RED CLOUD. NEBRASKA. CHIEF
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FEDERAL RESERVE BANKS
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HOW THE SYSTEM
DOES FOR BANKS
WHAT THE BANKS
DO FOR CUSTOMERS
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UK imftsliiK ly the United States
senate the other day of a Joint
resolution (S. J. lies. 12.'1S) nutlior
Izlnj; the Federal Reserve hunk of
St. Louis to erect n bullillnK to
cost S100,(M)0 for its brunch bank
at Little Rock, Ark., brought out
In debate the fact that the Arkan
sas bank had loaned $:,SS.OOO.
(XX) in the years 101 0-121 and had
made net prollts of $1,011,000.
These federal reserve banks are
Koine un all over the country a
fact which shows the magnitude and Importance
of the system. In response to a public demand for
Information about the Federal Reserve nankins
system and Its operations the following olllclal
statement is presented:
vw A federal reserve bank docs for banks almost
exactly what banks do for their customers. It
receives money on deposit from such banks as
have become members of the Federal Reserve
system, and lends to them. All national banks
are members of the Federal Reserve system, and
many state banks and trust companies have
become members also. Every member bnnk Is
obliged by law to keep with Its federal reserve
bank an amount of money which bears a certain
proportion to the deposits It has received from
its customers. This is called a "reserve," and as
the federal reserve banks keep the reserves of
their members they are called "reserve" banks.
At times, member banks borrow from their federal
reserve bank Just as Individuals borrow from their
own bunk. Individuals cannot deposit money
with a federal reserve bank, or borrow from if;
their i elation with It Is through the member
banks.
Refore the Federal Reserve system was In oper
ation, each Individual bank stood virtually alone.
Tills was safe enough as Jong as things went well
Jn the business world, but even then the machinery
of banking was so cumbersome that It often
worked badly.
' In order to meet the requirements of law and
to pay depositors, all banks used to keep large
'amounts of gold and. currency on hand and most
of them also kept money on deposit with other
banks in the larger cities. When all went well,
jtho money on deposit with the city banks could
be withdrawn In currency whenever It was
wanted. Rut when, as sometimes happened, busi
ness or banking conditions were disturbed and
suspicion was In the air, the banks were anxious
to Increase the amount of cash on hand lest an
unusual number of depositors might want to with
draw their money. And it was at those times that
the city banks were least able to furnish cash.
For the available supply of currency was limited,
and there was no quick way of Increasing It.
The limited supply of currency led to the panic
of 15)07. For, moved by apprehension, almost every
one of the twenty-four thousand banks sought, for
Its own protection, to withdraw such currency as
It could from other banks and pay out as little as
possible to its depositors. Though emergency
measures were finally taken, they were too late
to prevent the coming of trouble, and the existing
"banking machinery fell apart Into thousands of
separate units.
Each bunk had to trust largely to Its own cash
resources, because, however willing, the other
Ibnnks felt they could not give up much of their
.cash, for by doing so they might impair their abil
ity to meet the pisslblp needs of their own cus
tomers. Each bank, In seeking to protect Itself,
'necessarily weakened the entire banking strac
ture. The defenses were weakest when the
'danger was greatest.
' The result was that every few years n money
('panic occurred, bringing disaster and depression.
These money panics from which the United States
suffered, and which the organization of the Fed
jeral Reserve system now prevents, were, of course,
,'qulte different from the commercial crises from
;whlch every country occasionally suiters.
, Under the Federal Reserve system there Is n
quick, certnln, automatic way by which the banks
that are members of the system help one another,
'in good times and bad. This Is Important to every
'business man, every farmer, every working man,
'every citizen. It is the result of organization the
!klnd of organization that makes a system of
reservoirs In a community better than many sep
inrate wells.
It Is appropriate to think of the Federal Reserve
Iftysteni as exactly that a system of reservoirs.
There are twelve of these reservoirs, tho federal
reserve banks of Roston, New York, Philadelphia,
Cleveland, Richmond, Atlanta, Chicago, St. Louis,
.Minneapolis, Kansas City, Dallas and San Fran
,:!seo each serving the needs of tho member
ilrnnks In Its own federal reserve district. In each
'at these reservoirs credit Is stored up, and from It,
its the need arises, credit Is supplied to tho mem
jber banks and through them to their customers,
including not only business men and farmers, but
'other banks as well. The process Is much like the
storing up of wuU-r In a city reservoir, from which
It Is supplied to houses and their occupants.
It may ho thought strange thnt such a thing as
credit, which In this sense Is tho power to make
loans, can bo stored up. Rut the fact Is, a great
lenl of It Is stored up In the federal reserve reser
voirs. For, as wo havo seen, tho member banks
deposit In tho Federal Reserve banks most of tho
gold they formerly kept In their own vaults and
isonio of the money they used to keep on deposit
with other banks. And It Is tho gold which fed
leral reserve banks requiro In this and other ways
Hint gives them the ability to make loans and
issue currency.
i Tho provisions of the law nro such thnt tho
federal, reserve banks can make loans to nn
lamount between two nnd three times as much as
the gold they have. So, having a supply of gold
4
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In storage, they have u lending power In storage
also. As this lending power Is used, the level In
tho reservoirs falls. In 11)20 the reservoirs ran
very low, because the farmers and business men
made unusually heavy demands upon them at a
time when they had already been drawn down by
the war needs of the government.
The supply of water In a reservoir 'becomes
useful when It Is distributed through the water
mains. The supply of credit In a federal reserve
reservoir becomes userul when It Is distributed
through the member banks. Rut Just as It Is the
Individual and not the reservoir that draws the
watw, so It Is the business man or the farmer
who takes the first stop which may result In
drawing upon the reservoir of credit.
For example:
A grocer In Austin, Texas, wishes to buy fifty
barrels of Hour. He has not enough money In the
bank with which to pay for It so he asks his local
Austin bank for n loan. This Is the llrst step Just
referred to.
The Austin bank, satlslled with the grocer's
credit, makes him a ninety-day loan on his note.
The grocer buys the Hour, and proceeds to sell
It barrel by barrel to bis customers. An bis cus
tomers pay their bills, tho grocer accumulates
money with which he n.v off his note.
In ordinary times and In slack seasons, a bank's
own resources are sulllclent for Its customers'
needs. Rut perhaps the Austin bank, which Is a
member of the Federal Reserve system, Is asked
to make the loan to the grocer at a time when
many people are asking for loans to carry on their
business. Or perhaps Its depositors for one reason
or another nro having to draw down their
deposits. If the Austin bank Is to continue to lend
money and pay its depositors, it in turn will have
to borrow.
Refore the Federal Reserve system wns In oper
ation, the Austin hank would hnve had to ask for
a loan from some larger bank with which It had
an account. Ordinarily the loan could be obtained.
Rut if money happened to be scarce the larger
bank might bo compelled to refuse to lend, be
cause Its own resources were running below what
It might need to meet all the demands of Its cus
tomers. Now, however, as a member of the Federal
Reserve system, the Austin bank Is In a quite
different position. It has u bank of Its own, the
Federal Reserve bank of Dallas, to which It goefl
as a matter of right given it by law. It sends to
tho Federal Reserve bank of Dallas the grocer's
note and other notes upon which It has already
made loans. With these ns security, the Austin
bank asks the federal reserve bank for a loan.
This Is the second step In drawing upon the
reservoir of credit, and follows the llrst step which
the Individual tool: when he borrowed front his
bank. Roth steps must be tnken before tho federal
reserve bank lends a dollar.
The Dallas Federal Reserve bank examines tho
notes to see whether they are sound and accept
able, and of the kind the Inw permits It to lend
upon. Relng satlslled, It makes the loan to the
Austin member bank. This Is called "rediscount
Ing"; and the rate i)f Interest the federal reserve
bank charges Is called the "discount rate." Tills
Is a published rate, applying uniformly to all mem
ber banks. In its district, and Is often quite differ
ent from tho rate the member bank charges Its
own customers. The rate a member bank charges
Its customers Is determined, subject to state law,
largely by local business conditions and local
banking custom.
Later, when the grocer's note falls due, the
federal reserve bunk sends It back to the Austin
member bank and receives payment for It. The
Austin bank In turn receives payment from the
grocer nnd gives litm bilck bis note. Tims the
circle If. completed. Meanwhile, the grocer has
been able to carry on his business,
The simple, transaction of the Austin grocer is
typical of the vast mass of loans which enter Into
the operations of the Federal Reserve system.
Suppose, for instance, that instead of tho grocer,
the borrower Is a dry goods merchant in Rutte, a
hardware dealer in Chicago, n steel maker In
Rlrmlngham, a lumberman In Seattle or an
exporter In New York each a responsible busi
ness man In good financial standing locally.
Suppose, again, that the borrower Js anyone
who owns a United Stntes government bond or
note, and puts it up at his bank as security for a
loan. Such borrowings from member bnnks,
whether large or small, can bo borrowed upon by
tho member banks at their federal reserve banks
if they are within ninety days of falling due. It
was loans of this sort, rediscounted at the federal
reserve banks, thnt enabled millions of people
throughout tho United States to subscribe to the
Liberty and Victory loans.
Just such reasons as prompted the Austin
member bank to borrow from Its federal reserve
bank, sometimes cause a federal reserve bank
to borrow. Rorrowlngs by many member banks,
representing loans that they have already made
to their customers, sometimes draw down the
reservoir to such a point that It must bo replen
ished If the federal reserve bank Is to continue
to lend.
This country Is so vast that one section of It
Is apt to have credit to spare when another sec
tion needs credit. All that Is necessary is a quick
and easy means for bringing them together. The
Federal Reserve system furnishes the means and
has often used it. A federal reserve bank renews
Us power to lend by borrowing from another fed
eral reserve bank In a district where the demand
for credit Is smaller. It puts up as security the
notes upon which It has lent to Its member bnnks.
In other words, one of the twelve reservoirs In
the country-wide system pipes In some of the sur
plus credit from one or more of tho other reser
voirs and so renews Its power to lend.
Tills Is the kind of beneficial co-operation be
tween agricultural and Industrial districts that
actually too!; placo In tho dllllcult years of lOUO
and 1021. At times, when agricultural districts
such as Richmond, Atlanta, St. Louis, Minne
apolis, Kansas City or Dallas, having received
largo nmounts of money in puyment for their
crops, had surplus credit, they lent It to Indus
trial districts which were In need of It. At other
times, when the situation changed and Industrial
districts such ns Cleveland, Roston, New York or
Philadelphia, having received payment for goods,
had sun Ins credit, they lent It to agricultural
districts.
Very closely connected with the power of tho
federal reserve bnnks to lend Is their power to
Issue currency federal reserve notes. The power
to lend, taken by itself, would be of far less value
If the power to Issue currency did not go with
It. Just ns the customer who makes a loan at his
bunk may need to draw out part or all of It In
currency, so a member bank In making u loan at n
federal reserve bank may need to draw out part
or all of It In currency. The power to Issue cur
rency Insures to everyone who has a deposit In a
solvent bank the ability to draw it out In cur
rency. That explains why tills country never
again need have a money panic such as that of
1007; explains, Indeed, why there was no sug
gestion of a money panic In tho dllllcult months
of ID'.'O.
Look at a live-dollar bill bearing tho portrait
of Lincoln. On Its face It says that it Is an
obligation of the United States; on its back that
It Is redeemable In gold at the treasury In Wash
ington. Federal reserve notes are also redeemed
In gold at any federal reserve bank.
Each federal reserve bank Is required by law
to set aside security, dollar for dollar, against
tho notes It Issues. The security may be either
gold, or borrowers' pnp-or very shortly to be paid,
representing either loans for the production or dis
tribution of goods and farm products, or loans to
holders of the United States government securi
ties. Tho gold which the law requires a federal
reserve bank to maintain as a reserve against Its
notes must always bo nt least forty per cent of
the amount of Its notes In circulation.
These notes get Into circulation and pass out
of circulation In much the same way as money Is
drawn out of a bank and returned to It.
When a ninn needs currency he draws a check
on his bank nnd cashes It. If ho has not enough
money In the bnnk to meet the check, he may
havo to make a loan. In Just tho same way, when
n member bank needs currency, It draws and
cashes a check on Its federal reserve bank. Per
haps tho member bnnk hud to borrow at the fed
eral reserve bank for this very purpose. Thnt Is
how the total amount of currency In circulation
Increases.
Oi. the other hand, when n man has more cur
rency thnn he needs ho deposits It at his bank
and perhaps pays off a loan with It. Just so does
a member bank at the federal reserve bank. That
Is how the total amount of currency In circula
tion decreases. As federal reserve notes for which
there Is no demand nccumulute in a federal reservo
bank, they are either destroyed or put away in
Its vaults until some need calls them out again.
Whether the volume of federal reserve notes In
circulation Increases or decreases depends not
upon the- Initiative of the federal reserve banks
but upon tho needs of the member banks. Their
needs, In turn, are decided by the needs of their
customers. As in drawing water from a reservoir,
It is the Individual who takes the first step.
The plan at organization which the law lays
down for the Federal Reserve system does two
things. It provides a nation-wide system so knit
together that nation-wide resources may work as
a unit in a national emergency, or be mobilized to
meet a local emergency too severe for local re
sources to cope with. It als preserves the right
of local self-government In hanking. These nro
principles with which Americans are familiar In
the working of the federal and state governments
under the Constitution.
The country Is divided Into twelve districts,
each with a federal reserve bank. In many dis
tricts tho federal reserve banks have one or moro
branches for the better service of the member
minks. Each federal reserve bunk has Its own
stockholders, directors, officers and clerks lll:o
other banking Institutions. The stockholders: are
tho member bnnks. Its nine directors are resi
dents of the district, some from the cities and
some from the country. Three are appointed by
the federal reserve board In Washington, nnd tho
other six are elected by the member banks, each
having one vote. In voting, the banks are divided
into three groups, each of which elects two di
rectors. These groups are composed, respectively,
of the smallest banks, the middle-sized banks, ami
the largest banks Only three of the directors can
bo officers or directors of other banks. At least
three, and usually a majority, are representative
of industry, commerce and agriculture. For these
are the Interests which, through the member
banks, the system is Intended particularly to
servo and protect.
These men are responsible for the mnnngement
and control of tho federal reserve bank. They
elect Its officers, determine the policies under
which It operates, and establish, subject t ap
proval by the federal reserve board, the rate of
discount it charges. All profits, after setting
aside the surplus provided In the law and after
paying the member banks six per cent dividends
on their stock, go to the United States treasury
and are used to reduce the national debt.
The co-ordinating body is the federal reserve
board In Washington, which Is made up of seven
members five who are appointed by tho Presi
dent and devote their entire time to the work,
together with the secretary of the treasury and
the comptroller of the currency.
The federal reserve board, however, Is not an
operating body. Except for Its power to requiro
one federal reserve bank to lend to another
federal reserve bank, Its powers are almost
entirely supervisory. Rut tho board does not pass
upon tho Individual loans which a federal reservo
bank makes to a member bank. The board Itself,
of course, cannot lend money because It has none
to lend.
In their right to borrow, at n federal reservo
bank all member bunks, large or small, are equal.
Tho law says that a federal reservo bank shall
moko each member bank such lonns us mny bo
snfely and reasonably made.
Tho Federal Reservo system provides the
entire country with a currency resjwnslve to Its
varying needs, and thus removes tho danger of a
money panic. Moreover, It provides tho entlro
country with a great reservoir of credit from
which farm and range, forest and mine, factory
and store, may recelvo assistance In producing
and marketing all the Innumerable goods and
wares which go to make up American commerce,
Industry and agriculture.
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