltin.










FIGURE 3
TCTAL A-STS AND TITE ?EFOST OF ALL CCERCIAL BANKS, 1953-1968

(In millionrs of dollars)


600 560 520 &8S 0
440

400


560 520
480 440O 4 00

360o 320 280

240

200 160

120 80

40o


360
-- 320
- - 280

260 200 160
---- 120

- 80
40
______ ____o


1953 5L 55 56 57 58 59 60 61 62 63 6L


Dollars 600 -


Dollar.


Total assets - -- -Time deposits -------------------













7IGURE 3 (Continued)


Dollars 600 560
520


480 440 400 360 320
280 240
200 160
120 80


Dollars
600


560 520
L3 0 440


400
360

320 280 240
200 160
120 8 0


1965 66 67 68 9 70 71 72 73 74 75 7 Source: Derived from Fel eral Reserve bulletin,










more than L43C of the total resources of the banking system, almost doubling in relative size, An analysis of the data found in T'abl 3 and Figure 3 makes this increased reliance on time deposits as a source of funds seem even more startling.

The total assets of all commercial banks are presented in Table 3 on a monthly basis for tbe period 1953-1968. The growth in total assets is plotted against the growth in time deposits in F igure 3. :Eetween the end of 1953 and the end of 1960 the total assets o the banking system increased by slightly less than 6' while time deposits increased by ao 3t 63$. During the next eir;ht years, however, tKe total assets of the system increased by more than 93, and time deposits increased by more than 182.- Thus, starting in the early 1960's, not only did time deposits come to play a much more important role as a source of bank funds, but they also took on this role at a time wfhen commercial bank assets began to grow at a much faster rate than had been the case in the previous decade. The early 1960's were, in fact, a time during which far-reaching changes w'ere taking place in the American barkin- system.










The Challeo:,re of Co etitcn


Throughout the decade of the 1950's it became

more and more evident to commercial bankers that -they were operating in an increasingly competitive environment. Large companI es that previously had relied on ban! credit were firdng that they were generating enough cash from retained earnings and depreciation to meet all of their needs, wThile others were going to the com-,ercal p.aper market for their cash reeds. Lar:e companies were also beginning to finance their own cu.s omrers, with the result that accounts payable "-ad rcolaced bank Icans as the major short-tr, iabil-it of many ,'al' e i fi-s by tle end of the decade.' Vany firms, lare and small, were finding 7 it worthwhile o re_.uce heir checking acco,.it balances and placE their excess funds in earning! assets such as Treasury bills and commercial aer. In addition, individuals were bec omin mrloe schisticated, and wer finding that they too could earn a return on excess funds t ' at formerly were left in demand deposits, Finally, and most important, commercial banks wvere havinto compete with oher financial inclitluicns 'for funds. Savings a:ns and savings and loan associations









TALE 4
CLNGE II PERCE-T OF SA'ITNGS 0 7OUSEOL7S TI KS
AND SAViTCS TIm LOANS, 1 96 r'UG:- 1965


Savings of House- o lJ S
in ?anks Change in
and S & Ls Percent Percent
(billions) in Earks in anks


1945 1946 1917
19!88 1949 1950
1951 1952
1953 1954 1955
1956 195?7 195? 1959
1960 1961 1962 1963 1964 1965


34 5 39.3
41. 7 L3.2 4 4. 8
40.8 46.3 49.8 55.6 61.7 68.7 75.2
82.4 92, L

12.3
139.3
"-58.9 177.? 19.6 216.6


78. 55
78.12 76.50
74.54
72.12 69.76 67.67 65.4-7
63.05 60.26
56.98 54. 65
53.76 52.11 50. "A4
49.10 89.53
48.685 4P.8.22 L-9.08


-
- .L3
-1 .62
-io/
-1.96
-2 44


-2.42
-2.79
-2.95
-2.43
- .33
- .89
-1.6
-2.07
- .94
+ .43
- ,46
+ .86
- -
4- /Z


Smirce: The ITatior~a1 r~Yi ri-- Pevie;c, D~ce'Ther, 1966. 134.


Source: The Nlaticnal


1966, 184.










had in many cases entered the c rcial banks' here of consumer credit lendin7, either directly or through the indirect method of mortgage refinancing.

Eet.een the end of 'orld 'ar ITI an 1961 nonbank financial institutions grew more t-an four times as 10
. .... ,,o , - L.. - i s i unions fast as commercial banks. 1 .utual thrift institutions enjoyed important competitive advantages over commercial banks, incluAtInS a ,rivi1legeI tax position, exemption from the cas reserve requirements imposed on member banks, and freedom from restrictions on the rates they could pay for savings. As a result, as can be seen from Table 14, the percent of savings of households in commercial banks creased from 7.51 iu 1945 to less than 50.0c in the early 1960's.

During the early 1060's several changes occurred which enabled commercial banks to compete more effectively w-it. nonbank financial institutions, including certain regulatory changes. During the 1950's the reserve requirements on savings deposits in member commercial ban's varied between 7, and 5~. During the early 10oo's4
During the early 19~'s these requirements were lowered to If, and in late 1960, member banks were permitted to count all vault cash as required
11
reserves.










Throughout the postwar period commercial banks have paid federal income taxes on the same basis as other firms, with the exception of relatively modest tax-exempt allocations of net income to loss reserves. On the other h and, savings and loan associations were permitted tax exemption on virtually all allocations to reserves and undivided profits until 1963. Beginning with 1963, the amount of net income that savings and loans were able to transfer to reserves andr undivided profits on a tax-exempt basis was significantly reduced. As a result, the ratio of federal income tax payments to net income for savings and loan members of the Federal Home Loan ?ank System, which equaled .0000 for 1962, rose to .14177 for 1964.12

The competitive position of commercial banks

also benefitted from liberalization in restrictions on investments in conventional mortgage loans by national banks. Prior to 1964 national banks were not permitted to invest in conventional mortgage loans with loan-to-value ratios in excess of 60 and terms exceeding 10 years, and even then the amount of such loans could not exceed 60% of time and savings eposits or the amount of capital, whichever wa . reate . Since late 19~4, however,









TABLE 5
YIELDS ON SELECTED LOG-TER SECURITIES, 955-9


Convent ial FHA Insure
Home Tome
Mort age Mort ;age Corporate Loans" Loas*, U.S. Bonds Uc ?onds


1955 1956
1957 1958 1959
1960 196?.
1962 1963
1964
1965


. 0516 .0534
.0583
.o572 .0593
.062Li .0599 S0593

.0502

.0581


.04,79 .0542 .0549
.057 .0618

.G581 ,0563 . 547 0 5 45,

.0545 0 . 5 ,5


.0282 .0308 .034?7 .0343 .0407 .0Li01
.0390 .0395



.0420


.0306 .0336

.0389 .0379 .0438


.0Lk35 .0 ,33
S0426 .00 .0o4L'9


Source: The ,atioinal ankin Review, ' ceber, 1966, 188.
*U.S. averages, besed on GHA field office opinions.
**The series for U.S. bonis are averages of deily figures for bonds maturing or callable in 10 years or more. The series for corporate Londs are Moody's Investors Service series for Aaa rated securities,










national banks have been per.,:itted to invest in conventional mortgage loans with loan-to-value ratios of no more than ? and maturities of no more than twenty-five years. Such loans have been permitted to equal up to 70, of time and savings
13
deposits.13

During 1965 the Federal Home Loan Bank Board

placed ceilings on returns to severs paid by federally-chartered associations wh" ch took part in plans permittin- different returns on various accounts. Prior to this time savings and loan associations had been generally free fr Xi.
restrictiLmns on returns to savrs,

Ano;er important factor in improving; the

conmpetitive position of commercial banks was the relative decline in home mortgage interest rates during the period 1955 to 1963. As shown in Table 5, interest rates on home mortgage loans, especially conventional home mortgage loans, declined relative to interest rates in general during this period, which greatly aided commercial banks in the price competition for savings.

Also of importance is the fact that commercial banks began to accept greater credit risks during the second postwar decade. This acceptance is









TABLE 6
PER~'CEN Co "INAN:1CIAL ASSETS OF 000N~EECIAL 3ALKS AND
SAVINGS APD LOANS I- N ATOR AS, CATE-O ,RTE
AT YE ..R , T LE0 TET yE S



1955 1958 1961 1964

Commercial Ean s "

Member Eank Reserves 10.8 9.4 8.1 6.9 Interban: Deposits 8.2 7.9 7.0 8
U.S. Governent Securities 31.5 30.1 26.4 20,5 State an unicpal bonds 6.3 7.2 7.8 10. Corporate onds .8 .6 .3 3 Loans 38.9 L-1, 46.3 51.8 Bank Loans, n.e.c. 21.0 22.1 2.8 27.4 Shortage Loanrs 10.3 11.0 11.6 13.4
Federaliy-Suported 6.5 6.7 6.8 7.6 Con'venional' 3.8 4., 4.8 5.8
Consumer Credit Loans 6.5 6.9 3.2 9.0 Other Lceans 1,1 1.1 1.7 2.0 Security Crog> 2.5 2.0 2.4 2,6 7'el:ios ?inancial Assets .9 1.2 1.7 1.7

Savings an: Lean Ssciations"

Demand D7eposit and Currency . 3.3 2.6 2,3 U.S Gover~ =ent Secrites 6.6 7,6 6.9 6.4 Loans 84.6 84.I 85.1 86.0 o-ta Loans 83.3 82.7 83.8 84.
Federally-Suporte -19.9 16.7 13.7 9.6 Conventi onal63.4 66.0 70.1 75.3
Consumer Cr~ t Loans 13 1. 1 1.1 iseaneous nancia1 Assets 5.0 5.1 5. 5.2
Misellaneous ?Financitai A s sets <. ,, 0 5.


Source: h national l ankine Review, December, 1966,


189.


*Board of Governors of the Federal Reserve System, Flow of Funds, Assets ar Liabilities, 1945-65.










reflected in Table 6. Th,- perce-Tage of asset s in loans, w.,here credit risk, is generally higher than for other bank assets, increased from 38P.97 in 1955 to 51.8' in 1964.

All of the foregoing: discussion, of course, leaves out Lhe one most important factor that has aided banks in their quest for a larger share of time and sa-vings deposits -- the advent of the negotiable certificate of deposit.


The Cet.'fic.te of Denosit


In February, 1961, -e First INatio-al , . Lank of

New York Cit-y anncunced that it would henc f rt, issue interest b -arin,, negiable, a~d miark>-abl time certificates of deposit (tne CD). Other large banks throughout b ; s em quickly followed sui. This was the beginning of anatept by th"- system to attract some of the short-term corporate funds 'at otherwise would be invested in U.S. Treasury discount bills, federal agency issues, prime finance eand industrial commercial paper, bankers' acceptances, and other short-erm securities. Their purpose -as to reg-ain some of the deposits they had lost to nonbank financial institutions during the 1950's and to increase their lending potentiala6










Originally, most of the major money market banks attempted to limit their certificates of deposit to million dollar denominationris, and the dealers in the secondary market still generally confine their trading to million dollar units. As time passed, however, many large banks offered CD's in denominations of .500,000OO. Smaller banks ay issue CDs for iO0,000 or less. It is generally felt that these relatively high dollar limits discourage any possible lare-scale shifts out of demand deposits. Any funds available in these amounts, over and 9bcv the customer's operating_ requireme-nts, have probably already foI'ind employment in the short-termn securities mar'-ets.

There are a number of reasons uhy co meTiLCI

banks be'an to issue C s in the 1960's. For onie thing it offered a way for a bsnk to raise its deosits. Traditionally, the deposit structure was considered to be beyond the control of bank manage ement.18 The CD made it possible for bank management to have some measure of control over not only the bank's deposit structure but deposit totals as well. In this way the issuin- bank's lendin power would be enlared. Of course, tbe availability of reserves for the system as a whole is essential ly determined by Federal Reserve policy. The indi-vidual banker









could anticipate, however, that the offcrin of CDs would enlarge his share of total r serves by attractin a larger share of total deposits.

The offer of CDs also reouresented an attempt by
10
commercial banks to increase the stability of deposits. Deposits hat beco-e incre-asinrgly subject to wide fluctualons a bank customers (especially corporate money manaqe-rs) became more adept in the methods of "scientific" cash management. It was felt that the money market character of the C'Ds would enable banks to compete. for the interest-sensit-Ive funds that coroorations, state and local iove"rments, and other public bodies ere putting into the short-term se Cur, rties a ts. eThe time deposit funds thus acui-ed ou]l become available for bank use during the life of the , thery proviin a rltiely stable pool of funxs which would permit the extension of loan aul investment ma urities.

Of course, the most importantly reason for issuing CDs was to stop the flow of savings deposits out of the com-ercial bankin;- system into nonbank financial institutions. Accordin: to one bakin authority:


Without the right to compete
eq -italy with nonbankin.r institutions, arIs would suffer from a
-terri~i handicap placed upon them
by a onesied se- of rules. .










As walti-le ers, co:rmercial baoks
must retain thIs aility to compete for the custro:er's savn-:s if we are
expected to serve his borrowing
requests --and fulfill the country's
deman for maximum economic growth
and flexibiity.20


On the other hand there are critics of certificates of deposit that maintain that bank efforts -to retain customers' demand deposits :eve been seriously cor.p1cated by the development of this instrument. Some of the critics even suest that the entire total of certificates of deposit rerresents a diversion of

their customers' balances from interest-free demand deposits to interest-earning time certificates. There -o 1out wTere so-e corporate treasurers in the early 1960's who had not thought of' investing their

surplus funds until they learned of C. To t~e extent that there were such treasuv'ers in corporations here and there, the tendency toward the more efficient

management of corporate cash was perhaps accelerated by the advent of the CDs. However, the total amount of demand deposits affected probably has been minimal and, in any case, it should be assumed that even in these cases the corporation ultimately would have learned that it is possible to earn money by investing surplus funds. E. Sherman Adams, Vice President of










the First nationall City Eank of New York City, had the following to say on t~ is: ,ubjc: "For - --Cost part, these are funs whi , but for the CD innovation, would not be in t: banki yst toO ay, ut would be ,22
invested in other short-term money market instruments,"22 The -rowth of the bankin- syster after 1960, as shown in Table 3, and the halt ir th'e flow of funcnds out of the banking system, as sho-un in Table L, would crtai~-y seem to confirm this con clusiLon.

Thus far we have ignored one important point: the maximum interest rates at .hici, CDs may be issued are fixed by the Boar'd of "overn .S of the Federal Ieserve System unjer Peulation Q As rates on alter..ti e short-torm -nst-ume.nts i..reas.. and. reach t)p .....io " .

limits, commercials banks colOd be priced out of the market. As t?is occrred, outstandInr certificates would be redeemed at m~,tur-'ty as -leositors sou t more attracive r-ates elsewhere. As the reader is
more~~A ta reader ,. ...

aware, this sition did in fact: confront commercial banks several times during the 1960's. Prior to 1966, each time interest rate levels on short-term securities commoarab'le to C.s approached Resulation Q limits, the Federal Reserve raised the le al rates payable o CDs.24 On December 6, 1965, Re.ul ation Q maximum limits ,,ere raised to 5 fcr CDs mat1 i in ^0 days cr mor as










r ates continue. to is. ut then, w stat-.em re.u'rns n: or- ct'er instru2e. s et ev 6 bfo" middle of 19c ts -) , 1. t .e c i n occuret,25 Terala S. oa lor elat -ed w-at 'ap- p a t .org anU Guaranty Trt in l Yo ~rk:


s many maturin nCD ee rolled ov~er
a ... o oa-1, ,,: e comestic0soure
of d e n_ ti an_ ! ti' e .... e posit were so.ug_,h-t
out, R~eposits at foreign branches w.... ere
increasef,3 EurYo 3 11ars aere onvd eera fn: ore to.h, te n ent te led'ss c o I cnT id
., >uiies wre: bouht anC sold, an.


y the -.nk to .et by te crisLO,eel]ess:- to E, '.0mrjnG7ua aty .nd the .. c the bank:inT sy t:: .-id ... ather th. s-,_o, ..., but -"ti

e::pe ienc poi...e. out serious pro l- . h-commercal banks Os f . A co,, .ci. il k

not e sure lt i ill b ale -o reiss.. certificates2 of deposit as they 1atu:re.

Of "oue, tis discussionn applies equally -Tell

to other i t epos its hl -y commercial banks, ch-Oare subject o Re 2ulation 2 t h tere re no recipee daa available, small, non-negotiale time Ceri'aes af deposit ha.ve also o rapid.... urine the 1960's. ct. th l of 19









bankin system increase from 2814 of total assts to 38. 1 of total assets. Lr;e ne Sotable Ds accounted for 57.1,1 of this 'ncreas, , ani amounted to 8.0' of the total assets c .the system at the er of 1969.28 hus, other tpes of time deoosi1s accounted for '2. of the c-rowth in total time deposits, further th'reatenin e bank's ability to remain qolTent-I as t, -= 6 reain solvent s interesF rates in the market clash with Regulat, on Q l imits. Vost bankers have come to realize that by investing funds from time- posits in security es or loans than nai7ure at about the cae tie as the time deposis they an hedge against a "liqu.dity crisis" in their bank.l: But this is a problem for others to de.l with

The point to be made from this discussi on is that the lar-e volu- of certificates of e:osit issued during te 1o60's -- more than twenty-t hre billion dollars orth in denominations of 100,000 or more at the end of 196829 -- has resulted in an increased cost of funds for the banking system as a rhole.30 As a result commercial bank holdirs of liquid assets declined substantially throughout the 1960's, as bank holding s of U.S. Government securities declined to less than 1 t of total assets in 1968. At the same time commercial bank hoidinls of loans --










generally the most risky of bank assets -- increased' substantially. In the first section of this chaonter we learned that commercial banks held about 35, of their assets in loans at the ;-r of 1954 and about 455 in loans at the end of 1961, Fy the end of 1968, commercial banks held more then 565 of their assets in loans, 2 If ccumercial] banks have been able to assure so much more risk ani at the same time Preatly decrease their holdins of liquid assets, the question might well be asked whether or not commercial bnr.ks needed so much liquidity in the first place. The answer to this question must wait until t'e next chapter.


Fank 7ebeuures and Canital


The use of senior securities by commercial banks dates back to the early 1930's. The Emergency Banking Act of 1933 authorized the Reconstruction Finance

Corporation to purchase preferred stock and debentures issued by commercial banks as an emergency measure to aid distressed banking institutions. As a result, more than 7,000 commercial banks sold senior securities to

the RFC. Despite their widespread use, however, bankers retired these senior securities as quickly as possible

due to the stigma of "distress financing;" associated









with their issuance. By the mid-1950's very few commercial banks had any senior securities outstanding, and until recently Federal regulatory agencies and nost state benking authorities denied requests to issue .3
senior securities if common stock could be sold.,

DesTite this background, the" Commission or .oney and Credit, in its report of 1961, recommended the exploration of two suggestions -- bank authorization to issue debentures subordinated to the claims of depositors, and issuance of preferred stock. Following this report, in 1962, the Advisory Conwittee on Banking to the Comptroller of the Currency report that "there is no soin-d reason why national banks should . be derived of any legitimate capital-raisinr method that is av-ailable to corporations genrerally."34 As a result, on .ecem ber 28, 1962, the Comptroller of the Currency published new rulings permitting nstionai banks to issue convertible or non-convertible capital debentures, subject to h .is approval. At the time of the ruling there was '21,000,000 worth of bank debentures outst anding. By the middle of 1966 there had been 26 public offerin-s of debentures with a face value of i ,135,000,000, plus a substantial but unknown amount, of direct placements.)6

In a 1968 study on the use of subordinated

debentures by banks37 it was found that in 63/ of




Full Text

PAGE 1

CHANGING LIQUIDITY PAHERNS IN THE AMERICAN BANKING SYSTEM By JERRY WAYNE LEE A DISSERTATION PRESENTED TO THE GRADUATE COUNaL OF THE UNIVERSITY OF FLORIDA IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY UNIVERSITY OF FLORIDA 1969

PAGE 2

The vrriter "ishes ro express his doeo^^st r.ppreciation to the nenVerc of his supervisory coiar;ittee, Dr. C. A. r'atthe::s , Cho-irman, Dr. R. K, Blodgott, and Dr. John H. James. The vriter especially vrirhes to rhanh Dr. i1nt;the''3, not only for his g-uidance in prcrarin,^ this study, hi;t also for his cdvice and enooura-^BTient to this v-rrlter over t-ie past four years. The ^-/riter also vjishes to thank hr, jldvrard J, Lee, Deputy Banking Connissioner of the Dtate of -lorida, for his assistance in supplying data for rhls study. A special note of "^rArnks is due to my x-*ife, Linda, who has frivon consoant encourarenitnt and assistance i^'; the 'ritins and preparation of this thesis. i i

PAGE 3

TABLE CP CCNTEXrS Page ACKNCV/LEDGKENTS ii LIST 0? TABLES iv LIST 0? PIGUPES vl LIST C? EXHIBITS vii IivraO'JUCTIOM 1 Introdueticn .......... Purpose, "'Isthod, Scope . , , I. THE 3ECC:raARY RESERVE IN THEORY Definition of Secon.Iary Reserve . . . . . Functions of the Seooniarv Re^Derre . , , . Secondary Reserves and Capital Funds . , . Deterrrdnimr Licjiidity Requirements . , . . Liquidity Standards . , Other Bank Assets and Liqiiidity ^ Secondary Reserve Assets Conclusions , , , . II. THE INDUSTRY TRENDS: 1953-1963 . . . . , The Liquidity of the System The Challense of Compet it ion The Certificate of Deposit Bank Debentures and Capital The Need for LiquMity" Conclusions , , III. THE SECC'nCARY RESERVE IN REALITY The Sa^mole Classification of Data Secondary Reserve Characteristics of Sample Banks . . . , 2 5 10 1 1 15 -5 51 59 60 78 B5 92 99 109 116 11? 130 1^4-0 IV. EINAL CONCLUSIONS BIBLIOGRAPHY .... 152 157

PAGE 4

LIST 0^' TABLS3 Table Page 1. U.S. GoverrTient Bonds Helc cy Coni.r.src lal Ban^s, 1953-1908 61 2. Time Der-oslts }-eli by Corr'riercial Panks, 1953-1968 69 3. Total Assets of All Corr.-.Tierclal Banks, 1953-196B 73 ^i-. Chan:^e in Percent of Savings of rioiise-iolds in Eanks and 3a\'"in.Ts and Loans, 19''-^6 through 1965 .......... 79 5i Yields on Gelected Lon^-Terni Sscirrities, 1955-1965 8 A 6, Percent oT Binancial Asset.-' of Co.Tinieroial Danks and Savinss snd Leans in I-Iajor Asset Catercries at Tear End, Selected Years . . 3'J7. Holdings of Secondary Reserves of Thirty Larrre Sts'^.e Parks Chartered in ^Lo:*:-ica, 1967-1968 1?5 8, Holdings of Secoiidary Reserves o^ Forty Medium~Sie:ed State Banks Chartered in Florida, I967-I96S .... 126 9. Holdings of Secondar;/ Reserves of Porty-'^ive S::iall State Banks Chartered in Florida, I967-I968 128 10, Size and Decree of Flvctiaaticn Cxharacteristics of Secondary Reserves of Thirty Larre State Banks Chartered in Florida, 1967-1968 132 11. Size and De^rree of fluctuation Characteristics of Secondary Reserves of Forty :;ediur:-31 zed State Banks Chartered in Florida, 1967-I968 I33 iv

PAGE 5

Table Page 12, Size and Degree of Pluc-tuation Characteristics of SeccnAary I-^eserves -j of Forty-Five Small State Banks Chartered I in Florida, 19^?-1968 13^ j 13. Distribution of Ratings for larre Banks ] in Sample 1^2 1 l^J-. Distritution of Ratings for I':ediun-Sized I Banks in Sample 1^^ 15. Distribution of Ratings for Small Eanlcs ^ in Sample . 1^5 '.. 16, Distribution of Ratings for All EanJrs in • Sample , . 1'48 3 J \ ] i

PAGE 6

LIST riGURES Figure Page 1, U.r. Govern-aent Bonds Held by Coirmercial J_'CillAo» 1 y J> ^ — .1 >' J • • « • • • t ft » • t ft ^^J 2, Ti^e Deposits Held by CcnTnerci'j.1 Banks, 1953-19o3 71 3, Total Assets and Time Deposits of .All Corcnercial Hanlcs, I?53-'968 75 vi

PAGE 7

LIST C SXHT2ITS Exhibit Pa;je 1. Consolidated HalancP.heet of Lar£e "erioev Comr.-?rclal Scnks, December 2^:-, 196° 39 vii

PAGE 8

INTRODUCTION

PAGE 9

Introduction During the first fex\j^ears of this decade (the 1960's) a number of significant changes occurred in the Anerican Coimnercial Banking Industry, In the first half of 196I several large money-market comm.ercial banks in Kev: Yor]c City began to issue negotiable tim.e certificates of deposit (CDs),"'" This was a radical departure from, past banking practice, vjhich emphasised asset m.anagement and assumed that the com.position of bank liabilities v:as more or less beyond the control of individual banks. The change \':as accepted, ho'-Jever, both by the regulatory authorities and by the banking com.munity as a v.'hole, and the practice of issuing CDs spread rapidly. The total volum.e of CDs outstanding rose steadily from almiost zero in early I961 to more than Alo , 000 , 000 , 000 in June of 1968, and represen'^ed an imiportant source of funds for the bariking system, curing this period. Another significant change occurred in December of 1962 vfhen the Com.ptroller of the Currency approved the issuance of capital notes and detentures by comjLercial banlis which could be included in their 2

PAGE 10

3 capital accounts, as long as such notes v;ere subordinated to deposits. Coriir:ercial banks 7rere quick to take ad'/antage of this, and sold mere than .^^1 , 500 , 000 , 000 worth of these securities during the following three yesrs. This represented 'f-?,^ of the increase in nev7 capital funds raised by the banking system during this perioa. ' The decade of t'ne 1960's also brought chari^ges in the composition of commercial bank assets. Eetvjeen 1961 and 1966 commercial bank holdirigs of U.S. Government securities decreased by about 17%, while loans increased by 79"? and holdings of other securities (mainly municipal securities) increased by The decline in the holdings of U.S. Government securities occurred at a time v/hen the money supply (currency and demand deposits) was growing at an annual rate of which included a 20% increase in total demand deposits. Over tlie same period — 196I to I966 — time deposits increased by 95%. Thus, according to traditional measures, there was a significant decline in comjnercial bank liquidity during this period. The loan to deposit ratio rose from ,52 in August of I96I to .6? in August of I966, while the ratio of cash and government securities to total assets declined from .^2 to .29 over the same period.

PAGE 11

Many of these changes vjere the natural result of increased competition in the bankins industry, both among individual commercial banks and betv;een comnerciai banks and other financial institutions. It has been necessary for commercial banks to aggressively seek nevr sources of liability funds and invest then even more ag-gressively to simply maintain their competitive position with non-bank financial institutions. However, these changes did result in a substantial drop in commercial bank liquidity if such liquidity is measured by the amount of "liquid" assets held relative to total assets. Ey the end of I968 commercial bank holdings of U.S. GcverriTient securities had fallen belc'i 1^-% of total assets. This compared with a percentage in excess of 35% in 195^^* This suggests that perhaps comiiiercial banlcs did not need to hold so many liquid assets in the first place — that perhaps commercial banlcs meet their liqiiidity needs in ways other than relying on secondary reserves. Perhaps commercial banks maintain a certain level of secondary reserves (liquid assets) because it is the "traditional" and "conservative" thing to do. Perhaps the regulatory authorities "encourage" commercial banks to maintain a certain "average" or

PAGE 12

"normal" level of liquid assets to corLforia to "sound banking practice," Since the existence of the Federal Deposit Insurance Corporation and the increased knov:ledge and sophistication of the banking authorities have almost eliminated the possibility of widespread bank failure because of a liquidity crisis, this would mean that barJ-:s tend to l-iold an excessive amount of liquid assets which are not needed to meet the reasonable demands made on a bank* This is the hypothesis of this paper. Kypothes is : Ccmmercial banJks in the United States, because of unnecessarily conservative banking practices and overstrict supervision, tend to maintain an excessive amount of their assets in a highly 1 iqnid form (the secondary reserve) at the sacrifice of additional income. Furthermore, the secondary reserves of most commercial barJcs are not related to the true liquidity needs of these banks as the sizes of most bank's secondary reserves are determined by an informal, system-wide standard — the industry average. Purpose, Meth o d. Scooe The purpose of this study is to exanine the banking literature, the banking industry as a vrhole,

PAGE 13

and a sample of cosraercial ban'-s to ieternir-o Wiiether or not coHim^rcial banks actually de':'lr]e viho.t their o\
PAGE 14

In Chi;pter III the assets of a sarr.'Dle of 115 state banl^s chartered in Florida will be exairilned , The analysis T-rill atteirpt to shcvf whether or not commercial banks tend to niaintain their secondary reserves close to the industry averacs or at some mlnimun level, vrhether secondary reserves fluctuate or remain fairly steady, and vrhether the size of a bank affects secondary reserve policy?'. An attenpt is also made to brlns out the differences and similarities betvreen the secondary reserve policies of the different banks. The conclusions that can be draT«rn fror.: an analysis of this sariple nust necessarily be liTiited because of the nature and tine span of the sample (ss erplain,-;d in Chapter III). Nevertheless, the sample is c=ufficient to provide for son^e r:eania:^ful conclusions, '-fhich can be found in Chapter IV. It is hoped that this study v:il] shed some light on hoT-r commercial banks actually deternine their policies in regard to liquidity, and ho"r these policies are affected by traditional thought, regulatory supervision, and changes in competi-ion. In discutssing liquidity this paper is r^rirerily concerned witl: the liquidity of individual banks as opposed to t?ie liquidity of the system as a "hole. Although both

PAGE 15

types of liquidity are closely related, and one type cannot really be discussed without at least implicit consideration of the ot?ier, each type calls for a different method of analysis. For example, an individual baiik may increase its secondary reserves by purchasing short-terra U.S. GoverniTient securities from, another bank, and the liquidity of the system does not change. In the same light, the liquidity of the sytem, may increase through Federal Reserve action v:hile somie banks lose secondary reserves because of local considerations. This paper will emphasize ':r:e liquidity of individual banks. This study m.ay be quite useful to the managers of somie banks (especially sm.all banks) in evaluating their policies and practices against the policies and practices of the sample banks in this pa.per. The regulato.'y authorities may also find this work of seme sm.all use in form.ulating future policies. In any C9se, it is hoped that this thesis t;111 help other students of money and banking more clearly understand the forces that shaped comm.ercial banJk policies during the decsde of the 1960's,

PAGE 16

Notes 1, W, H. Baughn and C. S, Walker, The Bankers* Handboo k (Homewood, Illinois: Dow Jones Irvjln, Inc., 19 , 6lO. 2, G. Walter Woodworth, "Bank Liquidity Management: Theories and Techniques," The Banker Ma gazine . I50, No. ^ (Autumn, I967) , 76. 3, Table 1 in Chapter II.

PAGE 17

CHAPTER I THE SECONDARY RESERVE IN THEORY

PAGE 18

Definition of Secondary Reserv e The phrase "secondary reserve" is somex%"hat of a loose terci in the American Banking Industry. Bankers differ widely in their opinions as to exactly v;hat a "secondary reserve" consists of. The term cannot be found in any of the \''arlous bank acts, and it apparently does not have any official status, A study of the histox'y of American Earixing indicates that secondary reserve accounts of commercial 1 banks in most cases "J-ast grew,""^ Funds that x^rere not needed by commercial banks for loans and C'lsocvnts became available at oertain times and were Invested in short-term liquid assets such as comm.ercial paper and Treasury Bills. The purpose of these acquisitions ^^;^.s to have on hand a number of assets that could be sold quickly when the demand for loans increased, Paul M, Atkins summed up the bankers' motives in Tl'e Bankers Mas:azine of August, 193C, in the fcllowlns way; The principal attention of the banker when buying these "secondary reserve assets" was not focused on the organization of a secondary reserve, but rather on the selection of assets which were safe and which could be sold or disposed of in some other 11

PAGE 19

way at his o\ra discretion. His eye was on the credit position of these assets, and he was interested in Vfhether they would pass the inspection of the bank examiner rather than on their adaptability to meet the needs of a secondary reserve. Thus, the term "secondary reserve" is not subject to a precise definition, as it has never been legally defined. Of course that does not mean that every banker has a different opinion as to what a secondary reserve is. On the contrary, there is a fairly uniform consensus of opinion as to xfiiat a secondary reserve is. There is, however, as will be broufght out later in this thesis, some difference of opinion as to what assets should be included in the secondary reserve. Textbooks dpaling with coramercial banking will almost always have a section or two dealing with secondary reserves, although in many cases the author will avoid trying to define the term "secondary reserve; directly. They generally prefer to describe which type of assets might be included in a secondary reserve and why there is a need for such a reserve. Where a definition can be found the langiiage used is usually of a general, unspecific nature. In 193'3» for example, the Eank Management Commission of tl:ie American 3anl:ers Association issued a Statement of Principles and

PAGE 20

standards of Investments for Commercial Banks in vrhlch it defined secondary reserves, in the follovring vjays Secondary reserves consist of shcrt-term, readily marketable investments vrhich normally may be converted into cash through sale vrithout material loss. They ordinarily include bankers' acceptances, treasury bills and other short-terra Governments, prime commercial paper, and other short securities of the^ highest quality and broad marketability,-^ Other definitions emphasize the use to v/hich a secondary reserve should be put — that is, as a potential source of cash to replenish the primary reserve vrhen that reserve declines for som.e reason, J, H, V/ilkinson, Jr., for example, defined a secondar-/ reserve in this way: The secondary reserve can be defined as the first line of defense ^rhicVi v/ill be employed to replenish the primary reserve vrhenever that reserve needs to be replenished because of VTithdrawals of deposits or an increase in loan demand. If, then, the outstanding characteristic of the secondary reserve is that it be available for transition into primary reserve without other than an inconsequential loss, it logically follows that only prime securities with short maturities — not more than four years j-are eligible for such an account," These two definitions, by reason of their length, are probably the exception rather than the rule. Some

PAGE 21

authors define secondary reserves in a sentence or less and ciove on to other matters, A typical definition would be: "By 'secondary' reserves are meant highly liquid earning assets that may be converted into cash with little or no delay and at practically no loss,"^ Other authors, although they may deal with secondary reserves at length, offer no direct definition of the term,^' The most meaningful "definition" which this author found was in a monograph prepared by the American Bankers Association for the Commission on Money and Credit. In this book also no "direct" definition is offered, but the authors are able to define "secondary reserves" quite ade:iuately using ar indirect method. They state: Since a banlc's cash assets can be counted only to a very limited extent among liquidity assets ^primary reserves must be m.aintained at a minimum level!] , a secondary reserve of short-term, readily marketable, high quality assets must be maintained. This provides the bank with its real source of liquidity. The secondary reserx^e is used in an accordionlike fashion, expanding to take up the slack when deposits increase faster than lending opportunities and contracting as necessary to meet deposit withdrawals or loan increases.? The authors go on to expls.in what they mean by "short-term, readily marketable, high quality assets," and what assets

PAGE 22

can be included in this category. They say that any U.S. Government bonds with niaturities of up to five years can be included in this category, but any other assets, re=rardless of quality, should mature vrithin a maximum of tvro years to be eligible. "Other" assets eligible to be counted as part of the secondary reserx'"e woi;ld ordinarily include money market loans, Federal Funds sold, Government securities bought under repurchase agreements with Government security dealers and other barJks, bankers* acceptances held, call loans to security brokers and g dealers, and open-market comm.ercial paper. At this point it is sufficient for our purposes to say ti'iat a secondary reserve consists of shcrt-term, readily marke tabl e , h j gh q v.al ity assets, Fun^.tions of the Secondary Reserve There is some differences of opinion among students of money and banking as to what functions a secondary reserve serves in a commercial ban>;, Hox'jever, almost all agree on at least tx'-'o of the functions of a secondary reserve. The first of these functions is to provide a bank vrith a source of funds vjith 77hich to meet deposit drains. The second function is to provide for funds with which

PAGE 23

to meet increased loan demand. These tvio functions will be considered together as they are closelyrelated and are at the core of the rationale for the maintenance of a secondary reserve of highly-liquid assets. Thus, according to The_ Bankers Handbook: In the use of funds supplied to the bank, the chan-ging volume of deposits coi-xpled with the nature of the community's credit needs produces basically four functional asset categories; (1) cash, (2) liquidity reserves , ( 3) customer ] Pans , and , 4 resi dual investments . , . . The liquidity reser ve category is made up of a wide range of income producing assets where C^heD prim.ary function is to provide the bank with a source of funds, through conversion of these assets, to m^eet deposit drains or loan demand. This is the immediate source of liqiaidity for the^ bank in its normal banJcing operation, These same sentiments, in one form or another, can be found expressed in almost any text that deals with secondary reserves (or "liquidity" reserves) to any extent, James 3, Duesenberry, although he devote only one chapter to commercial barxk operations in Money and Credit; Im'oact and Control , mentions that most banks try to prepare for deposit withdrawals by investing in securities which can be readily sold V7ith no risk of loss, such as short-term Government

PAGE 24

1? bonds. Another author says that it Is clear that a bank should carry enough liquid assets to meet the "seasonal demands of depositors," which can be forecast from experience, as well as to meet the "cyclical variations in deposits," taking measures to increase liquidity during times of prosperity, These two functions of a secondary reserve are clearly identified in a text prepared by the American Bankers Association for the Commission on Koney and Credit entitled The Commercial Banking Industry . The text points out that the greater part of comjnercial bank liabilities by far is in the form of demand deposits, and thus adequate liquidit.y is required to meet anticipated K-ithdravials of the^e aepo.'^its avA to provide a margin of safety for the unforeseeable. Adequate liquidity is also needed to satisfy the legitimate credit needs of its customers and to provide portfolio flexibility should a rise in interest rates make available attractive investment opportunities, "The part of the bank's investment portfolio that constitutes its secondary reserve (liquidity account) is the prime source of such liquidity ^-^ Roland I, Robinson, in The Management of Ban>: Funds, discusses these two basic reasons for protective

PAGE 25

1 i!liquidity in seme detail. He holds that there are two great reasons for the protective liquidity of commercial banks, First of all, banks must meet their legal obligation to convert demand deposits into currency on demand without fail. Secondly, although there is no legal responsibility to do so, any bank vjhich v:ants to enjoy good profits, to perform its expected function in the community, and to attract customers must be prepared to meet all legitimate loan demands. He states: "There are tx>ro ways in >rhich a bank can prepare for these needs: by holding cash and by having investments v.'hich can be converted into cash quickly, in sizable amounts and with negligible loss,"^^ Each individual banker, of course, is interested in 'che circumstances that cause deposit variations. The principal factors involved are changes in the aggregate of bank loans and investments and changes among individual banks in the distribution of deposits. These variations are of several kinds, which Robinson lists in t'ne following way: 1, Business fluctuations, which cause the demand for bari]<: loans to go up or dovrn. This, in turn, affects the ievel of deposits, 2, Seasonal variations in the demand for bank credit and for currency to put into circulation cause bank deposits to fluctuate.

PAGE 26

3. Relative population clianges among areas — some parts of the country grow rapidly, others hardly at all. ^. Competitive shifts in which sone banlis groxj at the expsnse of others. 5. Changes due to sliifts in the relative prosperity of various depositors; for example, when there is farm prosperity, agricultural banks gain deposits more rapidly than do other types of banks, 1° The author points out that seasonal movements of both loans and deposits can be fairly well anticipated as to vrhen they occur and approximately how large they vrill be. However, there are some deposit movements which cannot be accounted for — random movem.ents. The banker must take these movements into account as well: "Recognition cf random movement is, perhaps, a sort of clunsy efforc at preparir^g for the unknown future. It is a guard 17 against the unexpected; ' Besides seasonal and random factors, the individual banJ< should provide for some protection against the m.ovement of what might be called "unstable" accounts. An example of this type of deposit might be amounts "due to banks,," Also, "public funds" m.ay also be highly variable, as their placement depends on who holds political power at the time. The accounts of "uninvested trust funds," "im-estment trusts," and "rich investors" may also be subject to wide variation.

PAGE 27

And of course, the ''big" account in the "little" bank presents ariother illustration. A bank sh.ould always be prepared to lose its biggest single account, "While every bank has reason to v;elcome deposit accounts and particularly the big ones, the small banker should never make himself slavishly beholden to one big account," In the establishment of a secondary reserve, it is important that a distinction be made betvieen the demand and time deposits of a bank. Demand deposits are payable at sight v/henever they are demanded durinj^the regular banking xhours. Time deposits, cn the other hand, are payable only on so.iie specified future date or after the lapse of a determined length of time, upon notice. At the ssne time, banks pay a relatively high rate of interest on tine deposits, while interest pasonents on demand deposits are prohibited. Thus, the return that a banJk must earn on time deposits must necessarily be higher than the return it must earn on demand deposits,"''^ Thus, a bank would be expected to keep a high percentage of the funds it derives from time deposits invested in high-earnir^g assets. This leaves demand deposits to supply funds for the secondary reserve. Therefore, the dependence of the

PAGE 28

21 secondary reserve upon the deposits of a bank takes effect in three x-rays: 1, The amount of the deposits and their distribution betx^reen demand and time deposits, 2, The fluctuations in the amount of tliese t'io classes of deposits, 3t The distribution of the size of the deposit accounts, 2® A conscientious banker must, of course, be sensitive to changes that occur outside of the barJc as well as to chan^^es that occur within the bank. Individual cocmunities are subject to economic factors that are peculiar to a particular region. The danger of relying on one m.ajor industry or customer has already been uenticned. Changes in the industrial components of a communitj'or population changes may call for an adjustment in bank strategy. These and any other "local" considerations all play a part in 21 the operations of a commercial bank. In addition to local considerations, national economic conditions m.ust be taken into acco\;nt by the individual banker. The more widely diversified a banl-r's service area, the greater the probability that national conditions will be reflected in the banlr's business. Treasury and Federal Reserve policy especially must be watched closely.

PAGE 29

A secondary reser\'-e may have other functions apart froir. the two that v:e have mentioned. Some authors maintain that secondary reserves are a bank's protection against panic withdrawals during periods of crisis and depression, Raymond P. Kent, for example, states that: ,,, it is a generally accepted doctrine of good banl: management that the secondary reserve plus the prim^ary reserves should always be sufficient to enable a bank to meet even the panic vrithdrav/als that may occur in periods of economic crisis and depression. The idea is, of course, tnat the bank miust alv:ays be in a position to protect its solvency; and it must be in such a position even when, as in periods of prosperity, times of economic crisis and difficultv appear to be exceedingly remote,^ This function of a secondary reser^/e, however, is not as generally accepted as Mr. Kent would have us believe. In fact, his statement is anything but a "generally accepted doctrine of good banJc manageF.ent , ' Donald R, Hodgman, for e^-ample, in Commercial Banlc Loan and Investm.ent Policy , stands in direct opposition to Mr, Kent, Ke states: I shall assume common acceptanc'3 of the proposition that in time of a perverse liquidity crisis only prompt and povrerful action of the central bank to monetize

PAGE 30

assets of the commercial banks can provide the banking systerrt xvith enough liquidity to go around. In such a cataclysm the survival of even a vrel 1-sanased banJt may depend more upon the policy of the central bankpthan on that of its ov;n managemient, He goes on to say that in a general liquidation crisis the central banl: alone can provide adequate liquidity. No individual banlc can safeguard its own position by holding saleable assets, since no one vrill be willing to purchase them in a liquidity crisis. He concludes; Therefore, the task of management is to anticipate these deposit drains which, while exceeding the amounts that can be met by borro/:ing at tVie Federal Reserve Bank, hs.va p good probability of occurrence without involving the entire banJ-cing system and thus forcing a liberalization of central bank policy. The size of such drains determines the "rock bottom" for the investment portf o] io.^^'This latter view would seem to hold more water than the view expressed by Mr. Kent. The correctness of this position stems from the fact that it is impossible for the whole banlclng system to possess any large degree of liquidity. It is quite clear that the liquidity of any particular bank's assets depends upon the willingness of the other parts of the bariking system to lend or invest freely. Of

PAGE 31

course, commercial banks may shift the burden of providing liquidity upon the central bank, but any wholesale attempt on the part of the system to 25 liquidate its loans and investments must fail. It should be noted that the emperical evidence provided by the experiences of the 1930 's supports this view. C, A, Wright, in a study conducted for "The Bankers ilagasine," stated the following: Figures published by the Federal Reserve Board indicate that there was no dearth of eligible paper in the Federal Reserve System as a whole durinp; the crisis of 1931-32. Nevertheless;, tl'.e general widespread demand for liquidity necessitated by the emotional behavior of depositors led to the exhaustion of primary reserves by r.any otherwise sound banks, and to the liquidation of secondary reserves on a scale great enougl'i to dem.oralize the security mftrkets; the possibility that this . demoralisation was occasioned by a general desire for relatively liquid forms of wealth x-rould seem to be confirmed by the extension of price declines to the commodity m.arket. It therefore seems reasonable to conclude that, during a period characterized by rapid liquidation, it is impossible for the banking system to alter within itself zhe distribution of its credit resources so as to maintain a safe position. In different terminology, "shiftability" of assets is no longer sufficient to maintain the liquidity of large portions of the banking mechanism, 2 o

PAGE 32

The author goes on to conclude that; The existence of eligible paper in 1931-32, the situation was the same in 1933* ^'''as insufficient to •prevent "Tidespread bank closings, and a resort to " shif tability" throuc^h the market also failed. It seems evident that the preservation of banki^ifr liquidity in time of crisis involves the absorption • by the public of assets formerly held by the banking system; ... in other words, the public m.ust exchange its quick deposits for slo':i assets just when it is unvrilling to do so. 2? This position is further substantiated by a banker by the namie of "Eugene H, Burrls who in the last part of 193^. while president of the Oregon Ban}: and Trust Company, vrrote an article which appeared in "The Bankers Magazine." Kis article was concerned vrith whether or not it was desirable to rely on bonds (any kind of bonds) for liquidity during a crisis. He stated that his bank had met all of its liquidity requirements through note collections rather than through the sale of any assets. He further stated: Shall we bankers not face the facts? Bonds have acted no differently in this depression than in every previous depression. In every form.er depression, v;ithout exception, for at least fifty years, bonds as secondary reserves

PAGE 33

have been a frail staff to lean upon, VJe may point to them •rith pr^'de. We may advertise them,B^.t v;e dare not sell them, 28 From this discussion t?ien, iie shall conclude that commercial banks cannot pi-otect themselves by m^aintaining sufficient liquidity to mset excessive withdravrals brought on by a liqiiidity crisis. Only during "normal" tim^es can a commercial bank obtain liquidity (cash) through the sale of assets. Secondary R esei -ves and Capital ?und s There is another function of the secondary reserve, however, vrhich is considered most important by many bankers. This function has to do with the amount of capital funds in a comiaerclal bank and the degree of risk entailed in a bank's lending and investing of funds. Almost all commercial banks are capitalized at less than ten percent of total assets. This means that a commercial bank cannot afford to expose itself to a very large degree of risk as it cannot afford to lose very much. There are two types of risks that can result in losses for a bank. The first type of risk is the credit risk, vrhich depends on tlie quality of a bank's assets (the risk of a loan going bad or of default as

PAGE 34

to interest or principal on a bond or note) , The second type of risk is market risk, vrhich results from changes in the Interest rate structure, FroiT; the standpoint of capital adequacy, raarket risk is not particularly important unless the secondary reserves of the bank are inadequate to meet the potential needs for liquidity. If this is the case, then the banl
PAGE 35

.>'V?* Enough assets I'rivolvlng no credit risk should be included among the bank's investments at all times to hold within reasonable bounds its overall risk exposure — including risks assumed in loans. To provide proper balance for a bank's total assets, for example, it may need to hold a larger volume of U.S.Government securities than would be needed solely to provide liquidity. 31 Determining Liquidity Requirements VJe are noi-^ in a position to say something about the size or magnitude of the secondary reserve for a commercial banlc, J. H. V/ilkinson, Jr. feels that there are four basic factors that should determine the size of a secondary reserve for any commercial bank.-^^ These factors include the nature of the deposits of the bank, the size and condition of the bank's capital account, the condition of the loan and discount portfolio, and the position of the business cycle. Charles L. Prather lists these same four factors as the determinants of the size of the secondary reserve. -^-^ Paul F., Atkins, in an article prepared for "The Bankers Magazine," listed nine factors that determine the size of the secondary reserve. They are; 1. The larger the volume of deposits the larger should be the secondary reserve.

PAGE 36

2, The larger the proportion of deniand deposits to total deposits, the larger proportionately should tiie secondary reserve be since demand deposits require a relatively larger reserve than do tine deposits. 3, The less the stability of deposits the larger should be the secondary reserve. ^. The higher the rapidity cf fluctuation of deposits, the larger should be the secondary reserve » 5, The smaller the ratio of total surplus to deposits, the larger should be the secondary reserve o 6, The less liquid the funis in which the net worth is Invested, the larger should be the secondary reserve. 7, The smaller the proportion of the local loans and discounts eligible for rediscount at a Federal Reserve banlc, the larger should be a secondary reserve, 8, The larger the proportion of the earning assets invested in local loans and discounts and in loca!'. mortgages, the larger should be the secondary reserve, 9, The srraller the primary reserve (within limits) the larger should be the secondary reserve o 3^ Although this list would seem to be quite exhaustiv a second reading will show that it is also quite general and unspecific. The author is aware of this, and states "Like so many other instances in the field of practical economics, this is a case where good judgment based on experience must be applied. "^5 This still tells us nothirig about how a bank should determine the size of its own particular secondary reserve, and it is to this subject that we now turn.

PAGE 37

In order for an Individual banker to determine his liquidity requirernents he must begin with an analysis of past deposit activity to determine whether there are any repetitive, predictable performance patterns. The study should go back at least five years and encompass a full business cycle if possible. Data ir.ay be for aggregate deposits, or they may be divided into types of deposit categories. The data should be in terms of daily figures, or at least vreekly averages. These data may then be plotted on a l?--mcnth graph, vTith each year superimposed on th« preceding year's plotting. This vfill permit the banlcer to see more clearly the nature of seasonal patterns in deposit or loan activity for fu.ture reference. The sam.e data should then be plotted on a graph cover! n the full historical period being reviewed. This will provide the banker with a rough picture of his gro'.'ith pattern and is the basis for establishing a program for the employment of funds. By inspection a hard core line might then be dravm so that it roughly parallels the deposit trend, but is sufficiently below the deposit plot so that at no time does the graph for actual deposits fall belov; the hard core line (except for any extremely unusual

PAGE 38

and temporary deposit loss) . The volume of deposits falling telo''AT bhs hav"! cor-e line represents the "stable" portion of the bank's deposits, to be used in cash, customer loans, and the residual investment area, with the exception of providing for loan liquidity, as discussed below. The volume of deposits exceeding the hard core line represents the volatile area which should be employed in liquidity reserve assets. To the extent that deposits decline, a portion of the legal reserve cash funds are released and may be used to supplement the liquidity reserve function. Whether the individual bariker wishes to take this into account in determining the size of the liquidity reserve, or whether he wishes to ignore it and thus look upon such funds as providing him with a margin of protection against unforeseen demands, is a matter of choice. In the plotting of loans to help determine liquidity needs, the banker is primarily interested in how high loan demand might go. Therefore, he should plot a loan ceiling line to appear above the plot of actual loans in the same manner that he plotted a hard core line for deposits. The difference between the actual loan level and the loan ceiling line at any given time represents T:he

PAGE 39

amount of liquidity he should' wish to retain in his liquidity reserve for loan deiDands, Since this liquidity is in addition to the araotint of protective, or deposit, liquidity being maintained, the equivalen of the loan liquidity assets must be established at the expense of the residual investment area. The next step is to project the hard core line, or loan ceiling line, into the future period, for example, into the next 12-month period. Finally, he superimposes on this projection, for each monthly period, the average derived monthly llquid.ity need for that future month. The result is a projection of anticipated actual deposits (or loans) for the next 12-month period, and the diversion of these funds between hard core," or stable deposits, and those requiriTig offsetting employment in the liquidity reserve. These estimates, of course, are based solely upon historical performance and adjustments in projections to current conditions should be made If warranted. In any case, until it can be established that any differences are attributable to basic (or temporary) factors, a conservative tack should be followed. If the differences are tem.porary, which implies a self-correcting movement, no changes need be made in the forecasts.

PAGE 40

Of course, the method just described in not the only approach that can be used, and there ar^ undoubtedly many variations of this method. However, the statistical method, in whatever form, can be used by an informed banker to more adequately estimate his oxvn liquidity needs. These sentiments can be found expressed by any number of respected authors, although the method may be different from that described above, Roland I, Robinson, in The Management of Bank Funds, states: Although there are a number of vrays in vrhich seasonal influences are felt in banks, for the purpose of roujh estimation the m.ain forms of influence are tv'o; (1) fluctuations in short-term loen demand, and (2) fluctuations in dem.and deposits , . . . Tlie effects of these two major factors in terms of cash dem.and are opposite. The gro^-:th of loans gives rise to cash demands, the decline of deposits gives rise to a cash dem.and, ,,. Because the v;hole estimation of seasonal fluctuations has the sole purpose of figuring out the shape and size of expected cash dem.ands, these two factors have to be used in reverse; the seasonal highs of loans and the seasonal lows of deposits are added to find the cash dem^and , 37

PAGE 41

3^ The American Bankers Association, in The CorriTTierclal Bankin g Inaustry , describes a statistical method for estimating loan highs and deposit lovjs and goes on to say: Once estim.ates have been m.ade of the probable deposit floor and loan ceiling, the size of the secondary reserve can be determined in the follovjing manner, 1) Compute thie difference betv:een current deposits and the estimated deposit floor, and the difference betv.een current loans and the estimated loan ceiling. The sum of these differences, plus whatever extra m.argin of safety is decided upon, represents the total potential I loss of funds for vjhich provision must be made in the secondary reserve • 2) From this total subtract any deposits vjith the Federal Reserve Bank or correspondent banl^s in excess of legal requirements and m.inim.um acceptable balances, A further substraction can be made for the amount of legal reserves that v;ould be released by a decline in deposits to the estimated deposit floor. The resulting balance is the amount required in the liquidity account, 38 The list could go on, 39 examples cited above are representative and sufficient for our purposes. The major point to be miade here is that each bank m.ust determine its ov:n liquidity needs as reflected in a study of its pest history. Each bank si:culd determine hov: high its loan demand might go and hcv7 Iotj its

PAGE 42

deposits rn.ight go (perhaps taking into account the ad ji:.stnents nientioned abave) in order to determine lio^ mu.ch Liquidity it would need under adverse (but not crisis) conditions, The effect of risk exposure (capital adequacy) on the size of the secondary reserve will also vary among individual banks. Liquidity Standards A subject that s?iould be brought up at this point is the supposed existence of "formulas" or "ratios" for determining the proper size of a secondary reserve, J. Laurence Kclb, ^or example used the follcv^inr, formula vrhile at the Elmira Ban]; and Trust Company in New York: Secon da ry Reserve si.all consist of prime comriercial paper, call loans, bankers acceptances and prime bonds and notes maturing within four years. These reserves shall not be less than (a) 2'^% of all Timie anrJ Dem.and Deposits plus (b) 5C,;' of Public Deposits,^0 Donald R, Hcdgman, in Com,mercial Bank Loan and Investment Policy , makes mention of banl^: "ratios" such as the "total investments to total assets" ratio and the "governr.ent bonds to total assets" ratio. Cnarles L. Prather also mentions these

PAGE 43

ratios in his i-ioney and ParJ 'ing; . ^ Eu.gene K, Burris, in an article espousing "Soientific rlanagement Policies" for co.TiT.ercial banks, stated: Prom banking experience it has been concluded that, generally speaking, 35 per cent of demand deposits and 10 per cent of time deposits represent proper proportions to be invested in quick assets readily convertible on occasion to meet ordinary withdrawals. ^3 These references seem to hint that there are certain minimum "liquidity ratio?" that a bank should or must adhere to. The fact that the banking industry is heavily regulated -Tould seem to support this vjevr, Hoicever, this autr^or i-ias not able to find any evidence vrhich Nould lend support to this proposition. There are certainly no legal requirements for com_mercial banks to maintain some minimiura liquidity ratio (aside from primary reserves). In response to this author's inquiries on this subject, Mr, Frederic Solomon, Director of the Division of Supervision and Regulation of the Federal Reserve System, had the follovring to say; The loan-to-deposiL ratio to which you refer has been used for many years by bankers and ban]^ supervisors to

PAGE 44

3? der.onstrate tho extern: to which a bankhas used its available resources to acconinodate t}:e credit needs of its customers, Th.e presumption is that the higher the ratio of loans to deposits, the less able a banJc 'Jill be to ir.eet additional loan demand and sudden deposit v;ithdravals , A sustained', inordinately high ratio r.ay result in proloii^ed and continuo-'.s borrovring, a questionable practice for banks. There is no stand ai-d loan-to-deposit ratio applied universally by bank super-'.''isors as the ideal loan Dositioa for any given bank. The average ratio for all co!r.iriercial b?5rJ^s ... is sonsetimes used as a guide and banks --rith ratios ranging too far beyond the average f^re arbitrarily criticized by sone bank supervisors. The pit ''alls of this are obvio':s. /: ratio of, say, tO per cent, for a bank with substantially all of its loan portfolio in long-term paper :s, a"^ least on tl'^e surface, excessive and should be critici"ed, Ho-.'''e\''er , an 80 per cent ratio In a ban';::i';h a portfolio corpri.sed chiefly o-^ short-tern, -orirae paper is clearly tenable in the absence of other factors usually h.avincan adverse effect on liquidity. It is "apparent fron this that no rule of thumb can be established to neasure all banks. ... The ""atio of cash assets and U.S. Goverriiaent securities \.o total assets to '-rhich ;/cu refer is only infrequently used by ban]-: supervisors, ... To appraise the liquidity requireraents of an individual bank one needs to knoiT trenendously more about the ban]^: than either of these tvfo ^ratios, or any other ratios, can reveal."''' . ^ron the foregoin;i discussion, this author can only conclude thst there are no "standard" liquidity ratios

PAGE 45

in bhs Anierican banking system. If any such standard exists, it is an informal one. Actually, it is quite reasonable to suspect that there may T;ell be an informal liquidity standard in the system in the form of the "industry average." It is quite likely that most bankers would hesitate to deviate too far from the industry averages in their loan and investm.ent policies, either through fear of disapproval by the regulatory authorities or through adherence to "conservative" banking practices. Discussion of this subject, however, is put off until a later chapter, Other Bank Assets and LiqiJ.iclty At this point one riight ask the question: v7hy should a com.mercial bank' plan on m.eeting all of its liquidity requirem.ents from the secondary reserve? Certainly there are other assets held by a barik that generate some liquidity (see Exhibit 1), The repayment of loans comes imim.ediately to mind. We will consider this subject by looking at each of the different types of assets held by a commercial bank in turn. Banks carry accounts vrith correspondents for a number of diffei^'ent reasons, such as to provide clearing facilities for customers, to have the

PAGE 46

EXHIBIT 1 CONSOLIDATED EAL/VMCS SrlEET 0? LARGS ?:SMBER COMMERCIAL EAHKS , DECEMBER ?A , I968 (In millions of doll&rs) Assets Loans Commercial and Industrial s5 73»C50 Agricultural 2,01? For Purchasing or Carrying Securities 8,577 To Einancial institutions 17,6'-^6 Real Estate ' 3^ ,9^'.'Consumer Instalment 18,5^7 Porei-sn Govern/iients 1.125 All Other 1^,058 Valuation Reserves 3t237 Total Loans ^?166,995 Investments U.S. Governnei-'.t Securities 29,l60 State and Municipal Securities 3^»517 Other Bonis, Stocks, and Securities ^-ii^i'ii Total Investm.ents 6S , 121 Cash Assets Reserves •Tith ?,R, Banks l6,602 Other Cash Assets 35,76? Total Cash Assets ^ T52,3o9 All Other Assets 10.867 Total Assets -1295, 11 5 Liabil j ties Dem.and Deposits $112,121 Tims Deposits ' 111,85'^ Borrow in?; 3 Prom P.R. BanJcs 2U>^ Prom Others 11,21^ Other Liabilities 17,808 Capital Accounts 21,8''^2 Total Liabilities and Capital Accounts 3295 , lf5 Source: Federal Reserve Bulletin,

PAGE 47

services of the correspondent in the form of execution of buy and sell orders in the securities markets, and to obtain custodial and safe-keeping services for securities. The bank which provides these services incurs costs in doin^ so, and will either charge for them directly or require that the benefitting barJc keep a sufficient averag^^ minimum balance to provide an opportunity for the correspondent to hold enough earning assets to provide commensurate compensation. These balances held vrith correspondents can be used to provide liquidity to meet a loss of funds. Usually, however, such balances are held at levels comnensurate with services rendered and offer only a very limited source of liquidity .^^^ Cash in vault is sterile as it earns no return, and commercial banlcs generally try to hold it to minimum levels. Excess stocks of vault cash are ' costly to a ban_k because of the greater need for protective measures and Insurance to which they give rise, and because of the income lost through failure to invest the funds. In a comprehensive study it was found that: "The Interviews suggest that without exception bankers were currently attempting to hold only that amount of cash which they regarded as sufficient to meet minimum operating reauirements ,

PAGE 48

As a result, there is virtually no usable liquidity In most banks' holdings of vs.ult cash. By the same token, cash items in process of collection are also kept at a minimum, and are not a source of pla.nned liquidity. Required reserve balances at the Federal Reserve Bank obviously can not be used for liquidity purposes, Hovrever, excess reserve balances represent free cash and so are available for liquidity needs. Usually, however, banlcG will try to keep tlieir excess reserves at a m.inimium.. The cash flcvr which arises from the repayment of leans at maturity is one aspect of lean portfolio liquidity. This cash flow is a functicn not only of the maturity composition of the loan portfolio bu.t also of the borrowers' intentions to repay loans at scheduled maturity dates, This depends on a customer's abilities to repay, tacit understandings with the bank, and other intangibles . According to one banker: The liquidity of loans depends on the pay-out prospects cf the Individual borrowers. He have 60-day notes which are renewed coiit Inuously so that their actual maturity is longer than some term loans. The maturity composition of the loan portfolio is Important for public relations because It is used by many analysts, but it is of little practical significance for liquidity,-'-'

PAGE 49

Apart from this "unreality" cf some loan maturities, it must be remembered th:;.t loan behavlcr has already been included in the calculation of liquidity needs. An expansion of total loan volume does increase the need for liquidity and a contracbion does decrease it, but this has already been taken into accoiint. Therefore, while it is appropriate to include a projected loan decline as a source of liquidity to rest deposit x^^lthdraT•rals , it is not appropriate to consider Icen runoff as a source of funds for loan expansion. On the other hand, an individual band: could possibly refuse to renev: a loan that is due. Hov/ever, this would be a desperate measure an'-" v'ould not be employed short of a Genuine crisis in the life cf a ban]':. Also, such action is alniost certain co be an ineffective measure if atcem.pted d.urinc 3ssneral liquidity crisis. The m.aturity composition of a bank's loan portfolio is en important factor, hoT^ever, in determinin£the eligibility of loans for rediscount, '^'his would appear to be the primary contribution of short loan maturities to a commercial bank's liquidity. Traditionally the h.oldinc of call loans repayable upon a bank's demand has been regarded as a source of liquidity v-ithin the loan portfolio.^There are two

PAGE 50

43 types of leans which bankers custoraarily '-irite on a deriand basis at the present time: loans '.'•ith securities as collateral and loans on receivables. In Donald R. Hodg.7ian's study of cor.imercial banks^^ it V7as found that in general, the reason bankers give for making these tv;o types of loans on a demand basis is not to preserve the liquidity of tne bank, but to protect the bank against a sudden Increase In risk, resulting fron a deterioration in the borrower's position or a sharp drop in the market value of the collateral. None of the bankers interviev.'ed in the study regarded security loans to custorers as callable simply to meet liquidity needs, and only a fexv t'n ought of loans to brokers and dealers as callable at the bank's convenienf^.e . We conclude, therefcz'F, tho.t loans v:ritten on a demand basis do not in general constitute a source of liquidity for a commercial bank . In the same study bankers were interviewed to determine whether they considered the sale of loans CI as a possible source of cash to meet liquidity needs. -'^ Among the ban2>cs interviewed (18 major banlcs in San Francisco, Few "ork, and Chicago; only t'nree regarded the outright sale of loans to another barJr or financial institution (other than the ^'ederal

PAGE 51

Reserve Bank) as a device to gain liquidity. Even these three a3:reed that such sale was considered highly unusual. The author concludes: On balance the banks in the survey do not look to the sale of loans as a potential source of liquidity other than in the sense of gaining "elhovi room." through Darticipations , Even here, there is the important qualification that these participations may intensify the T.ajor banks' liquidity problem in time of a liquidity cr^jsh rather than ease it. ... Accordingly, it appears that the sale of leans to gain liquidity is a v;eak reed for any bank to rely upon. 5 V/e may conclude, then, that since cash assets tend to be held at a minimum, and since the loan portfolio's contribution to all but last-ditch liquidity is insignificant, the bank must turn elsevjhere for liquidity. In other words, the bank must m.aintain a second.ary reserve of highly liquid assets to provide for deposit vrithdravrals , increased loan dem,ands, and unnecessar;/ risk exposure. This conclusion, hovjever, ignores one important fact: a bank is not necessarily restricted to the asset side of the ledger in meeting its liquidity needs. There is a certain amount of flexibility in managing the liability side of the balance sheet as well. An individual banl-c, for example, may aggressively

PAGE 52

^5 try to attract time certificates of deposit. The individual bank can also use various forms of borrox^ring-. These include the purchase of federal funds, the sale of securities under repurchase agreements, borrov/ing from correspondent banks, borro^^^ing fron the Federal Reserve, and borrovring through the issuance of unsecured notes, The management of liabilities can be an important factor in a commercial bank's operations. In fact, the m.anagement of liabilities has come to play a very important role in the Am.erican Banlcing Industry in the last ten years, Ive vrill not examine this role, however, until the next chapter, so for the present \re v:ill assume that tne management of liabilities doss not greatly affect an individual bank's liquidity position, Secondary Reser'/e Assets As was mentioned previously , -^"^ a secondary reserve should consist of short-term, readily marketable, high quality assets. The commercial banlcer must, of course, determine vrhat assets meet these criteria. There is no formula that can be applied to decide exactly vxhat assets should be included in the secondary reserve. There is general agreement, however, as to v'hat type of assets can be included in the secondary reserve.

PAGE 53

The Bankers' Handbook, for example, states the fcllovan^ Typically, the liquidity account includes U.S. Treasury bills and other Treasury and federal agency securities of short (less than oneor tvro-year) maturities, short-term high quality municipal obligations ^rir.h broad market acceptance, cominercial and finance paper, bankers' acceptances, broker and dealer loans, Federal funds sold, and securities purcViased under repurchase agreement (RPs).5° , Lists similar to this can be found in a number of other references . 5^ Most of these authors agree on the general type of assets that may be included in the secondary reserve with perhaps one exception. There is some disagreement as to whether medium-tern and long-term U.S. Govern:ient securities should be considered as part of the secondary reserve or as part of the investment (residual) account. Some authors feel that mediumi-term and long-term U.S. Goverrjnent bonds should never be included in the secondary reserve. The definition above, for example, excludes all securities that hax'e m.aturities of longer than two years, J, Harvie Wilkinson, Jr., states that only prime securities with short maturities -no^: mere than four years — are eligible for the secondary reserve, Ke further states that all miedium-term and. long-term U.S. Co-/ernmenb obligations will automatically

PAGE 54

^+7 be excluded fror. the secondary reserve since they have maturities of more than four years. Ray.Tiond P. Kent is in cciTiplete acreenent vjith this view, and states: Treasury bonds are not generally rep-arded as includable airiong secondary reserves at the time of their original sale or v:hen, in any case, they have several years to run to maturity, Tliey are not liquid in the sense of early assured repayment of the principal, and their miarketability is in question — in the sense ,., ^ of salability at no appreciable loss. ether authors feel that the vrhole concept of using long-term Goveriu-ent bonds as part of the secondary reserve i/s in violation of every principle of a vrell organized banking structure. The logic behind these pronouncements is that the market values of long-term bonds — including U.S. Goverrxment bonds — fluct\;ate widely. Thus, even though U.S. Government bonds are essentially rlskless as to default, changes in the interest rate structure can result in v:ide fluctuations in their prices. In^ a period of rising interest rates (and falling bond prices) a commercial bank would not be ^nuiKg to sell its long-term U.S. Government bonds, for to do so would result in a capital loss on the bonds (assuming they ' were purchased when prices vjere high).

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^8 This is not r.he only side of the scory, ho-Jever. There are other authors v.-ho feel that all U.S. Govermisnt bonds should be included in the secondary reserve. The reason is that U.S. Go\''ern.T.snt obligations are excellent collateral for loans at a Federal Reserve bank (or at any other financial institution for that matter). Existing regulations provide that U.S. Governj:;ent bonds shall be accepted as collateral at all Federal Reserve banlcs at par regardless of vrhat the ir.arket price may happen to be. This means that, in effect, there is a lov.-er level beloT'j x
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It is impossible to say vrhich of the two views presented above is correct, or even which view is more correct than the other. It all depends on hew you want to look at it. For the purposes of this study, however, the latter viev; must prevail. There are three reasons for acceptiiig this view. First of all, as was mentioned, all U.S. Government securities are excellent collateral for loans at the Federal Reserve banks and other financial institutions. Since these securities are eligible to be discounted at par at the Federal Reserve bali^s , any banker may use them to obtain funds at no loss regardless of what the market price of such securities mi.glit happen to be. However, since borrowin;at Federal Reserve banks is considered to be a privilege to be exercised only for short periods of tine, ^5 using such securities as collateral for loans at the Fed is not an appropriate source of liquidity for long-term loan expansion. Nevertheless, this source of liquidity is very well suited to the seasonal needs of m.any commercial banJcs, For example, an individual commercial bank may find that it is pressed for cash because of deposit withdrawals or heavy loan demands at a time vxhen the m.arket value of its long-term U.S. Coverrjnent securities is lower than the price that was paid for

PAGE 57

thsm. At such a time the banlc mipht vrell prefer using these securities as collateral f or a loan until the pressure subsides, '.'^aitintT for a ir.ore opportune time to dispose of the securities. Also, in times of dire need, the Fed vrould certainly accept such collateral for as long as vas necessary. Secondly, Florida lav; states that commercial banks operating under a State charter must keep a primary reserve (cash reserve) amounting to at least 20% of the aggregate am.ount of its deposits in the form of cash and/or bonds and securities of the United States and bonds and securities guaran"^.eed as to principal and interest by the United States. The wording of the statute is as follov:s: Every bank shall at all times have available in cash an amount equal to at least tf-eritj"per cent of the aggregate amount of its deposits. Such portion of said r^^serve as the bank may desire may bp invested in bonds and securities of the United States and bonds and securities guaranteed as to principal and interest by the United States, ovrned and I'lnpledged by the bank, or whach arf in excess of the total deposits v'hich they are pledgee to secure, and balances payable on demand, due to the company from banks with whom such com.p^ny m.aj'' keep its current account . ^''^ If all U.S. Govern.'nent bonds can be counted as tart of a bank's pririary reserve (in :^lorida) , then such bonds

PAGE 58

4 51 are certainly' good enou':h to be counted as pare of a bank's secondary reserve. The third reason (xrhlch is actually an extension of the second) is that the one-hundred fifteen commercial banks which form the sample used in Chapter III of this study are all state banks chartered in Florida. Conclusions We are no:-: in a position to dra'.v some conclusions about commercial ban];<: secondary reserve accounts. First of all, "secondary reserve" is not a precise tern and has never been legally defined. Nevertheless, there is general agreement in the inoustry tha^ a secondary reserve consists of short-term, readily rL;arketable , hi^-h quality assets. Second, a secoJidary reserve corves three main functions: (1) to provide a ban]< '.-Jlth a source of funds vrith which to meet deposit drains; (2) to provide a ban:rc with a source of funds with which to meet increased loan 5 errand; (3) to prevent capital impairment through the forced sale of assets at below-cost prices and provide for a satisfactory level of risk e-posure. Protection against depression is not a function of a secondary reserve as it is impossible for commercial banks to maintain sufficient

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52 liquidity to meet excessive x-/ithdrav7al3 brought on by a liquidity crisis, Tliird, the size of a bank's secondary reserve depends on the nature of the deposits of the banlc, the size and condition of the loan and discount portfolio, and the position of the business cycle. Each individual banker must determine his own liquidity requirements by analyzing his bank's past history and the environipent viithin wnich his bank opei'ates, This analysis should include a statistical analysis of past deposit and loan activity l^rith a projection of these data into the future. In the flnj^.l analysis, this is a case where good judgment based on experisr:ce niuj-'t be appl i ed. Fourth, it is possible that /.inerican banks adhere to an inforr.:al liquidity standard in the form of the industry average. If this is so, it means that nost banks do not determine their own liquidity needs, but rather rely on the industry average (and perhaps regulatory prodding,) to tell them how large tr.eir secondary reserves should, be. This subject is discussed in Chiapter III, Fifth, the secondar3A reserve is a bank's primary source of liquidity as none of a bank's

PAGE 60

other assets — includins loans — can be expected to contribute anything but an insignificant amount to a bank's liquidity. Sixth, it is possible that a bank may obtain some degree of liquidity through the effecti'/-e management of its liabilities. This subject is discussed in Chapter II. Seventh, for the purposes of this study all U.S. Government bonds vrill be counted as part of a bank's secondary reserve.

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Motes 1. Paul M. Atkins, "The Scientific Organization of a Secondary Reserve," The Bankers MaiTazire . CXXI , No. 2 (August, 1930), 21?. ' 2. Ibid . 3. Paul K. Atkins, "Secondary Reserve Policies and Programs," The Bankers i4a?azine . CXXXIX, No. 5 (Decenber, 1939), ^^79~, ^4-. J. Harvie Wilkinson, Jr., Tnvestnent Folioies for Cor^mercial Banks (Nev: York: Karoer and Brothers. 1935), 13. 5. Charle? L. Prathei^, M oney and 3a nit in (Chicaf^oj Richard D. Trt-in, Inc., 19^1-9), 32?. " 6. ?or exa-iple, see Donald R, Hodf^raan, Ccmnerc ial Bank Loan and Investment Fo IIcy (ChamTjaia-n; Fni-"-ersT^ of Illinois. 1963) , 46-75; Roland I. Robinson, The ' "' Mana -e rrent of Bank Pu .nds (Ne'rYcrkr rTcGra--/-r:ilTP'l962) , 23-92; and H. Parker '-Jillis, Ameri can Bankin? (Chicago: LaSalle Extension University, 1916)", 1^7.76. 7. The American Bankers Association. The Co!rm°r -c:al Banking" Industr y (Snglewood Cliffs, N.J.: ?r^ Lce-Hai IT Inc., 1962), 273-7^J-. ?. A mere detailed discussion of the tyoes of assets found in the secondary reserve can be" found in a later section of this chapter. 9. Eaughn and V/alker, 00. cit .. 562. 10. James 5. Buesenberi'y , Money and C^ed t ; Impact and Control (Sngle'/.^ood Cliffs, N.J. : Print i ce -'^a^ t Inc. , 196?) , i;.2. 11. Rollin 0. Thomas, Our Modern Bankinga >^d 'lon^tar" System (Nev^ York: Prentice-Hail, Inc., I950) , 2l4. '~ 12. The American Banl^ers Association, op. cit. . 271, 13. Ibid, 1^1-. See Robinson, op. cit . , 23-^1-0.

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55 15. Ibid, , 23. 16. Ibid. , 26-27. 17. Ibid. , 60. 18. Ibid. , 63. 19. Othervjise, time deposits Aould not be profitable, given the lov: rate of return on total assets in the banking industry. 20. Paul Atkins, "The Relation of Deposits to Secondary Reserves," The Bankers I^^a^razine , CXXI , No. ^ (October, 193^), ^79. 21. For a more detailed discussion of this, see Baughn and Walker, op, cit. , 5cS-72. 22. Raymond P. Kent, Money and Bankin^r (Nev; York: Holt, Rinehart and Winston, 19ojT^ 297. 23. Hodprir.an, 22^S:j^> 57. 2^. Ibid_._, 7'f-. 25. ^or a "lOT^e detailed discussion of this c-ub.iect, see Thomas, op . cit . , 220-27. 26. Charles Ashley Wrischt, "Eanlc Liquidity and che Sccles Bill," The Bankers Map;azine , C a XX , No, 5 (May, 1935) , 528-29. 27. Ibid. , 533. 28. Eugene H. Burris, "Do Ban]: Secondary Reserve Theories Need Revising? . " The Bankers V.a-rozine , CXXIII, No. 6 (December, 1931) » 73^' 29. See Baughn and Walker, or;, cit, , 562-77. 30. Prather, 00, ci^, , 32^. 31. The American Bankers Association, op , cit, , 271. 32. See Wilkinson, op. ci t . , 17-23.

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56 33. Prather, op. oil:. , 328. 3^'-. Paul M, Atkins, "Secondary Reserve Policies and Prosrams (Part II)," The Hankers MaRa^ine , CXL, No. 1 (January, 19^f-0) , 7-W, 35. Tqi±^, ^. 36. The following method Is a synopsis of the approach described in Baughn and VJalker, op. cit., 572-77, 37. Robinson, op. cit . , 6'4-6S33. The American SarJcers Association, or;, cit., 273-79. ~ 39. For example, see Hodgman, op . cit. , 4-6-53, or L. Sumner Pruyne, "Framin?; a Flexible Bank Investment Program," Burroughs Cleari ng House , 35, Mo. (January, 1951), 32-33^^ ^ '^O. J, Laurence Kolb, "Setting Up a Bond Account Formula," Burrou g hs C lea ringHouse, 2^^, No. fJanuarv. 19^1-1), 13. " ' " ^1. Kodgman, op. cit . , ^0, ^2. Prather, ov. cit. . 277. ^3. Eugene H. Burris, "Today's Bank Investment Program," The Bankers r-'ag azine. CXX, No. 1 (January, 1930), 1^!-. 4'!-. From a personal letter to the author from Mr. Solomion. ^5. See Chapter III. 4-6. The Am.erican Bankers Association, op, cit. . 2 7 J . " 47. Hodgman, oo. cit. . 56. ^8. The American Bankers Association, or., c^t.. 273. — ^^•9. Hodgnan, op. cit.. 57-58.

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57 50. Ibid. , 5B. 51. Ibid. , 59-60. 52. Ibid. , 59. 53. Ibid. , 60-61. 5^. Ibid. , 61. 55Baughn and /Jalker, op. cit . , 551 • 56. There is a good reason for making this assumption as v;iH be made clear in Chapter II. 57. See pace 15. 58. Baughn and Walker, op . cit. , 581, 59. '?or exaniple , see Paul M. Atkins, "Secondary Reserve Policies and Programs (Part II)," The Bankers rna^a^ins, CXL, 'vo. 1 (January, 19^''0) ; VJilkinson, op. cit. , 13; '"he American Bankers Association, op. cit . , 27'4-75; Paul h. Atkins, "Tne Scientific Organization of ' a Secondary Reserve." The Banker s Karaz ine ; CXXI , Mo. 2 (August, 1930); Paul K. Atkins, "Secondary Reserve Program," The Bankers Mas:az^ne , CXL, No, 2 (February, 19^'0) ; and Richard i'. Stern, "CoPimcn Errors in Portfolio Management," The Bankers :^a?9Zine , GXXXVIII, No. 1 (January, 1939Ti 60. Wilkinson, op . c i^ . , I3. 61. Kent, op. cit. , 305. 62. See Board of Governors of the Federal Reserve System, "Regulation A: Advances and Discounts by Federal Reserve Banks," Code of Federal Re.Q:ulat ions , Title 12, Chapter II, Part 201. 63. Paul K. Atkins, "Secondary Reserve Program," The Bankers r!a'^:azine , CXL, No. 2 (February, 19'^0) , IO9. 6k, Paul M. Atkins, "Difference Between BanJc Secondary Reserve and Investment Accounts," The Bankers Magazine . CXXI , Mo. 3 (Septemiber, 1930), 3-^1-5. /llso see Paul M, Atkins, "Liquid Assets for the Secondary Reserve," The Banker s Xag azine, CXXIII, No. J (Seotember, 1931), 3i^l-^-2.

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65. See Chapter II, 66, Fred 0. Dickinson, Jr, , Coinptroller and State Comr^issioner of Banlcxn:;?-, Lr.v's of the Sta t e of Florida , BankingCode, Second Part, ParagraDh "559 . l6 (Tallahassee: 1968), 71-?2. CO

PAGE 66

CHAPTER II THE INDUSTRY TREMD3: 1953-1968

PAGE 67

The Liquidity of the 3ysteni In order to determine the changes in the liquidity of the American banking industry over a pei^iod of time it would be desirable to tabulate the secondary re=;erves he].d by the systen: f or a nu;iber of years. In order to do this it would be necessary to have a detailed breakdoHn of the assets held by the banl-cin;; industry, Unf ortunatel?/, such inf ornnati on is not available,"^ The Federal Reserve does report the principal assess and liabilities of a] 1 commercial barJ<:a on a monthly 2 basis, divided into ^cu.r .v-i/oups: loans, 'O.S, Govtrrir'enT. securities, other securit i'^'S , and cash assets (""oquired reserves and excess reserves), S:nce U.S. Go\''err::::ent securities account for mere than ninery percent of the liquid assets of all ccm:r'.erc ial banks," total . U.S. Government securities held are used in this chapter as a substitute for secondary reserve and as a measure of the liquidity of the banking system. The amount of U.S. Governmient securities held by com.mercial banks, as a percentage of total assets on a monthly basis for the years 1953 through 1968, is presented in Table 1. These same data are presented on a quarterly basis in graphic form in Figure 1. 60

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61 TA3LS 1 U.S. G0VERMM2NT BONDS I'SLD 3Y COMMERCIAL BANKS, 1953-1968 (As a percentage cf total assets) 1953 195^ 1955 1956 1957 1958 1959 J anuarj '^h . 7 . J ^ • ( . ^ 30.0 26.9 27.1 29.0 r e or uar^ ^; " • ^ 29. 3 27. 3 27.2 28. T^'f ^\ ly\ I'lax cn tIl 1 JM• 1 T T 1 23. 8 26,9 27.^ 27.6 April Q T Q ..' . 7 ?R . 6 27. 3 28 .2 27.3 May 33.3 3^^ . 32 .9 28.2 27.2 or ^ 28 . 6 i;6.9 June TO P v~ . '33.3 ?1 .8 27.5 27.2 26.2 July 35.1 3^.0 31.9 2?.? 26.3 28.6 26,1 Augu s fc 3'+. 8 35.3 31.3 2 "< , 0 26.6 29.3 25.^ September -^^ . 3'^9 30.9 / . V 26,6 28.7 25.0 October 3^^-.l 35.5 31.1 27.5 26.''J28.9 25.2 Noveinber 3^.5 35.1 30.1 27.7 26.8 29.0 2'+.6 December 33.3 3^>.0 29.2 26.9 26.1 27.3 24.2

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62 TABLE 1 (Continued) i960 1961 1962 1963 1964 1965 1966 1967 196S 24.6 25.1 25.1 23.2 20.3 18.^!16.2 14.4 14.2 25.1 24.5 24.6 00 n ' — t < 20.1 18.0 15.6 14.4 l^^S 23.3 24.3 24.2 22.5 19.9 17.2 15. 0 lit. 6 14.1 23.6 24.4 2''-, 0 22.2 19.3 17.0 14.8 14.0 13.6 23.4 24.5 23.9 21.7 19.0 16.7 l4.4 13.7 13.7 22.8 24.6 23.5 21.2 18.4 16.0 13.9 13.2 12.8 23.7 25.4 23.6 21.1 13.5 16.3 13.9 13.3 13.2 23.6 25.3 23.4 20.3 18.6 16.0 14,1 14.4 13.5 23. B 25.3 ?3.1 20.6 1? .5 15.8 l4.l 14,3 13.4 24.6 25.4 23.0 20.5 18.8 16.3 14. 0' li^8 15.7 24.4 25.1 23.1 20.2 18.8 16.2 14.0 14.8 13.1 23.? 24.2 22.7 20.1 18.2 15.7 14.0 14.1 13.0 Source • L. ^ X _ ved fro: ^i ?ede ral Res erve Bui letin.

PAGE 70

63 FIGURE 1 U.S. GOVERNHEMT HONDS HELD EY COMMERCIAL BAMS, 1953-1968 (As a percentage of total assets) Percent Percen i'.0 ' ^0 33 38 36 36 3^ "*3^ 32 "" 32 30 30 23 2S 26 26 • : 2k22 22 20 20 18 _18 16 16 IhIk 12 12 10 10 1953 5" 55 Jo 57 Jo 59 oO ol c2 u3

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64 FIGURE i (Continued) Percent • Percent 40 : 1^.0 38 38 36 36 3^' 34 32 32 30 30 28 24 22 20 18 16 14 12 1965 oo 5? o8 o9 70 71 72 73 7II 75 — 7^ Source: Derived from Feder al _ P. e -serve Bulletin, 28 26 24 22 20 18 16 14 12 10

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The data for the years 1953 thi-ouc;h 196I show that tliere vias a series of peaks ana troughs in the relative amount of U.S. Goverament securities held by t?ie banking systeiii as a v:hole. These I'ises and falls are quite easily identified viith p-iajor monetary policy changes initiated "by the Federal Reserve, The period 1953 through 195^, for eranple, vfltnessed a recession during i-'hicb raember bank reserve requirenonts vrere reduced se'^eral tinies, producing a big increase in the expansion of reserves and money. This brought aboii.t a peak in the amount of liquid assets held by the ba:ii-:ing systerii, as U.S. Jover'nrr.ent securities held increased to 35»5^ or total assets in October of 195^'-» During the recovery that follovred banl< loans increased and relative hcldir^gs of liquid assel:s decreased. This trend was sccentuated during the upsTTing in 1955-1957 as the Fed. 'Jas quick to implement a restrictive policy, virtually/ freezing both the amount of bank reserves and the reserve requirements. The result i-^as that the growth in the money supply >:as almost completely halted, Betv^een the second quarter of 1955 and the second quarter of 1957 1 monetary grovrth i-ias slightly under .^s2 , 000 , 000 , 000 , Banks responded to this by selling securities in order to expand loans, Duririg

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66 1955 and 1956, banl<:s ' holdings of securities '.^^ere redv-ced by $13,000,000,000, and loan^ grev: by $20,000,000,000, As a result, bank holdings of U.S. Govern:rient securities declined to around ZG'f, of total assets during: 1957 « Beginning in late 195? the Federal Reserve again reversed its policy as it becaii'ie e^'ident that a recession was well under 'Tay. Discount rates were cut repeatedly, from a peak rate of 3.5:^ in October of 1957 to a low of 1.75,^ in the spring of 1958. Three rounds of cuts in reserve rsquireirents came in February, Iiarch, and April of 1953. Once again, commercial bank holdings of U.S. Government securities rose, reaching a peak of 29.3;t in Augustof 1958. The sub3eq_uent recovery sai: the return to a restrictive policy, and the reserve base actually declined in the last quarter of 1959. Bank holdings of liquid assets again declined, falling to less than 23^ of total assets in mid-1960. However, once recession v;as clearly identified, Federal Reserve policy undertook a number of expansionary steps. Discount rates, raised to h% in Septem.ber of 1959, were cut in June and again in August of I96O, Vault cash became eligible to be counted as part of

PAGE 74

67 member banks' required reserves. The reserve base expanded, and bank holdings of U.S. Government securities again increased until the end of I96I. Thus, throughout the period 1953-19^1 changes in corrjnercia'i ban.ks ' relative holdings of U.S. Government securities can be largely explained by changes in Federal Reserve monetary policy. The overall tendency of a decline in relative holdings of U.S. Government securities during this period (from a peak of more than 2'5% in 195^ to a peak of about 25,%' in I961) is explained by the fact that commercial b^nks vrere in general unloading excess U.S. Government securities they had Inherited from V/orld '.7ar II and the overly-liquid economy of the Imjnediate post-^:ar period,^ Commercial banks were employing their funds more profitably, as loans accounted for aboub 35"^ of the total assets of the system at the end of 195-' and about kS% of assets . 6 at the end of 19bl. From. 1961 on, hovrever, changes in comm.ercial bank holdings of U.S. Government securities cannot be so easily identified with monetary policy. Beginning in late 196I and continuing through I965 there was a steady and rather steep decline in commercial banks' holdings of liquid assess. At the same time, this was

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a period of relative monetary ease and expansion. After 1965 fluctuations in ban]? holding:^ of U.S. Government secu.rities a.^ain correspond to changes in monetary policy with lo^is associated with monetary restriction (Summer of I966 and Spring of 1963) , and highs associated vjith mionetary ease (Summer of 1967 and Summier of J.968) , Nevertheless, the total volum.e of U.S. Government securities held by tlie banking system remained relatively lovr throughout this period. Vfe m.ust look elsewhere for an explanation of the rapid dec] ine in commercial bank "liquidity" that took place in the 1960's, Part of the answer is revealed by an analysis of the liabilities of coramei^cial banks over the period 1953-1963, Time deposits held by comr_ercial banks, as a percentage of total assets, are tabulate in Table 2 on a m.onthly basis throughout 'jhis period As was the case vrith U.S. Government securities, these data are also presented in graphic form in Figure 2o It can be seen from these data that time deposits ha\^e become increasingly important as a source of funds to the banking system. At the end of 1956 time deposits accounted for slightly m.ore than ZJ'I, of total commercial bank resources, 3y the end of March, 1968, time deposits represented

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69 TABLE 2 TIKE DEPOSITS HELD BY CCMHSHCIAL BAMvS , 1953-1968 (As a percent as's of total assets) 1953 195^' 1955 1956 1957 1958 1959 J anuary ^ J t u c. ^ t O 24.0 26.7 r e ux uax y ^ t 7 2^.2 25.1 27.0 riarcn 2^.2 25.5 27.2 23 . 1 Apn 1 ^J* y oil< 2^1.2 25.3 27.8 — "-r . ^ 2i^.3 25.7 27.6 23,1 2^. 1 2^!-. 2 } 25.9 27. 1 ' • ^ July 23.6 _-. • J 2'i.O 25.6 28 .0 2-^,8 24.^ 2^.2 2i^.6 25. 27.9 23 . 1 September 23.6 2^.2 24,2 2if.3 26.1 28.0 27.9 October 23.8 23.8 2^.0 2^+. 3 26.2 27.3 27.3 November 23.^ 23.3 23.6 23. B 26.1 26.9 27.^ December 23.1 23.3 23.1 23.^ 26.6 27.1

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70 TABLE 2 (Continued) 1 Qf>0 1 q6i 1963 1964 1965 1966 1967 1968 27.8 29.2 34.8 37.3 38,3 40.3 41.6 28.0 29.4 32.1 3^.9 37.5 39.0 40.4 41.9 ^2.9 28.5 30.3 33.0 35.6 37.5 38.9 . 0 42.4 43 . 3 28.1 30.2 33.0 35.8 37.8 39.3 , 0 42.2 42 . 9 28.^ 31.1 33.5 36.0 38. 0 39.6 4i .4 42.3 ^'-2 . S 28.5 31.3 35.3 37.2 38. 8 40 . 2 42 , 2 41.5 OP c ^ V . u Jo. J Jo . J 'tI . J '-T'^C . 0 28,8 31.8 34.3 36.8 38.4 ^iO . J^i'-3 . 3 42 . 3 28.7 31.1 33.8 36.1 3:^.3 40.1 41 . ?, 42.6 42.2 28.5 31.2 33.5 36.5 38.0 40.2 41.0 42 . 7 42.3 28.4 30.9 33.7 36.0 37.4 40.0 '••'0 , 2 ^2.6 42.1 27. S 29.9 33.4 35.6 37.0 39.2 39.7 41 . 0 40,7 Source : Deriv Q-i froi I ^ S d. 3 'al Rese rv9 Bu lletin.

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71 FIGU,RE 2 TIME DEPOSITS HELD BY COMKERCIAL BAMKS, 1953-1968 (As a "oercentage cf total assets) Percent 50 ~ iih h2 .'40 33 12 rir. 28 26 2ii 90 20 1953 5'=55 56 57 l9 So cT 50 i^B 46 hh 42 40 38 36 3it 32 30 28 26 24 22 20

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FIGURE 2 (Continued) Percent )i 0 LLl 4? ^ n _ " 'i-U _ ko 3 c -JO 3c 3^ 32 32 30 30 28 28 26 26 2^ 2^ 22 22 20 20 1965 6"d d? S"3 ^e>9 70 71 72 73 7^^^ 75 To"' Source: Deri^'-ed from Federal Reserve Bulletin.

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73 TA3LS 3 TOTAL ASSETS OF ALL COMMERCIAL BANKS, 1953-1968 (In hillions of dollars) 1 o
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TABLE 3 (Contin^jerl) .960 1961 1962 1963 1964 1965 1966 1967 1968 235 2h7 267 235 305 334 367 390 437 23^ 250 269 288 306 336 368 392 435 233 266 288 309 3U2 369 395 435 237 2ii9 269 289 311 3^2 374 i|-01 439 235 251 269 291 312 3']' 3 373 i{-06 44 1 237 252 273 300 322 355 385 .'-ii 9 239 255 272 299 3 -'-6 330 412 45? 240 254 272 293 316 3ii3 331 412 456 2h3 261 278 3C0 328 35I1 381 ^19 465 2k G 262 28' 326 358 332 i!-22 472 2^7 26'^ 283 307 331 ^ 387 425 479 258 27^1 290 312 372 398 /i43 493 Source: Federal P.aserve Bulletin,

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75 FIGURE 3 TOTAL ASSETS AMD TIME DEPOSITS OF ALL COMMERCIAL BANKS, 1953-1968 (In IP ill ions of dollars) Dollars Dollar: 600 600 560 560 520 520 ^l-SO U80 4^0 '4^0 360 360 320 320 280 _ 280 2^0 Total assets__ 2^0 200 _ 200 160 160 120 120 30 Time deposits __ — " 80 1^0 — """ l^Q 0 0 1953 5^ 55"~5o 57 58 59 50 5i 63 0^'+

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FIGURE 3 (Continued) Dollars 600 ~ ' 560 520 ^80 360 320 280 2^0 200 160 120 80 ^1-0 0 Dollars ~ 600 560 520 i^SO kho 400 360 320 280 2hQ 200 160 120 80 UO 0 1965 66 5? bS 09 70 71 72 73 7^ 75 To" Source: Derived from Federal Reserve Bulletin,

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more than ^^3% of the total resources of the banking system, almost doubling in relative size. An analysis of the data found in Table 3 and Figure 3 makes this increased reliance on time deposits as a source of funds seem even more startling. The total assets of all commercial banks are presented in Table 3 on a monthly basis for the period 1953-196? • The grovrth in total assets is plotted against the grovrth in time deposits in Figure 3» Between the end of 1953 and the end of i960 the total assets of the banking system increased by slightly less than 36'^^. vrhlle time deposits increased by about 63%, During the n^xt eight years, however, the total assets of th.e s,7s'cem increased by m.ore than 93.'^» a^-i time deposits increased by more than 182>', Thus, starting in the early 196G's, not only did time deposits come to play a much more important role as a source of bank funds, but they also took on this role at a time when commercial bank assets began to grow at a. m.uch faster rate th.an had been the case in the previous decade. The early 1960's were, in fact, a time durir-g which far-reaching changes were taking place in che Am.erican banlcing system.

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73 The C hal?er-:-:e of Co''n'oe t 1 1 ion Throughout the deca'i'.s of the 1950 's it bec&tae more and rr.ore evident to coiiniercial bankers that they were operating in an increasingly competitive environment. Large companies that previously had relied on banlc credit were finding that they, were generating enough cash from retained earnings and depreciation to meet all of their needs, while others were goir^ to tiie coniraercial pape:* inarket for their cash needs. Large companies vjere also beginning to finance their ovm custcrrers, with the result that accounts payable had replaced bank loans as the major short-t^rrn liability of pany s'naller firrrs by the end of rh.e decade. " i'any firiT.s, large and small, were finding it wcrth/while to reduce their checking account balances and place their excess funds in earning assets such as Treasury bills arid. comnercial paper. In addition, indi\'"iduals were becoming more sophisticated, and xTere finding that they too could earn a return on excess funds thai; formerly were left in demand deposits. Finally, and most important, commercial banks v;ere having to compete vrith other financial institutions for funds. Savings banl:3 and ?a\'ings and. loan associations

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79 CHANGE IN PERCENT OF SAVINGS OP H0U3SH0LDS IN BA^H^S AND SAVINGS Airo LOANS, 19^6 TKPOUGH I965 Savings of Kouseho!l.d s in Banks Change in and S & Ls Percent Percent (billions) in Barks in SarJcs 19'+ 5 3^^5 78.55 19^0 39.3 rj 0 -to 7o . 12 .^^3 19^1-7 . 7 -1 . oc ^3.2 oil r* )\ 7k»3k-1 . 9o 19^9 It J 1 n tfi,, 8 l?. 12 -2 . '4-4 1950 M-6,3 69. 7o -2 . 3^!1951 4Q . 5 6^ . 57 . 0 y 195?. 55 • 6 65.^-7 -2 . 2G 1953 61.7 63.05 60,26 -2. -'+2 19'^'468 . 7' -2 .79 l^OJ) 75.2 57.31 5^.98 -2.95 1956 -2.ii-3 1957 09 '1 5^k65 53.76 .33 19^3 103.8 .89 1959 11^.0 52.11 -1.65 i960 l2i!-.3 50.0^ -2.07 1961 139.3 ^9.10 .9-'+ 1962 153.9 i!9.53 1963 177.9 ^8.68 .85 196^ 196.6 ii-8.22 1965 216.6 k9 . 08 + .86 Source : The National Bar.kinr Revievr, Dece'T.ber, 1966, i3i^.

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80 had in many cases entered the coTrir'erclal banks' STDhere of consumer credit lending, either directly or through Q the indirect method of mortgage refinancing. Between the end of 'Jorld VJar II and I96I nonbank financial institutions grew more than four tim^es as 10 fast as commercial oanks. Kutual thrift institutions enjoyed important competitive advantages over commercial banks, including a privileged tax position, exemption frori the cash reserve requirements imposed on member banks, and freedom from restrictions on the rates they could pay for savings. As a result, as can be seen from Table the percent of savings of households in commercial banlcs decreased from 76.5-:^ in 19^5 to less than 50.0.^ in the early 1960's. "during the early i96C's several changes occurred which enabled commercial banks to compete more effectively with nonbank financial institutions, including certain regulatory changes. During the 1950 's the reserve requirements on savings deposits in member com.mercial banks varied between 7^% and 5^, During the early 1960's these requirements were lowered to kn, and in late I96O, member banks Tvere permitted to count all vault cash as required 11 reserves .

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81 Throughout the postv;ar period coirjnerclal banks have paid federal income taxes on the saae basis as other firns, with the exception of relatively modest tax-exempt allocations of net income to loss reserves. On the other i-:and, savings and loan associations vfere permitted tax exemption on virtually all allocations to reserves and undivided profits until I963, Beginning v/ith I963, the amount of net income that savings and loans v'ere able to transfer to reserves and undiA'-ided profits on a tax-exempt basis v:as slrnif ica>itly reduced. As a result, the ratio of federal incom.e tax payments to net incom.e for savings and loan members of the Federal Home Loan ?.ank System, which equaled .OO-^lOO for I962, rose to .l4l77 for The com.petitive position of comjnercial banks also benefitted from liberalization in restrictions on investments in conventional mortgage loans by national banks. Prior to 196^ national ban]<:s 7;ere not permitted to invest in conventional mortgage loans with loan-to-value ratios in excess of 60% and terms exceeding 10 years, and even then the amount of such loans could not exceed 60< of time and savings deposits or the amount of capital, whichever vjas greater. Since late 1964, however,

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82 TABLE 5 YIELDS OM SELECTED LONG-TSR:-: SECURITIE 3, 19551965 Convent ial r4crt,5e.g-e T 0 VI c "* FL^A Insured Home Morta'age Loans* U.S. Bcnds^^Corpcra.te Bonds "-^ 1955 .0516 , 0^-6^^ .0282 .0306 1956 .053^ .0V?9 .0308 .0356 1957 .0583 . 05^(-2 .03^7 .0389 195S .0572 .0549 . 03^1-3 .0379 1959 .0593 • J 1 1 • U' ;-U { . oq-38 .0618 .0^01 , Oil-'! 1 ± y o J. • ^jyy .0581 .0390 .0^35 1 Q^? • ^ / J .0563 .0395 .0^.33 1963 .0582 ,05^^7 ,0ij-26 196^^ .05 SO ,05^5 .0^15 . Qifi'-O 1965 .0581 .C5'!-5 . .04-21 .oi;-s!-9 Source : The National Banking; Review, Tec enber, 1 966, 188. *U.S. av erages, based on GHil field oi'fice opinion *'*^"The series for U.S. bonds are avera£res of daily fi.3-ures for bonds ir.aturins or callable in 10 years or more. The series for corporate bonds are Moody's Investors Service series for Aaa rated securities.

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national banks hava been permitted to invest in conventional inortgase loans vrith Ican-to-value ratios of no more than 30> and maturities of no more than twenty-five years. Such loans have been permitted to equal up to 70/t of time and savings 13 deposits, During 19^5 the Federal Hone Loan Bank Board placed ceilings on returns to savers paid by federally-chartered associations which took part in plans permitting different returns on various accounts. Prior to this time savings and loan associations had been g^enerally free from restrictions on returns to savers. Another important fact or in improving the competitive position of comjnercial banl-is was the relative decline in home mortgage int-erest rates during the period 1955 to 1965. '\s shov;n in Table 5t interest rates on home m. or t gage loans, especially conventional home mortgage loans, declined relative to interest rates in general during this period, xs'hich greatly aided commercial barJcs in the price competition for savings. Also of im.portance is the fact that commercial banks began to accept greater credit risks durirjg the second postwar decade. This acceptance is

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84 TABLE 6 PERCfi^NT CP FINANCIAL ASSETS 0? COMNEECIiUL BA^KS AND SAA/IMGS AI-!D LOANS IN I'lAJOR ASSET CATEGORIES AT YEAR END, SELECTED YEARS 1955 1953 1961 1964 Commercial Banlfs" Member Bank Reserves 10,8 9.4 8.1 6.9 Interbank Deposits 8.2 7.9 7.0 5.3 U.S. Governinent Securities 31.5 30.1 26.4 20.5 State and ;;unicipal Bonds 0.3 7.2 7.8 10.3 Corporate Bonds .8 .6 . J .3 Loans 38 .9 ^!-o. 3 51.8 Baiik Loans , n . e . c . 21.0 22.4 24.8 27.4 Mortgage Loans 10.3 11.0 11.6 13.4 Federally-Supported 6.5 6.7 6.8 7.6 C om'^ent i onal 3.8 4.8 5.8 Consu^i^er Credit Loans 6.5 6.9 9.0 Other Leans 1.1 1.1 1.7 2.0 Seci.irity Credit 2.5 2.0 2.4 2.6 Miscellaneous Financial Assets . y 1.2 1.7 1.7 ivings and Lean Associations-Denand Deposits and Currency } . 7 3.3 2.6 2.3 U.S. Gox'"err_-nent Securities ,-• /• 0 . 0 7.0 6.9 6.4 Loans 84.6 84.1 35.1 86.0 Mortgage Loans 83.3 82.7 83.8 84.9 Federally-Supcorted 19.9 16.7 13.7 9.6 Conventional 63.4 66.0 70.1 75.3 Consuner Credit Loans 1.3 1.4 1.1 Miscellaneous Financial Assets 5.0 5.1 5.4 5.2 Source: The T^ational Bankinr: Revie'-; . Dece.Tiber, I966, 189 . *Board of Governors of the Federal Reserve Systen, ^lovf of Funds, Assets an d _Liabilities , 1945-6 5 .

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reflected in Table 6, The percerirage of assets in loans, uhere credit risk is generally higher than for other bank assets, increased from 3B.9/' in 1955 to 51.3,-? in 196^. All of the foresoinn; discussion, of course, leave out L'he one most important factor that has aided banks in their quest for a larger share of time and savings deposits — the advent of the negotiable certificate of deposit. The Ceitificate of DeT:.osit In February, I96I, the First National Bank of New York City announced tr.at it vrould henceforth issue interest bearing, negoviable, and marketable time certificates of deposit (the CD), Other large banks throughout cne system quickly follovred suit,-^^ This vras the beginning of an attempt by the system to attract some of the sliort-term corporate funds that otherxTise T>rould be invested in U.S. Treasury discount bills, federal agency issues, prime finance and Industrial commercial paper, banlcers' acceptances, and other short-term securities. Their purpose "as to regain some of the deposits they had lost to nonbanl^ financial institutions duri>:ig the 1950' s and to increase their lending potential."

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Originally, r.ost of tlie major n.oney market banks attempted to limit their certificates of deposit to million dol lar denoriinat ions , and the dealers in the secondary market still generally confine their trading to million dollar units. As time passed, hoT'rever, many large banl-^s offered CDs in denominations of 3500,000. Smaller banks may issue CDs for r|;iCO,000 or less. It is generally felt that these relatively high dollar limits discourage any possible large-scale shifts out of demand deposits. Any funds available in these am.ounts, over and above the customier's operating requirements, have probably already fcAuid employment in the short-term securities miarhets.'^' There are a number cf reasons uhj coiiiruercial banks began to issue CZs in the 1960's, ?ot one thing it offered i iray for a bsnk to raise its deposits. Traditionally, the deposit structure v;as considered 1 P to be beyond the control of bank miariagement . The CD made it possible for bani nanagemient to have some measure of control over not only the bank's deposit structure but deposit totals as xfell. In this ^:ay the issuing barik's lending power vrould be enlarged. Cf coLirse, the availability of reserves for the system as a x-rhole is essentially determined by Federal Reserve policy. The individual banker

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could anticipate, hov/ever, that the offorin,^ of CDs would enlarge his share of total r'^ssrves by attracting a larger share of total deposits. The offer of CDs also represented an attempt by coramercial banks to increase the stability of deposits. Deposits had becorr.e increasinsly subject to wide fluctuations as bank customers (especially corporate money mana^cers) becanie more adept in the methods of "scientific" cash manage me nt . It vras felt that the v?.oney market character of the CDs would enable banks to com.pete for the interest-sensitive funds that corporations, state and local coveTriaent s , and other public bodies were puttin>-^ into the short-term securities markets. The time deposit funds thus acoui-^ed ^-rould become available for bank use curing the life of the CD, thereby providing:: a relatively stable pool of funds which would permit tne extension of loan and investment maturities. Of course, the most im.portant reason for issuing; CDs was to stop the flow of savings deposits out of the commercial barJ<:in&; system into nonban_k financial institutions, /iccordins to one banking authority: Without the rigiit to compete equitably with nonban:t
PAGE 95

As multi-lenders, ccmrrierc ial banks must retain tnis ability to conpete for the customer's saving a if we are expected to serve his borrowing requests — and fulfill the country's demand for maxiinum economic growth and flexibility. 2^ On the other hand there are critics of certificates of deposit that r.aintain that banh efforts rc retain customers' demand deposits r.ave been serious]. y complicated by the developm;ent of this instrument. Some of the critics even suggest that the ertire total of certificates of deposit represents a diversion of their custom.ers' balances froni interest-free demand deposits to interest-earning tim.e certificates.'^'" T>iere no doiibt were som.e corporate treasurers in the early 196C's who had not thought of investing their surplus funds until they learned of CDs, To the extent that there were sucn treasurers In corporations here and there, the tendency tovrard the more efficient managem.ent of corporate cash was perh^aps accelerated by the advent of the CDs, However, the total amount of dem.and deposits affected probably has been minimal and, in any case, it should be assumed that even in these cases the corporation ultim.ately would have learned that it is possible to earn m^oney by investing surplus funds. E. Sherman Adams, Vice President of

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89 the First National City Bank of Nevr York Cit^/, had the follovilns to saj on this subject: "For the TuOSt part, these are fimds which, but for the CD innovation, would not be in the banking systej^i today, but would be 22 invested in other short-term money market ins^truments , " The growth of the banking,systeir. after 19'^0, as shox-;n in Table 3, and the halt in the flow of funds out of the banking system, as shoxrn in Table ^, would certainly seem to co/ifirm this conclusion. Thus far we have ignored one important point: the maxirium interest rates at whicl-i CDs may be issued are fixed by the Board of .',overncrs of the Federal Reserve System unJer Peculation Q/"-' As rates on alternative short-term instruments increa.'^^ and reach Re,;uiation Q limits, commercial banks could be priced out of the market. As this occurred, outstandinp: certificates would be redeer.ed at maturity as depositors sought more attractive rate? elsex'Jhere. As the reader is aware, this situation did in fact confront comrr.ercial banl^s se^reral times during the 1960's. Prior to 1966, each tim.e interest rate levels on short-term securities comroarable to CZs approached Regulation Q limits, the Federal Reserve raised the legal rates payable on CDs."^^ On Decem.ber 6, I965. Regulation Q maximum, lim.its were raised to 5'^'^ for CDs maturing in 30 days or m.cre as

PAGE 97

rates cortinued to ri&e. But then, when shortberm returns on ether instru.'nents vjent above 6;o before the middle of 19=6, the ?ed stood pat, and the collisicn occurred, 2^ Herald S. Taylor related what happened at riorgan guaranty Trust In h'e.vr York: As many iriaturin^; CDs were rolled over as ".'ras possible, new domestic sources of demsnd and tine deposits were sought out, deposits at foreign branches were increa5:ed, Surodollars were borrowed, federal funis -'ore bought, the bank went to the ^^ed's discount windov:, secu:~"ities were bought and soldj., and ter:i loans ''ere reduced or lirdted, Alir.ost every conceivable step w'as t'^ken by the bank to get by the crisis.^b Needless to say, korgan Guaranty and the rest of the banlcing sybes: did weather the s t or;.i , ^ but this errperience pointed cut a serious problen; that ccmtnercial ba rdcs r.ust face, A corner cial bardc can not be sure u?iat it will be able to reissue certificates of deposit as they iiabure. Of cou:\se, this discussion applies equally well to other tine deposits held by comnercial banJcs, which are subject to Regulation ~i. Although there are no precise data available, small, non-negotiable time certificates ofdeposit have also grown rapidly during the 1960's. Between the end of I96O and the end of 19f'8 total ti-ie deposits held by the conuriercial

PAGE 98

91 banking system increased fros 2^i.i:t of total assets to 38.1't of total assets. Lar^e ne,G;ot iable CDs accounted for 5?.l.'t of this increase, an:l amounted to 8,0;o of the total assets of the system at the end of 1968."' '^hus, other types of time deposits accounted for k2S% of vhe gro^-;th in total tine deposits, further threatening a bank's ability to remain solvent as interest rates in the irarket clash with Regulation Q limits. Most bankers have come to realize that by investing funds from time deposits in securities or loans thar. nature at about the same time as the timie deposits, they can hedge against a "liquidity crisis" in their bank. 3ut this is a problem for others to dsa] with. The poin^ to be made from this oiscussion is thai the large volume of certificates of aeposit issued during the 1960's — more than tvrenty-three billion dollars worth in denominations of /hOO.OOO or more at the end of 196s29 __ ^^.^^ resulted in an increased cost of funds for the banking system as a Tihole.^^ As a result com.mercial bank holdings of liquid assets declined substantially throughout the 1960's, as baric holdings of U.S. Government securities declined to less than 13/' of total assets in 1968. At the same tine commercial bank holdings of loans —

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generally the most rioky of bank assets increased substantially. In the first section, of this chapter x-re learned that commercial banks held about 35/^ of their assets in loans at the end of 195^*and about ^5% in loans at the end of I96I, By the end of 1968, commercial banks held more then 5o% of their assets in loans.-' If commercial banks have been able to assume so much, more risk and. at the same time greatly decrease their holdings of liquid assets, che question maght vrell be asked '/fnether or not commercial banks needed so much liquidity in the first place. The answer to this question must vjait until the next chapter. Pank ^ebenr u res and Capital The use of senior securities by comm.ercial banks dates back to the ea.Tly 193's, I'he Emergency Banlcing Act of 1933 autlicrized the Reconstruction Finance Corporation to purchase preferred stock and debentures issued by commercial banks as an em.ergency pleasure to aid distressed banking institutions. As a result, more than 7|0C0 commercial banks sold senior securities to the RFC, Despite their widespread use, however, banker retired these senior securities as quickly as possible due to the stigm^a of "distress financinp;" associated

PAGE 100

f with their issuance. By the mid-~195'^'s very few comnercial banks had any senior securities outstandins, and until recently P'ederal rep;ulatory ap:sncies and nost state banking authorities denied requests tc issue senior securities if common stock could be sold,' Despite this background, the Comm.ission on I'-oney and Credit, In its report of I96I, recommended the exploration of two suggestions -bank authorization to issue debentures subordinated to the claims of depositors, and issuance of preferred stock. Follov:ing this report, in 19^2, the Advisory Committee on Eani
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the cases an existing capital deficiency was the main reason advanced for issuing debentures, Accelei'^ated deposit and loan frrov/th had si:"ply oiit stripped the atility of these "banlrs to increase capital adequately through retained earnings. Nevertheless, the arrival of this method of financing was received with something less than enth>usiasm in some quarters. The Board of Governors of the ?^ederal Reserve System, for one, expressed strong disapproval over the use of subordinated debentures by comme^'cial banks. -^"^ Or)ponents of subordimted debentures cite the long-term fixed costs associated -Tith debt securities as their principal objection. It is argued that bank manegement vrill be under pressure to earn -ncre than the fixed rate on the debentures and, as a result, the quality of barJ: credit ttIH deteriorate as credit requirements on loans and the quality requiremencs on investment portfolios are lowered to' obtain higher yields, 39 It is also argued that the widespread use of banJc debentures during "imes of prosperity eliminates the safeguard of their use during a period of great stress. Accordingto one author: The general enth.usiasm for debt ^s being overdone. The use of debt has become fashionable, very "In" in contemporary corporate life. Every . business school graduate, keenly aware

PAGE 102

95 of the uses of leTerage and the tax deduotability cf interest, no'-" looks critically at a debt-free capital structure . ... Because debt is suitable f or corporate capital structures general 1:; , it is not axiomatic that it is suitable for comniercial banks. Nevertheless, the use of subordinated debentures offers some si?;nificant advantages to the issuir;? bank and its custoirers. For example, the issuance of capital notes and debentures avoids dilution cf stockholders' equity. In addition, the interest cost of the debt is deductible. One ir.port-ant advanta^^ie is thab because debentures have fixed maturities, there is not as ^^eat a liquidity need for seccndai'y reserves as there ..'culd be in time deposits. For t;ie same reason a barLk may invest these funds in lon'~er-term, hirher-yl eldingassets. (It should be pointed out that it miight be v:ise for the bank to invest in assets vrhioh iTould m^ature at tim.es appropriate for the servicing of this long-term obligation.) Subordinated debentiires have several advantages that relate direcrly to ban!-: customers. For depositors, these debt instrumients are clearly subordinate to their deposits, ether things such as asset holdings beiag equal, a depocir.or is more secure in a bank vjh.ich has

PAGE 103

96 the larger capital accounts In relation to total assets. Eorrovrers from a barJf with a larger capital base may find that suali a bank is more "ass^essive" in its lending policies. A bank Vi'ith. a smaller capital base is likely to hold more of its assets in a more liquid form than loans. Lastly, the successful use of debt capital v;ill enhance profitability, and this may encourage banks (or force them through competition) to pass on part of these savings to their customers. Stockholders also benefit from, the use of debentures, as a bank's issuance cf debt capital (as previously m.entioned) er.ables it to secure additional capital wit.hout diluting the stockholders' ea^uity. If rianagement is able to use these new funds effectively, it should add to the earnings potential of the comimon stock. Of course, it is possible that a bank may fail to use such funds efficiently and chus reduce the return on shareholders' equity. But this suggests a m.anagem.ent which has failed to acquire suitable assets with its new capital. Such a situation could occur, but it assur.es poor management, and this can occur even without senior securities in a ban2<:'s capital structure. Commercial banks have the option ot" offering debentures either as a straight debt issue or as an

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97 issue that is convertible into cornmor. stock. About one-third of the aiTiount of debentures offerings since UU 1962 have been convertible issues. The principal advantage of a convertible issue versus a straight issue is that a lov;er coupon rate can bo obtained on the convertible issue (other things equal). In addition, the convertible issues may present no refinancing problens and require no sinking fund pa.j'inents . If capital is raised by selling convertible debentures, and the anticipated deposit grovrth occurs, then earniT!gs , dividends, and tne price of the coTirr.on stock will rise also. Tlie price increase of the stock t'^ill caii.se the bends to be converted, and the bank is in a position to go to the debenture market for still more capital if it is needed. If the anticipated growth does not occur the price of the stock is not likely to rise, the debentures will not be converted, and. redundant capital is avoided. Actually, however, this is no advantage compared with straight debenture financing, A baii5<: can get the same results (at a somevvhat higher cost) by selling straight debentures and eventually replacing it with common stock when the price of the banlc's stock is presumably higher. Straight debentures also enable a bank to postpone the sale of equity until It considers

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the tir.e appropriate, without maklrifr an advance comraitraent a.r, to price. Also, the use. of straight debentures allows the bank the option of preplacin^ the debt vrith retained earnings, or with other debentures. ' In the final analysis, each individual bank must decide which type of offering best suits its particular needs. The use of debentures by coniinercial banks results in a reduction of the borrov/ing power of the issuing bank, as conurercial banks are limited as to the amount that they can borrow. This m^ans that a possible source cf liquidity during bad tines — borrovrlng — is decreased, for a bank that issues debentures. Add this to the fact tha~ coinrrerc ial bank holcirjjs cf liquid assets have declined, considerably during recent years and it seer:s even nore obvious that ccm'^.ercial banks were overstocked v'ith liquidity prior to the 1960's, This Would inply that secondary reserves of com.Tiercial bariks did not really perforr.^. their primary functions of protecting against deposit declines and providing for increased loan demand in the past. If commercial banks can operate today without so many liquid assets in their portfolios, they certainly could have done so prior to the 1960's. Or so it v-rould seem.

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99 The Nsed for Liquidity V/e have seen that the tremendous /^rovrth in commercial bank resources during the 1960'o has been the result of a number of factors. Supervisory restrictions v^sre relaxed, as rate ceiling's v:ere moved up and capital requirements Z'Jere liberalised. Increased competition frcr. nonbank financial institutions brought about the advent of the negotiable tine certificate o'^ deposit. In addition, the asset srov;th was dominated by the expansion of loans and other securities. Holdings of U.o, Governrent securities, on the other hand, doclined rna.ter ially , v;hich appeared to 3ii=:nal an inipairnent of ban2-c liquidity. Ti'aditional notions that th.e sources of bank funds are establisl-ied first and then deployed into suitable assets '.rere ho severely challenged, ' ^' Many people, ho-vever, argue that barilcs -lave considerably less need for liquidity today than was once the case,^^ Some argue that demand deposits now consist largely of needed vrorking balances, thus reducing the likelihood of che \/it:idra'-:al of funds for hoarding or conversion into other assets. As has alrea-ly been mentioned, Federal deposit insurance and advances in monetary management have almost

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IQO completely eliinlna'ei the possioijity of a liquidity panic. Jr. addition, the much greater volume of time deposits with definite r.aturity dates allows the portfolio L-anager greater knowledge as to the timing of withdrawals. To the extent that these withdravrals can be anticipated, it reduces the reliance or. liquid assets to meet unexpected deposit fluctuations. Many of those who claim that less liquidity is needed "by commercial banks today are very critical of pest bank management, which em.phasized that secondary reserves were the only source of liquidity.'^''' Pielying on secon'iary reserves as the only souz'ce of liquidity, it is argued, v'as exceedir^^ly crude and so over-conservative that strict observance would have prevented banks from adequately perform ln.g their main function of 'leetirj;; credit-worthy loan demands of the community. In addition, it completely ignores the dominant cause of deposit reduction — the contraction of loans. (The fallacy of this argument is obvious. It is true that deposit reduction for the system is the result of loan contraction in the system, but this is not necessarily tru.e for the individual banic. In fact, as was mentioned in Chapter I, the opposite is more likely tc be true for many banks, with peak loan demands coming at a time when deposit balances are

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lov.rest.) Another fault of the method is tliat it contemplates the possibility of cw^rencj hoarding and massive shifts of deposits ovaonz banks — as occurred in 1931-1933 — as a basis for liquidity needs for individual banlcs. Banking reforms since, the depression, hovrever, hav3 developed strong safeguards against a general breakdown of confidence in banks. /ilong v;ith the criticism, of course, a nevi "theory" has sprune; up, vrhich might be called the L iabilitie s r'ana^ement Theory . -^^ This theory did not discard asset managenent, but the emphasis shifted markedly toxfard liability manasement. Accord in'i to this theory, it is not necessary to observe traditional standards iii regard to self-liquidatinj loans and liquidity reserves, since reserve money can ba borrowed or "bought" in tlie money market whenever a reserve deficiency is experienced. There are several possible sources from which a ban]< may acquire funds by the creation of additional liabilities! the acquisition of demand, deposits; issuance of tim.e certificates of deposit; purchase of Federal funds; borrowing at the Federal Reserve Bank; issuance of short-T;erm. notes; raising of capital funds from sale of

PAGE 109

102 debentures, preferred st;oc>, or con:mon stock, or frcm retained earnini-:;s ; and the Eurodollar market, V;e v;ill consider these sources of funds one at a time. The acquisition of demand deposits as a source of liquidity may be suLomarily dismissed. The competitive redistribution of existing demand deposits (on vrhich interest is prohibited) am.onir banl:s is a continuous process, vrith some gaining; and others losing,. An individual bank may attract additiorjal dem.and deposits through advertising or offering more ser^/ices to depositors. Such efforts, hovmver, vjould require too m.uch tim^e to have any effect on a ba.nl-c's current liquidity needs. In addition, competitor banl-^s m.ay offset such action through adjastmients in their ov;n operations. Bankmanagement cannot count on this source of funds whenever funds are needed. The CD, of course, has been the predominant liability source of funds for the banking system since the early 1960's, However, a strong limitation on CDs as a dependable source of liquidity during boom conditions is the fac": ::hat the Federal Reserve controls the maximum rates payable on such instruments. The experience of the summier of 1Q66 makes this pcint quite clear. Certificates of deposit are no miore dependable as a source of reserve money than the disposition of the

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Federal Reserve Board to lift the rate celling as interest rates in general aro rlsirj^. Another liraitation is the fact that banks mist coir.pete strongly anonj themselves for existing funds in boom periods v;hen it is scarce. Also, it Is almost certain that the Federal Reserve ^'ill implenient a monetary poljcy of restraint during such a period. In other words, the banker vrho v:culd place heavy reliance on CDs as a source of funds must realize that during boom periods he T>Jill be coinpeting ^•rith other banks f or a stcck of reserves that vjilA be restricted, or even reduced, by the Federal "reserve authorities. The third source fro^. -'rhich the individual bank may acquire fun^s in the purchase ( borroTTirig) of Federal funds ^ The great bulk of Federal funds is loaned on a one-day, unsecured basis. Banks also utilize repurchase agreements under T-;hich the torrox'ri banlc actually sells U.S. securities under contract to buy then back in one or more days at a predetermined price.-' Tne Federal fun.ds market does not qualify, exceiit in a minor way, as a soui-ce of liqi:idity for the Individual bank because of its very short-term features, ard from the probable unavailability of funds at reasonable rates during boom periods vj}ien they are most needed.

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104 In practice, corrcv:in.:r frorii a Federal Reserve Bank predo:minant Ty takes the f orni of a ronevjabl e pro:.iiG?ory note for I5 days or less secured by U.S. securities. Other forns of "cor rovrins (though seldora utilized) are the discountingof eligible paper consisting of custo^.er notes v.'ith reniaining maturities not in excess of 90 days and the proceeds of vrhich v:ere used for working capital purposes, and a prcmissory note v;ith a rriaxiTnum maturity of 4 months and secured by any satisfactory bank notes, -^-^ Federal Reserve credit, however, is • generally granted as a privilege, rather than a right, .to meet day-to-day and seasonal liquidity needs of member banks. Ordinarily, borrowing for longer-terra purposes, including cyclical loan e.cpc-.ns ion, is not regarded as appropriate. Thus, borrowing at che Federal Reserve Bank does not appear to be a dependable source of liquidity for coirnercial bsnJcs during periods of expansion. This source of liquidity should be used primarily for shcrt-tern requireirients , including emergency and seasonal needs. The fifth source from which a bank may acquire funds is the issuance of unsubordinated, sliort-term, promissory notes. The y^irst National ?ank of Boston ivas the first to issue such securities in September of 1964.^^ These notes offered significant advantages over CDs, as they

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105 were not clas;_;if ied as dsposits, r.nd thus x-:ere not subject to niaxircur: rate re^iulstlon ( fiep-ulati on Q) . They vrere instead classified as borrovred funds, and not subject tc elt?ier le^al i-eserve requireiient s or to deposit insurance assessTients (they vrsre, of course, subject to the usual ler;al restrictions on borrowings) , However, the banking law of New York was interpreted to bar the issuance of such notes, thus t!:e noney-market banlcs of New York City were excluded fron the Tiarket. Also, in June of 1966 the Board of Covernors of the Federal Reserve System ruled that such notes, whether negotiable or non-negotiable, would henceforth be subject to the rej;ulaT:ions governing reserve reoulrei?.ents and payment of interest on deposi ;;s , ' The result vjas that the advantages of such notes over CDs vrere erased, and their effects on the iconey market beooraes Identical with that pertainiag to CDs: they are not a dependable source, except to a limited extent, to neet the liquidity needs of a barilc durin^g ocon; periods. The sixth source from which a ccrjnerc j al bank may acquire funds is by raising capital funds. The issuance • of preferred stock r.ej be dismissed because of its insignificance in the banking field, and also because of the depressed level of preferred stock prices during periods of high interest rates. As' for retained earnings,

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1C6 dependence on this source vjould not seerr; to be practical. In periods of increased earnings stockholders expect higher dividends instead of a reduction. The sale of coirmon stock also inay not be practical. Bank stock prices may "be depressed by the high interest rates associated with, boom cone'' it ions . Also, banks are often reluctant to issue more common stock because of dilution of earnin7:s and because of control considerations. High interest rates associated •-/ith boor, conditions also limit the possibility of issuing debentures for cash needs (as 7rell as the borrovrins limits placed on commercial banks) . Ho'^ever, this does not preclude the use of such instruments durin-5 earlier stages of an econom:::c expansion, vrhen debentures may :vell be an important source of funds. Ho'.'.-ever, raising ca.pital fiaids az any tiLie cannot be considered to be a source o" liquidity as sucr. to a commercial bark, A bank vrould hardly have time to issue an offering of debentures to m^eet a current dem.and for funds. The raising of capital funds, hovrever, may reduce the overall nee'-3 for liquidity, in that, on the average, more funds T-;ould be available to the issuing barJ:. A final possible source of funds for commiercial banks is the Eurodollar market. This market deals in interest-bearing time deposits, denominated in dollars, on the books of large foreign banks. Eurodollars originate

PAGE 114

107 x-:hen the holdei(usually a foreign harJ: or firm) of a demand deposit in an American bank ' transfers funds to a forei,r;n bank with instructions to open a Eurodollar account. This leaves ti-ie foreign bank T-:ith a nev: liability in the forin of a time deposit and a counterpart deposit asset on the books of the American bank. Having a olai'.a on dollars, the foreign bank is then in a positioii to make loans to others ;;ho wish to borrovi dollars -whether they be foreign business firiis ot" American banks. BorrcwiniT in the Eurodollf.r market by a U.S. bank does not represent a r^et addition to the reserves of the bankin.system. This follows from th:P fact that Surodollars h.=.ve dei.-.and deposit counterparts on the books of U.S. banks, A chanr.e In ownership of a Eurodollar time deposit from, one forei.i'n owner to another brings about a corresponding shift of U.S. demand deposits from one bank to another. ilevertheless , such borrowing may be a source of shore-term liquidity for an individual bank. However, it is iict 'an . appropriate source of liquidity for any bank belovr the tier of lar^-e m.cney m.arket institutions. Dealingsare in x^fnclesale lots with a minim.um of one million dollars, with most sinmle transactions in tens of millions.-'^ Direct access to this market is beyond

PAGE 115

108 the reach of sr.all and :redii;.n-g ize'^ lianks, biit the Eurodollar market is, within liniihs, '' an appropriate source of liquidity for a large money .TLsrket "bank. Thus, ovei-all it vjould appear that the nana,?-enient of bank liabilities deserves a socevrhat limited role in a banl'^3 total liquidity program. The management of liabilities appears best adapted to meeting short-term liquidity needs, particularly during boom periods. It v-Quld appear, then, that individual banks must still rely on the management of their assets to provide for adequate liquidity. ^ In SDite of all this, the experience of the 1960's shows that the management of liabilities has come to play an imr-ortar.t oart rn commercial bank operations and policies. Through the careful management of its liabilities a bank may be able to avoid the need for as much liquidity as it would othervrise require. This ' could well explain the decreased level of liquid assets held by the banking system during the 1960's. Whether or not -commercial banks in fact determine the level of their secondary reserves according to their needs v^as ' yet to be answered. This is the subject for the next chapter.

PAGE 116

109 C one 111, si on s In this chapter v;e have f ourio , first of al.l, that changes in bank holdings of U.S. C-overnr^ent securities prior to I961 ooul'3 03 closely identified with n-ajcr changes in Federal '-^essrve 'ncnetary policy. After 1961, hox'fever, holdinp-s of U.S. '^overri.'nent securities declined sharply wh?le total assets increased at ,9 rapid rate. Tin^e deposits also grev: very rapidly after 19^1 « as did barJc loans. Second, v/e found that nonbank co.r:pet ition resulted in the lo^^s of tine deposits by the banking systeri throu;~hcut the 1^5^'s. Thereafter, hovrsver, the trend vras I'eversed as coiTinercial banks eegan to ccmpste .Tcre effectively because of competitive .and regulatory chano:es and the advent of the time certificate of deposit. Third, it vras discovered that CDs offered banks some measure of control over deposits, tended to increase the stability of deposits, and allo-z.-ed banj-cs to brin^:;; more usable funds into the system. Hovrever, their use is limited because of Regulation Q, which could be a serious limitation on trie use of such instruments in the future, Fourth, the large volume of tim.e deposits outstanding during the 19f^0's tended to increase the cost of funds to the system. As a result, banks increased their holdings

PAGE 117

110 of loans and less liquul assets, which implies that they did not nee-? as ^:UOh liquidity as they previously had held. Fifth, cor.aiercial tanks began to use debentures as a source of capital during the 1960's. These instruirents are si;bord inated 1:0 deposits and have the advantage of avoiding dilution of stockholders' equity T-rhlle allowing more capital to be raised to meet increased needs. However, the use of debentures results in the reduction of a commercial bank's borrcvjing povrer, which further reduces its liquidity. Sixth, it ".'Jas found that there is reason to believe that cominercial ban^cs need less liquidity than they did in the past. It is argued that derr.and deposits tend tc be more stable, advances in 'r.oney managem.ent have made the occurrence of a liquidity crisis extremely unlikely, and CDs have definite m.aturities, m.aking for more stable deposits, T!:e careful management of 1 iabili ties " may enable a bank to a^/oid the need for as much, liquidity as it would oth.erwise require'. Seventh, we concluded that although the managem.ent of liabilities has come to occupy an important role in commercial bank operations, banks still must rely on asset mar^.ge-^.ent (the establishmient of a secondary reserve) to provide for most of their liquidity needs.

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VJhether or not banks determine the size of their secondary reserves accor<:lin'7: to their needs is a question that has not yet been ansv/ered.

PAGE 119

112 Motes 1, A brealccioT'Ui of the assets of large corii:r.ercial banks in the federal Pieserve Sj'sterr. is availabrie in the Federal Reserve Bulletin , however, the breakdovm is not complete, nor does it account for all of the banks in the system, 2, "Principal Assets and Liabilities and Kuriber , by Class of Bank," f ederal Piese rve B.ulletin (January, 1969) , A 19. ' 3, The Federal Reserve uses certain forms (-R 363} in their barJc examinations in which a detailed breakdovm of the bank's liquid assets are tabulated. The Federal Reserve sent this author a number of these f orris (datingback to 1955) in v.-hich the assets cf the "Averarve Insurea Comrnercial Bank" T"ere tabulated. These foras snow that U.S. Goverrj^ient securities are by far the naior elerr.ent In comniercial ba^ik holdings of liquid assets (assets eligible for the secondary reserve). Cn Oecenber 31, 196C, for exaraple, U.S. GcverriT.ert securities accounted for 9^i0'1 of the liquid assets of the "average" insured bank. 4, -""or a detailed discussion of monetary Tjolicy in the United States since 1951 see Paul 3. Trescott, "one ', Bankint^:, airl Fccnc-.ic '-Jej fare (New YorV. 'cG"p-.:-"i" "i '. 19b5) , "^'-78-512; " 5. Ibid. 6. "All Banks in the United States, By Glasses, Principal Assets and Liabilities, and Number or-arVs," Fe deral Reserve Bulletin (July, 1955), 775. and (J anuar y , 1 9 c 2 j , 5 3 . 7. See Note of this chapter. 8. Paul S. ?;adler, "VJhy Bankin.9is Chanri^c-," Banking. LVI , No. 6 (BeceT.ber, I963) , ij?. 9. Ibid. Also see Nary T. Mitchell, "New Yardsticks in Measuring BanJ: CcniDet ition for Decand Deposits," "^hp Bankers Na-razine . 1^9, No. 3 (Su.rjr.er, .1966), 37. "~ 10. S. Sherrrian Adams, "Commercial Bankin--Perspective," The Bankers Na-a^ine . 1^8, No. (Su-r^ner, 1965), 72.

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113 11. Jack H, Vernon, "Competition for Savin^rs Deposits: the Recent Experience," The National Banking Revie-: , t.Jo. 2 (Decenber, 1966), l85. 12. Ibid. , 186, 13. Ibid. 1^. Ibid. . 187. 15. Herbert Bratter, "CDs a Problem for the Fed," Banking. LYUI, I'o. 8 (February, I966) , 39. 16. Eaughn and VJalker, op . c i t . , 669-70, 17. "Certificates of Deposit," Federal Reserve Ef?nk of Nev: York, T-onthl^r Review . ^5, Mo. 6 (June, I963), 83-8^. Also see Tilford C. Gaines, "Certificates of Deposit Reappraised," The ranlrers Karazine , 1^7, No, 1 ('..'inter, 196^-), 35. ^ 18. Saup-hn and Walker, op. ci -'-.. , 610, 19. Fieldhouse, op, cit, , 82, Also see "The Fed Holds a Ti5-er by the Tail," Busines s Week , No, 1^23 (July 9. 1966) , 62. 20. "Savings Certificates Attacked, Defended," B ankers Nonthl; ^, LX}D:iII, No. 6, (June 15, I966) , 20. 21. Gaines, ot?. cit. . 38, 22. Adass, op. cit . , 73, 23. Baushn and Walker, op. cit. , 670, 24. Ibid. . 612. Also see Gaines, op. cit. . 38. 25. Harold S. Taylor, "The SuniTier the Eanl-iers Lost Their Cool," The Bankers Karazir.e . 150, No. 3 (Suminer, I967) , lOT ' 26. Ibid . , 11. 27. For a coT'iplete discussion of the liquidity crisis of 1966 see the reference in Note 24. 2c. A 29. Fede3-al Reserve Bulletin ( J a nr.ar 5^ , 1 9 6 9 ) ,

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11^ 29. Ibic! . 30. Pieldhouse , op. cit., 87, 31. See Table 1, 32. "Principal Assets and Liabilities and Number, by Class of Bank," federal Re;;erve Bulletin (January, 19o9) , A 19. 33. Edward J. Rock, "Panks Pind New './ays to Raise Capital," Hanki n'-^. LVII , Mo. 5 (November, I96'!-) , 58. 3^!-. Cited by Paul Jessup, "Bank Debt Capital: Urchin of Adversity to Child of Prosperity," The Banker 's Ka.^azine , lU?., No . 3 ( Surpme r , 1 9 65 ) , ^ . 35. Ibid. , ^3. . 36. .^usene ?. Brigha.in and Michael Kawaja, "The Use of Convertible Debentures in Commercial Bank Financing," The Bankers Nafvazin e, I50, No. ^i(Autuir.n, 196?), 26-27. 37. See E. A, Conforti, "Results of a Survey on Debt Einancin?; by Banks," 3urrou.'-;hs Cl earin~ Hou se, 52, No. 7 (April, 1965), 2^-29, 72-?8. 38. Martin Kern, "A Critical Look at Capital Notes," Bank in, LVIII , No. 5 (November, I965) , 50. 39. Mock, 00. cit., 60. Kern, on. cit. , 50-51. ^1. Por £. full discussion of the advanta^res of the use of debentures, see Jessun, or), cit . , ^6-5^1-, Also see Nock, opc cit. , ^7, 58-62. ^2. Jessup, or . cit. , 51. ^-3. Ibid. . 52.^^4-. Br i sham and Kawaja, op. cit . , 26-27. ^5. Ibid. , 31. ^6. Ibid.

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115 '4-7. Stanley Silver"berc, "Bank Debenture T^-'inancin?; : A Comparison of /ilternatives , " Tne Natio nal Banking Revlevj, 3, No. 1 (September, 19'^T. ^'"'^ ' ^!-8. Jessup, or> . cit . , '!-^3» ^9. ?or a cor.olete discussion of this sub,1ect see p. Lee Jacquette, "The Bank Liquidity-Profitability Ti>-chtro'3e , " The Bankers Fia^Taz ine , 150, Ho. 2 (Spring, 19^-7) » 9^-100.' Also see J. L. Robertson, "The Chan^rlng '.Jorld of Bankinr," Bankin? , LVII , Ko. 9 C'arch, I965) , '^-5, 122, 50. ?or example, see Adans, op . cit. , 71-77* Also see Baughn and '.'alker, od. c it . , 609-20. 51. For er'ample , see Jacquette, o^. cit. Also see G. Walter oodvrorth , "Bank Liquidity I-ianagenent : Theories and Techniaues," The Bankers :iar':azi ne, 15O, Ko. ^ ( Au t umn , 1 9 6 ? ) , 66-73. 52. See Robertson, or. . 0 i t: . ; and '..'codv.-orth, co. cit. , 66-73. Also see Baughn and VJalker, 00. ci t., 6l0-12. 53. See '.'oodv;orth 5'-^-. Ibid. , 73. 55^ Ibid. , 7^^ 56. Ibid. , 7^. 57. Ibid. , 75. 53. Ibii , , 73. 59. Ibid. , 77-78. 6c. Ibid.

PAGE 123

CFAPT^r? Ill THE 3ECC:TjA^Y ?E3ER73 I?I RSALITY

PAGE 124

The Sample In order to develop a saTiple setting forth the liquid asset holdin,?;s of a reasonably large number of coramercial ban>s, it is first of all necessary to have access to the detailed records of a large number of individual co~iinerclal banks. Obtaining such records proved to be a difficult task, as detailed records of individual comniercial bank asset holdings are not available to the general public. Most coir.mercial banJks do publish a yearly balance sheet (on Decenber 31) shovring major asset and liability categories. However, data from this source are too general to be of much use, and since bank management has plenty of time to prepare for such statements, the possibility of "x^indoi'j-dressing" casts doubt on the validity of any conclusions that might be dra-'in from an examination of such data. At the present time all United States banks are subject to examination at any time by one supervisory 2 authority or another. ^latlonal banks are examined by the Comptroller of the Currency, state banks are examined by state supervisors, member banks are examined by the Federal Reserve, and insured banks are examined by the ?DIC. Since examinations by the authorities may corns at 117

PAGE 125

118 any time, the examiners reports on a number of conrnercial banks would be an excellent source of data which could be expected to yield a true picture of individual bank asset holdings. With this in ir.ind, the author contacted the Federal Reserve, the ?DIC, and tho Cor.ptroller of the 3 Currency, requestln,^ certain information from the examination reports of a number of commercial banks in order to obtain a sample of the liquid asset holdings of a representative number of commercial banks. All three authorities Informed this author that all information in their examiners' reports was highly confidential and could not be released for any purpose. Having thus ruled out these three sources of information, which would have made it possible to obtaiii a sample of banlvs spread across the country, the author m.ade the same request to the Banking Comim.iss loner's office in the State of Florida.^ Again it was explained that examiners' reports are confidential, I'owever, the State Banking Commissioner keeps the call reports^ from all State banks from, the previous four examinations separate from, the rest of the examination reports. (The call report is the basic balance sheet of the bank in the examination report.) When it was revealed how the inform.ation would be used, the author v;as allox'red access to these form.s.

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119 Call reports are sent to Florida state banks twice a year for co'Tipletion. The reports are usually sent toward the middle of the year and toward the end of the year, but they may be sent at any time, and individual banks do not know when to expect then,^ The call reports that were made available to this author vrere for I967 and 1968 — a total of four reports for each bank. The dates on each report varied, but ustially were dated toward the middle of the summer and toward the end of the ?/ear. From the files, a sample of II5 state banks vrere chosen at random. It miust be pointed out that this sample has a number of characteristics which place some limitations on any conclusions v.'hich might be drawn, from, an analysis of the data. First of all, every bank in the sam.ple is a state-chartered, non-m.ember bank. These banks, therefore, are not under Federal Reserve supervision. Of particular importance is the fact that prim.ary reserve requirem.ents are different for member banks and for Florida non-member banks, A Federal Reserve member bank, which is classified as a reserve city bank, must maintain the following in the form of cash or deposits vrith the Federal Reserve Eank of its district: (i) -3 per cent of (A) its savings deposits, open account, that constitute deposits of individuals, such as Christmas club accounts and vacation club accounts,

PAGE 127

120 that are rr^ade under written •contracts providing that no withdrawal shall be made until a certain number of periodic deposits have been made during a period of not less than 3 months; plus (ii) 3 per cent of its other time deposits up to '^5 million, plus 6 per cent of such deposits in excess of -t^ million; plus (lii) l6h per cent of its net demand deposits up to !^?5 million, plus 17 per cent of such deposits in excess of .'|;5 million, "i^ If a member bank is not a reserve city bank, the requirements for savings and time deposits are the same, but the bank must keep 12fy of its net demand deposits u.p to five million dollars and 12hf? of such deposits in excess of 8 five million dollars in primary reserves,' A Florida non-mem.ber bank, on the other hand, must keep a primary reserve amounting to at least 20?? of the aggregate amount of its deposits in the form of cash and/or bonds and securities of the United States and bonds and securities guaranteed as to principal and interest by the United 9 States. However, even though the banks in the sample are. not examined by or subject to regulation by . the Federal Reserve, they are not completely different from, the rest of the banking system. The Florida authorities are not likely to use standards and procedures that differ greatly from the standards and procedures in force

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121 in the rest of the system."'"'^ In addition, essentially all of the Florida non-member banks are also examined by the ?DIG (there are ^tnoninsured banks in Florida), which ensures that the Florida non-member banks conform to the standards set up by that agency Another limitation is the size of the banks being studied. There are no state, non-member banks in Florida vrhich have assets in excess of $100 , 000 , 000 . 1Therefore, very large banks are not represented at all by the data in the sample. Hovrever, the reader should realize that less than 3.^5 of all the com.mercial banks in the United States have deposits in excess of $100,000,000.-^^ Apart from the fact that very lar~e banks are not represented by these data, the sample is fairly representative of the American banking system as to size. About 26^ of the sample banks have assets in excess of :*20 , 000 , 000 , and about 26^ of all U.S. banks have assets in excess of o20 , 000 , 000_. About JS% of the sample banks have assets between ^10 , 000 , 000 and $20,000,000, compared with a percentage of J7^, for all banks. The percentage is similar for smialler banks. Therefore, as far as size goes, the sample is representative of in excess of 95% of all American banks. Another limitation, which could be more serious, is the time span of the sample, which is four examination

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122 dates over a period of two years. With a longer time span, it would be possible to follow changes in the sample bank's liquid asset holdings and compare these changes with national avera3es and with changes in monetary policy. A tivo-year time span severely limits our ability to do this. Hovjever, this assumes that there is some recognizable pattern in the data. The limitation of the time span, then, would be ^''ery severe indeed if the data in the sam.ple tend to support . the hypothesis of this paper. That isto say, if the data shox^/ that the liquid asset holdings of all or most of the banks in the sample tend to be maintained at some specific level identified as the industry standard, then such a conclusion m.ight be subject to question because of the short time span involved. HovTever, if the data show the opposite -that the liquid asset holdings of the banks in the sample do not tend to be m.aintained at som.e specific level, but rather are quite diverse — then the short time span would not be a severe limitation. In any case, these three limitations — the size of the banks, the classification of the banks, and the time span involved -may serve to restrict the conclusions that can be drawn from this study. The reader should keep these points in m.ind as the analysis proceeds.

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123 The call reports from which the Information that is used in this study is derived separates the assets of the bank under consideration into a number of different categories. This author selected the categories that could be considered to be liquid assets and added them together for each bank and each accounting period. These "liquid asset categories" include: Cash, balances with other banks, and cash items in process of collection; United States ^jovernment obligations; Guaranteed securities of Federal agencies and corporations; and Federal funds sold and securities purchased under agreements to resell. The categories that vrere not included were the following: Obligations of states and political subdivisions; Other bonds, notes, and debentures; Corporate Stocks; Loans and discounts; Bank premises owned and furniture and fixtures; Real estate owned other than bank premises; Investments and other assets indirectly representing bank premises or other real estate; Customers' liability to banks on acceptances outstanding; and Other assets. Once the liquid assets of each bank were totaled, the resulting figures (four for each bank) were divided by the total assets of the banlc at the time of each

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12^ examination. This gave the holdings of the liquid assets of each bank as a percentage of total assets for each examination period. From each of these percentages 20"^ was subtracted, and the resulting figure gave the liquid asset holdings in excess of primary reserves (secondary reserves) of each bank as a percentage of total assets for each examination date. These are the figures that appear in Table 7, Table 8, and Table 9. Once this was done, the 115 banks in the sample were divided into three categories according to the approximate size of their total assets. The first category, classified as large state banks, consists of banks having total assets betvjeen ''i20 , 000 , 000 and .''^100,000,000. There are 30 of these banks, which are numbered from 1 to 30 inclusively, as shown in Table ?. The seconi category, classified as m.edium-sized banks, consists of banks hgvin-^ total assets betvieen -UO, 000, 000 and '^20,000,000. There are ^i-O medium-sized banks in the samiple, which are numbered from 31 to 70, as shown in Table 8. The third category consists of small state banks vrhich have' total assets of less than -'f.lO , 000 , 000 . There are ^5 of these banks, and they are numbered from 71 to 115. as shov:n in Table 9.

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125 TABLE 7 HOLDINGS 0? SECONDARY RSSER^/ES 0? THIRTY LARGE STATE 3AMS-" CHARTERED IN 7L0RIDA, I967-I968 ' (As a percenta£-e of total assets) ll^i: 12^ BAI'Tv SPRiriG ?ALL SPRING NUMBER 1967 1967 1968 y 22% V6% 30'^ 11^ 20,^ 18'^ Source: Derived from all reports (Form Gh , state of •JBanks havlns: total assets between -'20 000 00^^ $100,000,000. ^w,wju,uuw and ALL 19c \ '^^ 26;?: 2 16^ 10% xj% I2t ^ 23/ y 3^ 11^^ 8^^ 6 205^ 18';? 8 23'^ 25,-^ 29't 32^ 9 30% 2M zlt. 1^ 231 23t 2M% \\ 385 hi% 37:. 13 29^ 22;^ 28^ 31^ }^ 165 I8j^ 16^ 1° 39^ 26^ 21^% 2.% 17 22-^ 25-^ 21'^ ^ 23^ 20^ 23'^ 17'^ 9^ 18 23^ -9 13'^ 12;t i6'^ 20 28J? 3/1^ 21 2^:t 22'^ 25;^ 2 It 12^ 12^1^ 1?J 28^^ II 32 J 3i^,<^ 27'^ X M '^^ 26-^ 36^ 25 2^t 22?< 2° 19^ io^ if . f^^ II ^1^ 45^ 205 10^ 22^ 313 20/t 28^ Ela.) .

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126 TABLE 8 HOLDINGS OF SECONDARY RESERVES OF FORTY '-'EDIUFi-SIZED STATE BAMKS-CEARTERED IK FLORIDA, 1 96 7-1 968 (As a percentase of total assets) BAMK SPRING FALL SPRING FALL NUiXBSR 1967 1967 1968 I96S 31 57% _ 51% 1^5% 32 21% 20% 29% 21% 33 15% 17% 20% 19% 3h 22% 21% 26% 27% 35 27% 25%27% 32% 36 32% 31% 35% 27% 37 . 11% 11% 9% 10% 38 21% 21% 23% 2h% 39 2% 1% 6% 1% ko . 32% 36% 31% 31% til 21% 17% 28% 25% 27% 23% 31% 28% 1^3 2H 25% 16% 26% Uk 21% 22% 25% 19% ^5 16% 22% 22% 13% US 0% 1% 1^% G% 47 S% 9% 9% 7% ^8 25% 2k% 29% 27% k9 16% lk% 27% 22% 50 32% ^^% ^2% 51 29% 35% 29% 26% 52 26% 2k% 22% 23% 53 13% 6% 6% 7% 5^ 21% 25% 20% 23% 55 20% 20% 20% 19% 56 im 12% 28% 23% 57 52% h7% 51% 58 21% 18% 59 36% ^5% 60 30% " 25% 28% 25%

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12? TABLE 8 (Continued) BANK SPRING FALL SPRING FALL i}i u 1 1 u o n 1 q67 1 0^7 17 r 1 Qt^R 1 Q^iP X 7 u o 61 12% 17% 16,^ 13-^ 15% 62 _ 15t 9% 17% 63 39^ 37% 3r% 5% 3S% 15-^ ?s k% 65 23''^ 2Q% 23% 21% 66 k5% 35% k3% 36% 67 ii< 16% lU 68 30^ 26% 27% 2kt 69 lot 17% 12% 18% 70 30?^ 30% 29% 30% Source: Derived fro.-n call reports (Form 6^^, State of Fla.), ''Banks having; total assets between .-,10,000,000 and ^,20,000,000.

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128 TA3LE 9 HOLOinC-S CP SSCOMDARY RSSEH%'S3 OV FORTY-FIVE SKALL STATS BANKS* CHARTERED IN ^LCRIDA, I967-I968 (As a percentafTe of total assets) 3AWii SPRING FALL SPRING PALL njKBER 1967 1967 1968 1968 71 25% ^ ^ !^ 2o>: 2hfo 28% 72 32% 36% 26% 26% 73 38^ 36% 39;^ 7^ 27t 26% 29% 31^ 22^ 75 21^ 23% 21% 76 30^ 38% 2h% 23:^ 77 33% 26t 2 "5/0 78 9^ Ikt 12% lh% 79 Q% 9% SO 11^ 10% 17% 13% 81 30% 35% k-2% ^5% 33% 82 38^ 3h% 83 3^t 28t 32% 8^ 38% 3^,t 27% 35% 20% 85 36% 38% 39% 86 19% 22% 19% 18% 87 li^,:^ 7% 20% 88 38% h5% 50% 39 38% 35% 38% 90 39% ^8% 37% 91 60% ^5% 20% w ± /O 61% 92 22% 2o':^ 18% 93 37% 39% 3^% 94. 5o% 55% 53;-^ 95 63% 65% Ol.'Q 60% 96 1^1% ko% hit 3^% 97 1^2% ^7% 37% 37% 29% 39% 35% 98 32% 31% 99 27% 25% 28% 100 22% 6% 33%

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129 TABLE 9 (Continued) 3AI>IK SPHIN. FALL SFRIU^ rp^LL 196? 195? 1968 "1968 I'^l 5^^ ^9'^ 5l^t ^2^^ 2i|t 25^ 25;^ 2?l 36.^ 36t 35=^ 395 32;^ 23,5? 29t 23;? 2^ Is? ll'i 107 1.2^ Z,2^ ig'^ 21| l^^S 4lt 33^ 38'^; 2iJ 110 . 6J 16:?? iH4 {l^i 111 30 1 15-t 20^0 16^ JJ? 395 36^? 46^ ^^5 jk% ^4 17 1 C30ur 11^ 25% 20^ 39t 30,1 28^ 30% • Derived fron call reports (?orm 64, State of Fla.). Banks having total assets of less than .^0 , 000 , 000 .

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In summary, then, Table'? presents the holdings of liquid assets in excess ofprlir.ary reserves as a percentage of the total assets of 30 large state banks chartered in !^lorida for the four examination periods durin.^ 196? and 19o8. The sanie data are presented for mediun-sized banks in Table 8, and for ^1-5 sraall banks in Table 9. A brief look at these tables shoT'js that there seems to be a uide diversity in the anount of secondary reserve assets held by the individual banks. For example, bank l-'r held no secondary reserve assets (as defined above) during the ?all of 1963. Bank 11, on the other hand, held ^4-5^ of its assets in liquid form during the same period. Bank 91 held more than 60^ of its assets in liquid form during all four accounting periods. In addition, there does not seem to be any identifiable cyclical movement in the sample banks' holdings of secondary reserves. Whether or not this diversity exists for all or most of the banks in the sample calls for a closer exam.inat ion. Classification of Data The data from the sample of banks as presented in Table ?, Table B, and Table 9 do not lend themselves easily to examination and analysis. 'i^or this reason

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131 the data have been classified for each Individual bank according to the approximate size of secondary reserves held as' a percentage of total assets and according to the degree of fluctuation of the holdings as a percentage of total assets. These classifications are presented in Table IC, Table 11, and Table 12 for large banks, medium-sized banks, and small banks respectively. In each of these tables the number of each bank in the sample is followed by a rating for the approxim.ate size of the secondary reserve and a rating for the degree of fluctuation of the reserve. Each bank in the sample is ranked by a number from "1"^ to "5" according to the approximate size of the bank's holdin,gs of secondary reserves as a percentage of total assets. Banks holding between 0.^ and 10> of their assets in liquid form are ranked "1," banks vrith liquid assets between 11'"^ and 2Q% of total assets are ranked "2," banlcs with liquid assets between 2Vt and 30, '? are ranked "3," bardvS with liquid assets between 31, t and ^0^ of total assets are ranked and banks with more than k-l'i of total assets in liquid form are ranked "5." This ranking is completely arbitrary, and the author admits that there is som.e overlap of the ratings. The liquid asset holdings of bank ^9, for example, fluctuates between and 27% of total assets.

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132 TABLE 10 SIZE AND DEGREE C? FLUCTUATION CHAP^'ICT ERISTICS OF SECC:nARY RESERVES C? THIRTY LARGE STATE BANKS-"CHARTERED IN :-^LORIDA, I967-I968 BiXm SIZE 0? ?LUCBANK SIZE OF PLUCNUMPER RESERVE TUATICN NUMBER RESERVE TUATICN 1 3 C 16 3 C 2 2 B 17 3 A 3 2 B 18 2 B 3 C 19 2 A 5 1 B 20 3 B 6 2 A 21 3 A 7 1 A 22 2 A 8 3 B 23 3 B 9 3 B 2^1 B 16 3 . A 25 "3 B 11 5 A 26 2 A 12 ^ A 27 5 A 13 3 B 28 2 A 1^ 1 B 29 1 C 15 2 A 30 3 C Approximate Size of Holdings as a Percentage of Total Assets Ratin^; 0% 10^ 1 11,^ 20'^ 2 21^ 30^ 3 31^ ^0^0 k h\% 70% 5 KEY Fluctuation of Holdings as a Percentage of Total Assets Rating 0% ^% A .6% 10% 3 Wo 15% C l6t -^Qfo D Source: Derived from Table ?. *3anks having total assets betv/een $20,000,000 and ."^100,000,000. ...

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133 TABLE 11 SIZE AND DEGREE CT^ FLUCTUATION CHAR.\GERISTICS 0? SECONDARY RESERVES 0? FORTY MEDIUH-SIZSD STATE BANKS* CHARTERED IN FLORIDA, I967-I968 BANK Xj U 0 J. ZjIZj v^r 1j U — NUMBER RESERVE TUATTOM 31 c <1 q 32 J R A 33 2 A J J 1 X D 3 S4 •> J A :\ 35 3 B 2 A ii 36 4 B 56 , 2 D 37 1 A 57 5 B 38 3 A 58 2 A 39 1 A 59 •5 3 ^0 4 A 60 3 A 41 3 C 61 2 A 3 B 62 2 3 ii3 3 C 63 64 A 3 B 1 C ^5 2 B 65 3 A 1 C 66 4 B Zi7 1 A 67 2 B 48 3 A 68 3 B 49 2 C 69 2 B 50 4 C 70 3 A KEY See Table 10 Source: Derived from Table 8. *3anks having total assets between il^lO , 000 , 000 and .'^20,000,000.

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13^ TABLE 12 SIZE AND DEC •REE OF ?LUCT U AT ION CHARj\CTERISTICS SECONDARY RESERVES 0? _ Uii-X—' 1. y Hi C!?-^ ATT Q'T /' Titr BANKS* CHARTERED IN i7T T"n A 1 yo I'—iyOo BANK SIZE C FLUCBANK SIZE OF FLUCNUMBER RESERVE TUATION NUMBER RESERVE TUATION 71 3 B 9^ 5 B 72 3 B 95 5 A 73 ij. A 96 k B 3 A 97 5 B 75 3 A 98 B 76 3 C 99 3 A 77 3 B 100 2 D 78 2 A 101 5 . A 79 1 B 102 3 A 80 2 3 103 ii. A 81 5 C lOif 5 B 82 A 105 3 B 83 B 106 3 A rL OH' D 10? 5 A 85 ^ A lOo 1, B 86 2 A 109 5 3 87 2 C 110 2 D 88 5 A 111 3 C 89 k A 112 5 B 90 5 C 113 5 C 91 5 A 11^ 3 C 92 2 A 115 c 93 B KEY See Table 10 Source: Derived from Table 9, *Banks having total assets of less than .^10,000,000.

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This autnor ranked bank ^9 as a "2," but it just as easily could have been ranked a "3" (the average holding v;as 19.9'^ of total assets). Most of the figures, hovrever, fall v;ell v/ithin one category or another, and every attempt v;as made to give a true representation of the approximate size of the holdings of each bank. Each bank in the sample is also ranked according to the degree of fluctuation of the bank's holdings of secondary reser\''es as a percentage of total assets. The method of ranking the fluctuation of secondary reserves presented the author with a problem, for it is difficult to say what is a small degree of ' fluctuation and what is a large degree of fluctuation. The author decided to rank the banks as to the degree of fluctuation of secondary reserve holdings in the following way: banks whose holdings of secondary reserves did not vary by m.ore than Saof total assets during the period under review are rated "A" ; banks whose holdings varied between G% and of total assets are ratevd "3"; banks whose holdings varied betvreen 11'^ and 15'^ of total assets are rated "C"; and banks whose holdings varied by more than IS't of total assets are rated "D." An "A" rating indicates

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136 that the secondary reserve holdings of the bank involved vrere relatively stable for the time period under consideration! A "3" rating indicates that the bank's holdings of secondary reserves fluctuated to a moderate extent, A "C" rating indicates a relatively high degree of fluctuation, and a "D" rating indicates a very high degree of fluctuation. There are tx-ro na.jor reasons for rating the degree of fluctuation of the bank.s ' liquid asset holdings in this manner. The first reason is that the time period involved is quite short, extending from the Spring of 1967 until the ^all of I968. . Given this short time period, the ratings as described above seem quite reasonable, A change in a banlc's holdings of liquid assets by more than 5,"' of total assets vrould seem to indicate at least a m.oderate degree of fluctuation. In the same light, a change in a banlc's holdings of liquid assets by more than 10^ of total assets vrould seem to indicate a relatively high degree of fluctuation. The second reason for categorizing the banks in this -v-ray is because of the nature of this study. That is to say, if there is an informal liquidity standard in the banl-cing industry, if individual banks do try to m.aintain som.e target ratio of secondary reserves to total assets, and if banks m.aintain secondary reserves for scD.e purpose

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137 other than sieetinr: their liquidity neeclr, , then v.-e vjould not expect banks' holdings of ceconc!£?ry reserves to fluctuate very much at all. In a study such as this it is practically impossible to judge the 'effects that monetary policy may have had on the secondary reserve holdings of the banks in the sample Qurins the time period under consideration. In the first place, it takes time for tive effects of monetary policy to become evident. Thus, the sample might not show any immediate effects from changes in monetary policy. In the secondary place, monetary policy changed in direction se-v3ral ti^^es during 196? and thus negating the possibility of recogni2ing any cumulative effect for the entire period. This might not be too great of a problem, if the hypothesis of this paper is correct. If bank secondary reserve holdings are not related to the actual needs of most individual banks, then '\'e m.'^.ght expect changes in m;onetary policy to affect the holdings of all or most of the banks in the sample in the same v;ay from period to period. If, on the other hand, secondary reserves are related to the individual needs of eych banZ-:, then i':e v-ould not expect bank holdings of seooncLary reserves to fluctuate for each bank in the same vay. The effects of monetary policj-' might be evident in tlie overall patcern, but some baiiks'

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138 holdings v;ould fluctuate much more than the holdings of others (degree of fluctuation is taken up in later sections of this chapter) , and monetary policy lags and local considerations would presumably result in some banks' holdings of secondary reserves moving in the opposite direction from vrhat might be expected. If we return to Tables ?, 8, and 9 for the moment, and examine the data presented there, v;e find that this is exactly what happens. Monetary policy, in general terms, was expansive in the Spring of 196?, restrictive in the Pall of 196?, expansive in the Spring of 1968, and restrictive in the 1 fi Fall of 1968. Uith monetary policy as a guide, and assuming no lags, we would expect commercial bank holdings of liquid assets to decrease between the Spring of I967 and the Fall of 196? » as monetary policy moved from a period of ease to a period of tightness. For the banks in the sample, decreased their holdings of liquid assets, 37"^ increased their holdings, and 11% d.id not change their holdings (as a percentage of total assets). Thus, the effects of monetary policy were evident, yet the holdings of of the banks in the sample did not m.ove in the anticipated manner. Between the Fall of 1967 and the Spring of I968 we would expect corj-.ercial bank holdings of liquid assets to increase, as m.onetary policy m.oved toward a period

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139 of ease. For the banlcs in the sample, 5^:^ increased their relative holdings, 39;^ decreased their relative hol.dinss, and 11?? did not change their relative holdings. The results are the same: the effects of monetary policy are evident but not dominant. In the third interval, monetary policy again moved tov.'ard restriction, indicating that there should be a decrease in bank holdings of liquid assets. Once again, the sample shovrs the same tendency. About 56t of the banks decreased their relative holdings, 39""^ increased their relative holdings, and 5f? did not change their relative holdings. Finally, then, we can say that the effects of monetary policy are not clear. The data Indicate that monetary policy changes affected some of the banks' holdings of secondary reserves verj^ quickly. Many of the banks, hovrever, seem to shovr no immediate effects from changes in monetary policy for the time period under review. Actually, it is impossible to tell what eventual effects monetary policy vrould have on the sample banks, both because of the lags inherent in monetary policy and because of the frequently changing direction of monetary policy during 196? and 1968. A.lso, it is impossible to tell vrhat any

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1^0 particular bank viould have done during the tine span under consideration in the absence of monetary policy. It is clear, however, that monetary policy did not have any dominant immediate effects on the liquid asset holdings of the saiiiple banks. Secondary Preserve Characteristics of Sample 3anks In the previous section vxe classified each bank according to the amount of total assets, according to the relative size of secondary reserve holdings, and according to the degree of fluctuation of these holdings. We are now in a position to examine the data a little more closely. The distribution of the ratings assigned for the large banks in th.e sample are presented in Table 13. The banks are first of all broken dovm according to size, with the number of banks rated "1," "2," '3," '"4," or "5" as shown at the top left of the table. Rating "3" Is the largest category, accounting for of the large bani<:3 in the sample. Rating "2" accounts for another 30'^. of the banks, and the remaining Z7% of the banks are distributed am.ong the other three categories. Thus, ?3'^ of the large banks in the sample maintained secondary reserves of between ll^'j and 30;t of total assets. This is not surprising, as most banks

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141 operate under sonevrhat similar pressures anl conditions, and v;e vrould expect some degree of similarity among the liquid asset holdings of most banks. However, there is not that much similarity, as ratings "2" and "3" com:bined represent a range of movement of 2'^% of total assets. There is certainly no indication of an industry standard (or any other kind of standard) in evidence in these data. An examination of the degree of fluctuation in the individual large banks* holdings of liquid assets bears this out. As shov:n in Table 13 1 seventeen of the thirty banks — 57'' -had liquid asset holdings that fluctuated by more than S% of total assets, vrhich indicates that the large banks in the sample varied their secondary reserve holdings in accord ''rith local considerations and individual needs. V/hen the ratings for the size and fluctuation of secondary reserves are combined — the bottom half of Table 13 — there is still no evident pattern tha. t vjould indicate that individual large banks do not adjust their secondary reserve holdings to their own needs. Of the large banks rated "2" or "3" as to size (73?^ of the total), the secondary reserve holdings of hl% were relatively stable ("A" rating), the holdings of another h\% fluctuated moderately ("B" rating), and the holdings of l8;t underwent relatively large fluctuations ("C" rating).

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142 TABLE 13 DISTRIBUTION C? RATINGS I^CR LARGS BAMS IN SAKPLS* SIZE FLUCTUATION Numbe r RatlnPT of Banks 1 h 2 9 3 13 Zj. 2 5 2 Number Rat in?; of Banks A 13 B 12 C 5 D 0 SIZE AND FLUCTUATION Rat ins; Number of ranks lA 1 13 2 IC 1 ID 0 2A 6 23 3 2C 0 2D 0 3A 3 3B 6 3C 4 3D 0 Rating; Number of Banks Z|A 1 ij-B 1 4C 0 0 5A 2 5B 0 5C 0 5D 0 Source: Derived from Table 10. *See Table 10,

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I 143 The distribiition of ratings found in Table 13 is presented in Table l4 for the medium-sized banks in the sample. The distribution of ratings for medium-sized banks is ver:/ similar to the distribution of ratings for large banks, vjith the exception that there is slightly more variation in the size and degree of fluctuation of the secondary reserves of the individual banks. In this table, rating "3" is again the largest as to the number of banks included, accounting for 40"^ of the medium-sized banks in the sample. Rating "2" is the next largest category, accounting for 2$% of the medium-sized banks in the sample. These t'.-ro ratings com.bined thus account for SS't of the total. Rating "1" accounts for 15% of the total, and rating and "5" account for the remaining 20-t, As for the degree of fluctuation, the liquid asset holdings of ^0^% of the miedium.-sized banks vieve relatively stable over the two-year period, the holdings of another ^0% of the banks underwent moderate fluctuations, and " the holdings of the rem.aining 20% of the banks underwent relatively large fluctuations. Combining the ratings for size and fluctuation yields results similar to those found for large banks. Again there is no evidence of any industry standard in these data.

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TABLE 1^ DISTRIBUTION 07 RATINGS FOR IISDIUM-SIZSD BA?IKS IN SAMPLE* SIZE FLUCTUATION Number Ratln.^: of Banks 1 6 2 10 3 16 ^ 5 5 3 --s Number Ratln,g of Banks A 16 E 16 C 7 D 1 SIZE AND FLUCTUATION Number Rat in?: of Banks lA 3 IB 1 IC 2 ID 0 2A ^ 2E ^ 2C 1 2D 1 3A 7 3B 7 3C 2 3D 0 Nurabe r Rating; of Banks Ua 2 Lb 2 Uc 1 . 0 5A 0 5B 2 5C 1 5D 0 Source: Derived from Table 11. *See Table 11.

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145 TABLE 15 DISTRIBUTION OF RATINGS FOR SMALL BANKS IN SAMPLERSIZE RatinNumber of Banks 1 1 2 7 3 12 U 12 5 13 FLUCTUATION Ratln.fc Number of Banl^s A 18 B 16 C 8 D 3 SIZE AND FLUCTUATION Number Number Rat In? of Banks Ratln.f: of Banks lA 0 tPA 5 IB 1 Us 5 ic 0 3C 1 ID 0 3D 1 2A 3 4a 5 2B 1 Ub 5 2C 1 Uc 3 2D 2 4d 0 3A 5 33 a 3C 3 3D 6 Source: Derived from Table 12. *See Table 12.

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1^6 The distribution of ratint^s for small banks in the sample is presented in Table 15. A quick examination of this table v.'ill sho?? that the ratin^^s for the degree of fluctuation of the secondary reserve holdings of small banks follovT the same pattern as that found for large banks and medium-sized banks. However, the ratings for the size of secondary reserve holdings are different. About 29:"^ of the small banks are rated "5," about 21% are rated about 2?^^ are rated "3," and about lG% are rated "2." Only one small bank is rated "1." Thus, about 83> of the small banl-:s in the sample are distributed fairly evenly amiong the top three size categories. This tends to strengthen the contention that banks determine the size of their secondary reserves according to their needs. A sm.all bank in m.any cases means a new bank. It takes tim.e to develop an efficient loan program and to build up steady customer relationships. Small banks have small capital accounts, and m.ay be hard pressed to m.ake industrial loans to even very smiall businesses. The officers of a small bank are usually called on to perform a number of different tasks, as there m.ay not be any formial credit department, or loan departm^ent, or investment departm.ent. Thus, we would expect m.any small banks to maintain a larger percentage of their assets In liquid form than would be true for larger banks.

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14? The distribution of ratin:5S for all of the banks in the sample is presentel in Table l6. This table shoNs the same trends as the previous three tables • A majority of the banks in the sample -58'^ — are rated either "2" or "3" as to the size of secondary reserves held. About 59^ of the ban]<:s had secondary reserves that fluctuated at least to a m.oderate extent over the tvro-year period. '-Jhen all of the banlcs are rated accordin~ to size and fluctuation of secondary/ reserves combined, it can be seen that ^i6;5 of the sample banks are rated either "2A," "2B," "3A," or "3S." ?rom all of this we can say that there is some degree of similarity in the liquid asset holdings of about half of the banks in the sample as to size and degree of fluctuation, 'Te can also say, hovrever, that the degree of similarity is not great, as the tv:o size ratings ("2" and "3") encompass 201 of the banks' total assets, and the tv;o fluctuation ratings ("A" and "3") encompass a possible change in liquid asset holdings of IQf, of total assets, either up or do"-rn (or some combination of the tv;o) , This author -fould interpret these data to mean that there are similar external factors actlr^on many of the banks Ahich tend to result in somewhat similar holdings and fluctuations of secondary reserves.

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148 TABLE 16 DISTRIBUTION 0? RATINGS -^OR ALL BANKS IN SAMPLE* SIZE FLUCTUATION Rating 1 -2 -3 — u — . Number of Number Baril's Rat in*?; of ParJ'<"s 11 A 47 26 p L^L c 20 19 D _ _ _ ij. 18 SI2S AND FLUCTUATION Number Number Rating of Banks Ratln,g of Banks lA U 4a 3 IB 4 4B 8 IC 3 4C 2 ID 0 4D 1 2A 13 5A 7 2B 8 53 7 2C 2 ^C 2D 3 5D 0 3A 15 33 17 3G 9 3D 0 Source: Derived from Tables 13, l-^i-, and 15, *3ee Tables 10, 11, and 12.

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1^1-9 HoKever, there is by no stretch of the ina^^inat ion enough siinilarity to imply that there is any kind of standard to '''h.ich individual banlcs attempt to adhere. There is nothinc in the data to indicate that Individual banks do not determine their secondary reserve holdings according to their individual needs and the pressures of their enviroa^ient . It appears that soT.e banks utilize their resources much nore efficiently than others, as 32,'' of the banks held secondary reserves ar.ountin^ to more than 3Qr of total assets durin? the period under considerationt •'•'^ '.-.'e cannot state this v'ith certainty, hovrever, for vre do not knov" the individual circumstances that faced each bank. All T.-e can say v:ith certainty is that these data indicate that there is no industry standard determining the size of com.mercial bank secondary reserves, and that there is nothing in the data to indicate that com^mercial banks do not determine their liquid asset holdings accordin.fi to their needs and the 18 ' pressures of their environment. 1

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4 150 Notes 1, "ITindovr-dresslng" Is the practice of adjusting asset holdinss specifically for report ins purposes. For example, a bank might hold 70'o of its assets in loans for eleven months of the year, reduce loans and buy U.S. C-overmr.ent securities in December, and shox-: loan holdings of 5C,o on its annual statement. For a discussion of bank reporting practices see Prather, or), cit ., 259-78. 2, For a discussion of bank e:-ainination procedures see Baughn and Ualker, o?. cit. , 1052-65. 3, Basically, the infomiation requested "«ras the liquid asset holdings (as a percentage of total assets) of a number of co:rir.iercial banlcs grouped according to size. Specifically, the inf or^^^.at ion T"as requested of Mr. Edrard J, Lee, Deputy Banking Cor.nlssioner of the State of :"lorida. 5. State T'or:! 6^'-. 6. As explained by ilr. SdTTard J. Lee (see LJote 4). 7. Board of Governors of the Federal Reserve System, "?.e,^rulation D: Reserves of Ilember Banks," Code T'ederal Regulations , Title 12, Chapter II, Fart 201-i-, 8. Ibid. 9. See pa^e 50 in Criapter I. 10, For a diccussion of the interaction of the various banlcing authorities, see Baughn and Walker, op. cit , , 1036-51. 11, Federal Deoosit Insurance Corporation, Annual Re port (1967) , 161.' 12, See Comptroller of the State of Florida, Annual Report; Banking Department (I96S), Part II,

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13 • See federal Deposit Insurance Corporation, Annual Re-oort (196?) , l69, I83. The author is a^'^are that deposits are not the sane fchln^ as assets, but they are not far enough apart in size to nahe any si5nifica.nt differences, as de";Dosits account for about B8,'' of the total liabilities and capital accounts of conniercial banks, I'i. Ibid. 15. See Board of Governors of the i^'ederal Reserv System, Annual Report (I96?), 3-11; and (I96B) , 3-lC. 16. Ibli . 17. See Table I6. 18. The reader is advised to keep in nind the limitations of this sample , as discussed in the first part of this chapter.

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CHAPTER IV IMAL CONCLUSIONS

PAGE 160

Final Con _cl_u s 1 ons . In the first chapter of this thesis He viere concerned v:ith the theoretical justification for the maintenance of a secondary reserve by indi\''idual commercial banks. It Tvas found that a secondary reserve should consist of short-term, readily marketable, high quality assets, ?or the purposes of this thesis, a secondary reserve includes all U.S. Government securities held, rCoarclless of maturity, '/e found that a secondary reserve theoretically serves three main functions: (1) to provide a bank x-rith a source of funds vjith which to meet deposit drains; (2) to provide a banl^ with a source of funds with which to m.eet Increased loan demand; (3) to prevent capital impairment through the forced sale of assets at below-cost prices and provide for a satisfactory level of risk exposure. Protection against depression is not a function of a secondary reserve as it is Impossible for commercial ban]
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15^ U.S. Government securities) since 1953. -^e found that some significant changes occurred in the banking industry durin,^ the 1960's, The banl'ins system greatly decreased its holdings of liquid assets, began to issue time certificates of deposit in large numbers, and increased its capital through the issue of subordinated debentures. A theory espousing the effective management of liabilities cam^e into vogue. According to this theory, banks did not need as m.uch liquidity as they needed in the past because banks now had some control over their liabilities. Nevertheless, the decline in the banking system.' s holdings of liquid assets in the 1960's raised the question as to .:hether or not comim.ercial banlcs actually determiine their secondary reserve holdings according to their needs, '/e found that the management of liabilities cannot be relied on as a source of liquidity in tim.es of need. The decrease in the system's liquidity, then, might indicate that com.m.ercial barJcs did not need so much liquidity in the first place. This would indicate that individual banks adhere to som.e standard in determinir^T the level of their secondary reserves. In order to test this proposition, we exam.ined the liquid asset holdings of 115 state banks over a two-year period. We found that the liquid asset holdings of the

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155 sample banl:s viere quite diverse, both as to size and degree of fluctuation. The effects of monetary policy on the sample barJ-^s' holdin2:s of liquid assets are not clear. This is a result of the fact that there are lags inherent in monetary policy, and the fact that the direction of monetary policy vras changed several tim.es during 19o7 and 1968, Some im.mediate effects of monetary policy are evident in the sample, but it is clear that many other influences v^ere affecting the secondary reserve holdings of the sample banks. The T'Tide diversity in the size of the secondary reser^'es cf the d.ifferent banks indicates that some banks apparently utilize their resources r^ore efficiently than others, ':le found that there is som.e degree of sim-ilarity in th.e characteristics of the liquid asset holdings of about half of the banlcs in the sam.ple , This similarity, however, only indicates that many banks operate under simalar conditions. There is nothing in the sam.ple data to indicate that there is any kind of liquidity standard in the American banking industry, Finally, then, all of the foregoing analysis shovrs that there is no liquidity standard in the American banking industry, and there is nothing to indicate that individual comim-ercial banlcs do not determine their

PAGE 163

156 own liquidity needs accordln;^ to the pressures of their environment. The decline in the liquid asset holdings of comnercial banJcs in the 1960's can be attributed to the increased sophistication of bank managers and the banking authorities, and to the advent of liabilities manasement . Although the management of liabilities is not a true source of liquidity, it is a source of funds, which may significantly decrease an individual bank's need for liquidity. It must be mentioned once again, ho'Tever, that this conclusion is tempered by the limitations of the sample. There are no very large baiilcs in the sample, and all 115 ban^cs are state non-member banks. Also, the time span of the sample covers only t'/ro years. Individual readers vrill no doubt differ in their opinions as to just how limiting these factors are. This author feels that these limitations are not severe enough to negate the findin,gs of this paper.

PAGE 164

BIBLIOGRiYPMI

PAGE 165

Public Oocurnents Board of Governors of the 7eder£il Preserve System. "Regulation A: Advances and Discounts by Federal ^.eserve Banks," Code of T'^ederal Regulations. Title 12, Ct.apter II, Fart 201. . "Re;:ulation B: Open I'arket Purchases of Bills of B:-:chanse, Trade Acceptances, Banlcers' Acceptances , " Code of ^''ecleral Per;ul^'-tlons , Title 12, Chapter II, Part 202. . "Regulation D: Reserves of Member Banks," Code of "^e-^erai Re -"ulatioris . Title 12, Chapter II, Part 20^. . "Regulation ?^ : Securities of Ilember State Banks," Co-]e of Federal Re.gu.lati ons . Title 12, Chapter II, Fart 206. , "Regulation Q: Payment of Interest on Deposits," Cooe of :^ede:-al Regulations . Title 12, Chapter II, Part 21?. . "Regulation R: Relationships '-ith Dealers in Securities Under Section 32 of the 3ankin~ Act of 1933," Code of federal Regulations . Title 12, Chpater II, Part 213. Dickinson, ?''red C, Jr. Comptroller and State Commissioner of Banking. La'-rs of the State of Tlorida . Tallahassee, Florida: 196"^^; Federal Reserve System. T h e F e d e r a 1 R e s e r v e A c t . v/ashington: United States Government Printing Office, 192?. U.S. Congress, Report of the Joint Economic Committee. Standards for Guidin-r I'onetary Action. 90th Congress, 2d Session, 1958. 158

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159 Reports Board of Governors of the Federal Reserve System. Annual PeT)ort . 1952, 1962, and 1965-1968. Commission on T'oney and Credit. Honey and Credit . EngleT'Jocd Cliffs, N. J.: Prentice-rlall , Inc., 1961. Comp.troller of the State of Florida. Annual Report ; Banking F^epartnent . I968. Federal Deposit Insurance Corporation. Annual Report . 1967.' U.S. Federal Reserve System. Reply to Questionnaire Addressed '^o the Chairr.an of the Z-oard o: Governors of the '^edei^a"' Geserv^^ S^'steri "bv the .Suhcorp.mittee Q-f* "o^'i^ Go^'^t on '^"'""^ c s i o •'"'") Con^^"ittee ^'"^ "tG^ Fco"'''^or''io Report ', October, 19^9 • Books American Eani-:ers Association. The Commercial Banklnj^ Industry . Fn^le^.Tood Cliffs, M. J,: Prentice-Hall, Inc., 1962. Bank Management Comjnittee. The Role of Investments in Bank Asset Gana -Tcement . (Study 1: Give Representative Cases) Gei'r York : Gne American Bankers Association, 1965. Baughn, 'Gilliam H, and Walker, Charls E, (eds.). The Bankers' Handbook . HorieTTood, Illinois: Dovr Jones-Irvrin, Inc., 196c. Board of Governors of the Federal Reserve System^. The Federal Reserve System — Purposes and , Func t i ons . VJashington, D, C, 195-. Bradford, Frederick A. Honey and Bankin~ . Ilei' York: Longmans, Green and Co., 19''-6 . Burgess, G. R, The Reserve Banks and the Honey Harket . HeT7 York: Harper and GrotG.ers, 19G6.

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160 Crosse, H. Manq.sen':3nt Policies ^^or Go^inercial Banlcs . En~l eKood Cliffs , N. J . : Frentice-Hall , Inc., 1962. Duesenberry, Janes 3. Money and Credit; Iripact and Control . Snsle'/Jood Cliffs, N. J.: Prentice-Hall, Inc., 196?. Frazer, 'lillian J., Jr. and Yo^ce, 'Jilliam P. The Analytics and Institution? pf ':oney and Ban^'ing . Prince-on, N. J.: D. Van Kostrand Company, Inc. , 1966. Goldenneiser , E. A. American Monetary Policy . iTe-r York: I'IcGra!T-Hill BooV Company, Inc., 1951. Goldsmith, R. 'J. I^inancial Intermediaries in the American Scono:ay Since I9OO . National Bureau of Economic Research, Princeton, N. J,: Princeton University Press, 195'S. Hodgman, Donald R. Commercial Bank Loan and Investm.ent Policy. Cham.-Daign, Illinois: Uni^^ersity of Illinois, 1963. Kent, Raymond P. ypne y and Banking . Nevr York: Holt, Rinehart and v/ ins ton, 19^1 . Morrison, Georre R. Liquidity Preferences of Commercial Barks . Chicago: The University of Chicago Press, I96&. Pontecorvo, G,, Shay, Robert P., and Hart, Albert G. (eds,). Issues in Bankinrand Honetary Anal'^sis . Ne:-7 York: Holt, Rinehart and '/insron. Inc., 1967. Prather, Charles L. Honey and Bankin~ . Chicago: Richard D. Irwin, Inc., , Robertson, Ross I!. The Comptroller and Band; Supervision . VJashinTton: The Office of the Comptroller of the Currency, 1968, Robinson, Roland I. The Hana'remerit of Bank ~unds . New York: XcGraw-Hill Book Company, 1962.

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l6l Thomas, Rollin G. Our IjooerK Bankln,^ and Monetary System . Ile^^: York: Prentice-Esll , Inc., 1950* Trescott, Paul E, r'oney, Ran l 'ln.-, and Eoonomlc VJelfare, Nev: York: KcC-rav:-IIill Eook CoicDany, 1965. Wilkinson, J. Karvie, Jr. Investnent Policies for C omr, e r 0 i al B ank s . NerfYork: Harper and Brothers Publishers, 193^. Willis, H. Parker. Ar] e r i can Bank 1 ng , Chicago: LaSalle Extension University, I9I8, Articles and Periodicals A.dams, E. Shernan, "Cominercial Eankins; in Perspective," The EarJiers L'a.'~ar:ine , Vol. 1^-8, No. (Sunnner, 1965; , 71-77. "The Banking Indastry ixi E^rclution," Banking . Vol, LIZ, No. 5 (November, I966) , Ascheira, J. "Comnercial Barlcs and Financial Intern:ediaries: Fallacies and Policy Implications," Journ-?! o-^ Political Econoiny , Vol. LXVII, No, 1 (February, 1959) , 59-71. Atkins, Paul N. "B?;n:^r Invest^nent "Problems," The Bankers r:ar:azine . Vol. CXXZVIII, No. 5 (Nay, 1939), 373-78. difference Eet'^een Banl: Secondary Reserve and Investment Accounts," The Earlier s Na-azine , Vol. CXXI, No. 3 (September, 1930), 3^3-^8. "Liquid Assets for the Secondary Pieserve," The Bfjniiers Na-azine , Vol, CXXIII, No. 3 (September, 1931), 3^ 1 '^O . Present Importance of the Secondary Reserve," T he ::-an]-ers i:ap:azine . Vol, Gl-Odll, No. 6 (December, 1931), 775-77.

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162 , "Seconr'ary Reserve Policies and Programs," "The Bankers Kagazine , Vol. C}1XXIX, No, 6 (December, 1939) , ^'79-82. , "Secondary Reserve Policies and Programs (Part II)," The Banlcers Hager^ine , Vol, CXL, No, 1 (January, 19'^0) , 6-10. , "Secondary Reserve Program," The Bankers Hagazine. Vol. CXL, No. 2 (February, 19'^C), 108-12. , ''The Relation of Deposits to Secondary Reserves," The Rankers Magazine, Vol, CXXI , No, H(October, 1930) , 47?-?9. . "The Scientific Organization of a Secondary Reserve," The Rankers Magazine , Vol, CXXI, No, 2 (Aiigust, 1930) , 217-20. Axilrod, Stephen K, "Liquidity and Public Policy," Feieral' Reserve Bulletin (October, I961), ll6l-77. Banking Education Committee, "Banking and Kcnetary Develor.ments , " Bankinfc, Vol, LX, No, R (Sentember, 1967)," 53-57. Board of Governors of thie Federal Reserve System, Federal Reser"'7e Bulletin . January, 1953— ^^nuary , 1969* Eratter, E, "A Move to Liberalize FRB Lending Poi-rers," Banking . Vol. LVI , No. ^-'r (October, I963) , ^7, l^.'-2-^-''', "CDs a Problem for the Fed," Banking, Vol. LVIII, No. 8 (February, I966) . 39, I32. • "Committee on Financial Institutions Subm.its Its Report." Banlcin-, Vol. LV, No. 12 (June, 1963), 39-'i-0, 138. r "Is the CD a Deposit or a Loan?," Bankin'y , Vol. LVII, No. 9 (Narch, I965) , ^^6-^7. .g:-;am, Eugene F, and Ilavrajr, I'icJiael, "The Use of Convertible Debentures in Commercial Bank Financing," mkers Na-:azi:ie , Vol. :50, No. h (Autumn, 196?) , 1 •-'-^3 . Brill, Donald H, "Recent Chan^-os in Llcuidity," Federal Reserv e Bulletin (June, I963) , IS^.-oS, ~

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163 Brunner, K, and Heltzer, A. 11, "The ^ed's Approach to Policy," Fanl-ln^, Vol. LVI , Mo. 9 ^' (March, 196^4-), ^^9-3o. Burrls, Eugene H. "Do Bank Secondary Reserve Theories Heed Revising?," The B a nk e r s !! a t o. z i n e , Vol. GXXIII, No. 6 (December, 1931), ?35-''l. . "Todays Banlc Investment Pro~rair.," The Banker s i:a^razine , Vol. C:C^, Ho. 1 (January, 193^) » . "'-.'hat Are Liquid Assets?," The Bani-iers Magazine , Vol. CZX , No. 3 (March, 1930) , 329-3':-. "Chan::,-es in Banliing Structure, 1953-62," :^oderal Reserve Bulletin (September, I963) , II9I-9S. Conforti, Z. A, "Results of a Survey on Debt Rinancing by Banks," Burroughs Clearing Rouse , Vol. 52, No. 7 (April, i960}, 23-29, ?2-78. Crosse, Ho-rard D. "Bankin~ Structure and Ccnpetition, " The Journal of Rinance , Vol. XX, Ho. 2 (Hay, I965) , 3'-9-57. . "T^ederal Bank Supervision," Banking, Vol, LVI, Ho. 2 (Auc-ust, 1963), ^'2-'^, 1C--10. Cro::ley, Leo T. "Banking Under the 'federal Deposit Insurance GorDoraticn, " The Bankers i' a a-pzjrie , Vol. CXXXIII, !:o. 5 (Hcvember, 1936), 377-31. . "Loan and Investmenb Policy," The Bankers .:a-a2ine , '^ol . GXIH'II , i:o. (October, 1935) 369-'7i. Decker, C. P. "Principles of Bank Investment Policy," The Ban::ers Ha-azine . Vol. CCiXVII, Ho, ^ (Cctober, 1933), 333-^^0 . Deirald, G. "Tree Reserves, Total Reserves, and Honetary Gcntrol," Journal of Political Ecorom y. Vol. 71 (April, 1963) , l7r=3Ti ^ Federal Reserve Bank of He^York, "Certificates of Deposit," Honthly '^evie^T . Vol. '4S, Ho, 6 (June, 1963], B2-37.

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l6k , "Commercial ran-cc as Suppliers of CaTDital Funds to Business," Konthly .Review, Voi. ^5, Mo. 12 (December, 19o3) , 185-89. Gaines, Tilford C. "Certificates of Deposit Resnpraised, " The Bankers I'arazine, """ol . 1^7, No/l (Winter, 19o^nT~3''''-39 . Hahn, Philip J. "The Conflict in Standards of Ban!: Capital," The Bankers Ka-azine , Vol. 1^8, No. 3 (Suminer, 19d5), 25-39. Hayes, A. "Monetary Policy in a Competitive World," Federal Reserve Bank of Nevr York, Flonthly R evievr , Vol. No. 2 (February, I963) , 19-2^. , "Sor;e Stubborn Problems For Central Bank PoTTcy," Federal Reserve Bank of Hew York, Konthly Reviev, Vol. ^'5, No. 2 (February, I963) , 19-24. Holgman, Donald R. "Conrpetition in Banking and Its Regulation," Th e Bankers Kags z ine , Vol. 1^4-7, Ko. 1 (VJinter, 196^0, '^6-55. Jacquette, P. L. "The Bank Liquidity-Profitability Tightrope," Th e Bank e r s 'Cag a z i ne , ''ol. I50, No. 2 (Spring", 1967), 9^4-100. Jessup, Paul F. "Bank Debt Capital: Urchin of Adversity to Child cf Prosperity," Th e Banker s Kagaz ine , Vol. 1^-8, No, 3 (Summer, 1965), ^0-54, Kern, Kartin. "A Critical Look at Capital Notes," 3 a>i]^ing , Vol. LVIII, No. 5 (November, I965) , 50-51. Kolb, J. Laurence, "Setting Up a Bond Account Formula," Burrou.^hs Clearin.'^ House , Vol. 25, No. 4 (January, 1941], 12-1^, 3 1 . Kreps, C. H, , Jr. "Imioroving the Competition for Funds," Banking , Vol. LVl", No. 7 (January, 1964), 101-02. "Neasures of Banking Structure and Com.-oetition, " Federal Reserve Bulletin (September, 19^5) , 1212-22. Meek, L. I-C. "Proper Liquidity in Note Assets," The . Bankers Naga^ine , Vol. CXVIII, Nc. 6 (June, 1929), 919-21.

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165 Minsky, H, F. "Central Banking o.nd Money Ilarket Chan ^e 3 , " Q uarterly Jourve.l of Economics , Vol/71, No. 2 1957) , 171-b7. Mitchell, Georse vJ. "Eanl-: Competition in the '70s," ERnJnj25f Vol. LXI , No. 7 (January, 1969), 25-20. , "The Ever Changing Eed," Ban]-ring , Vol. LVII, No. 2 (August, 196^1-), W^WTlOS. Mitchell, Ilary T. "Ne'-r Yardsticks in Measuring Bank Competition for Jemand Deposits," The BanJcers Magazine , Vol. 1^9. No. 3 (Summer, I966), 3^--^3. Mock, Edrard J, "Banks. Find NeK IJays to Raise Capital," B a^il-ing , Vol. LVII, No. 5 (November, 196^1-), ^7, 5?-t)2. Mueller, Frederick, Jr. "The Bond Account and Government Cbl 1 -T3 1 n ons , " The Banl'ers Mag.-jzine , Vol . CXXVI 1 1 , No. 1 (January, 193^), 15-23. Munn, Glenn G. "Nev: Problems of In-esting Bank Funds," The Bankers Magazine , Vol. CXVIII, No. 1 (January, 192") , 15-17. , "The Secondary Line of Defense," The Bankers ' M^i^ine , Vol. CXVIII, No. 6 (June, 1929), 932-33. Nadler, Paul S. "IJhy Paixking Is Changing," Banking , Vol. LVI, No. 6 (December, I963) , ^'-6-'^!-7. and Corimercial Vol. XIX, No. 1 Pierce, James I, "Com.m-ercial Bank liquidity," Federal Rese:>-ve Bulletin (August, I966) , 1093-101. Pru.yne, I, Sumner. "Framing a Flexible Bank Investment Fro^-'remi , " Brrroug:hs Clearing House , Vol. '^St No. 4 (January, 1951 ), '"32-33 , tj7-70. Phillips, A. "Competition, Confu.sion, Ba.nk i n g , " The Journel q-^ Finance , (March.', 196^;), 32-^5. "Recent Credit and T'cnetar;/ Developments," Federal Reserve Bulletin (February, 1968) , 101-13.

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166 "Research into BarJcinir Struoture and Corapet ition, " ^eder^^l Reserve bulletin (Nover:iber, 196^1-), 1383-99. Robertson, J. L. "The Chan^-in-^ '.-/orld of Banking," Bankin.-, Vol. LVII, Mo. 9 (March, I965) , ^5, Robertson, Ross M. "The Conmaroial Banking System and Competing; Monnonetary Intermediaries," T^ederal Reserve BarJc of St, Louis, Monthly Revlev , Vol. ZXVIX, Vo. 5 (Kay, 195?) . 6I-69. Rurapf, A. Ile'Tell, "Re-S?:ar:ininr Investment Policy," Burrour^hs ClearingHouse , Vol . ''-5 . No . 2 (December, I960), 37-39, 88-90. "Savin^Ts Certificates Attacked, Defended," Bankers ^:onthly , ".^ol. L:g:xIII, No. 6 (June 15, I966) , 19-2^^. ' Shelly, D. "Sorie Implications of the Grot-rth of Financial Intermediaries," Journal of Finance , Vol, XIII, No, ^ (December, 1958) , 527-^'-l. Silverberr, S, "Sank Debenture Financins;: A Comparison of Alternatives," The National Bankinr Reviev: , Vol. 3, No. 1 (Septem.ber, 1965), ^5-53, Smith, L. "Cn the Effectiveness of Monetary Policy," American Fcono^ic Revie'-r , Vol , XL VI , Mo. (September, 1956), 58S-60 6 . Stern, Richard X_. "Com.mon Errors in Portfolio Nanagement, The Bankers :--a-va:!ine , Vol, CXXXVIII, No. 1 (January, 1939) , ^^9.53. Taylor, Harold S. "The Summier the Bankers Lost Their Cool," The Bankers Xag:azine , Vol. 15O, No, 3 ( Summer, 196?), 9-13. "The Fed Holds a Ti^or by the Tail," Business \Jee\ , No. 1923 (July 9, 1966), 62-63, To^'.-nes, J. A,, Jr. "Cost of Bank Capital," BankeT-s Xonthly . '^ol. L:CC:V, Mo. ? (July 15, 196S), 35-37. Tyng, E. "Capital Notes as a Source of Needed Funds," Burrou-Ths CI ear in? House . Vol. 51, Mo, 5 (February, 196?), 4^, o2-8^t.

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16 Vernon, Jacl' R. "Cotiipetitlon for Savings Deposits; The Recent 2::perience , " T he I^ational Ean]'inc Reviev: , Vol, ^, Mo, 2 (December, IS"--:'; , 183-92, 'Joodworth, G, '.•alter, "Bank Liquidity/ I'anafrement : Theories and Techniques," The Bankers I'"a~azin e , Vol. 150, ICo. '4 (Autu^m, 1967) , 66-78, .Jrigj-.t , Charles Ashley, "Baiil-: Liquidity and the Socles Bill," The Ban l rers ha~azine , Vol. CXZX, No. 5 (hay, 1935), 527-33.

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BIOGRAPniC.'yL SKETCH Jerry Wayne Lee vras born March 13, 19^!-^ f in Brovmvioocl , Texas. His family moved to Jacksonville, Florida, in 19^i8. In April, I966, he received the degree of Bachelor of Science in Biisiness^ Administra tion T'Tith a najor in Finance fron the University of Florida, In August, 19^8, he received the degree of Master of Arts in Business Adaiinistration from the University of Florida. Jerry L'ayne Lee is married to the former Linda Christine Woodson and is the father of one child. He is a member of Phi Sta Sigm.a and Beta Gamma Sigma.

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I This dissertation rras prepared under the direction of the chair!r.an of the candidate's supervisory committee and has been approved by all members of that committee. It v;as submitted to the Dean of the Collese of Business Administration and to the Graduate Council, and was approved as partial fulfillment of the requirements for the degree of Doctor of Philosophy. December, 19^9 ;ean, J College of Business A-dministrat ion