absorb the tax levied by the State upon depositors' balances. This tax is not levied upon all depositors but upon only those subject to it and the banks may pay it if they choose to do so. It is an amazing inconsistency that this absorption is ruled to be not interest, not "compensation for the use of funds," whereas the tax levied by banks for the transfer of funds to other banks is ruled so to be. In this connection, I point out in your letter an error which has also been made by many of those who have opposed this bill. Member banks are specifically authorized by section 13 of the Federal Reserve Act to levy exchange charges and, they so do. The only restriction is that such charges may not be levied against the 12 Federal Reserve banks.

The ruling of the Federal Reserve strikes directly at some 2,500 so-called nonpar banks as well as at a number of so-called par banks which charge exchange on direct sendings, and will wipe out a large number of them. What basis do you have for saying that these country banks, mostly small banks-more than 2,400 with deposits of less than $2,000,000-located in widely scattered parts of the Nation and operating under all kinds of conditions, shall conform to a set pattern of doing business or go out of business? That communities which cannot conform to your desires must do without banking facilities?

Here is the way the check clearing works:

Before the Federal Reserve ruling: A farmer in Georgia draws a $50 check upon the Bank of Anytown and sends it to a mail-order company in Louisville as payment for a purchase. The mail-order company deposits the check in a Louisville bank and receives credit for $50. The Louisville bank sends the check to its correspondent in Chattanooga for credit. The Chattanooga bank credits the Louisville bank with $50 and sends the check to the Bank of Anytown with the request that it receive, not credit, but payment either in Chattanooga funds or funds available at some designated point acceptable to Chattanooga. The Bank of Anytown is obligated to pay $50 for the check in Anytown, but not elsewhere, and when complying with Chattanooga's request it transfers the funds less the customary exchange charge of one-tenth of 1 percent, or 5 cents, deducted in reimbursement for the extra service. Fifty dollars cannot be mailed from Anytown to Chattanooga for 5 cents and, consequently, the Chattanooga bank is well satisfied to receive $49.95 for the check and charge the 5-cent exchange or service fee to expense because of the definite advantage it has realized in having its cash and loanable funds increased.

At the end of the month the Chattanooga bank does not charge the Louisville bank for that 5 cents or for any other expense if the latter's balance is large enough to support its activity. If the balance was not large enough the Louisville bank would be charged for whatever costs above a reasonable amount the Chattanooga bank bore, for whatever reason, in handling the Louisville bank's account. Similarly, whether or not the Louisville bank actually charged the mail-order company anything would depend upon the service charge schedule in effect and the profitability to the bank of the mail-order company's account.

Concerning this whole operation, the Federal Reserve says: (1) This 5 cents charge of the Bank of Anytown is a "shaving of the currency"; (2) the absorption of that 5 cents by the Chattanooga bank is a "secret rebate"; (3) it is a payment of interest; and (4) it is a "gouge."

First, as to "shaving of the currency": A $50 check was drawn for payment of an obligation. The firm receiving that check deposited it in its bank and received credit for $50 full credit. Is that "shaving of the currency"?

Second, as to the "secret rebate": The practice of charging exchange is specifically authorized by the Federal Reserve Act as well as by numerous State laws and is recognized legally as a long-standing practice. The practice of charging and of absorbing exchange has also been a long-established practice distinct from the payment of interest, just as is the practice of absorbing other expenses for valued customers. The almost universal system of service charges permits each customer in a given bank to know what free services he can expect and how much he will have to pay, and to know also that he is getting exactly the same treatment, relatively, as any other customer. But if one of the costs absorbed according to the established schedule happens to be an exchange charge, that is called a "secret rebate." If the latter is a secret rebate, then even more so is every individual transaction between a bank and its customer a secret rebate, because one of the characteristics of banking is the adaptation of service and terms of borrowing to individual customers and their needs. If absorption of exchange charges which are standard and well known can be classed as a secret rebate by the Federal Reserve, then it and other Government agencies may rule that the granting of credit at a preferential rate to anyone is also a secret rebate. Such 65785-45- -21

a ruling might easily be extended to your members' businesses. There would appear to be no reason to confine it to banks alone.

Third, as to the payment of interest: The Chattanooga bank absorbed a 5-cent charge. If this be interest, to whom, or for whom was it paid? Did the mail-order company receive interest? It benefited only from a sale of merchandise for which it received a $50 check and which it deposited with its Louisville bank. The Louisville bank credited the mail-order company with $50 and debited the account of its Chattanooga correspondent $50. It, therefore, could not have paid the mail-order company any interest. The Chattanooga bank credited its Louisville correspondent with $50 and, at this point, the bookkeeping transactions end and the collection process begins. The Chattanooga bank forwards the check to the Bank of Anytown but, unlike the previous holders of the check who ask for credit only, it asks the Bank of Anytown to pay the check and transfer the funds to Chattanooga, or to a point of its selection. The Bank of Anytown complies with the request for extra service which it performs for the customary exchange fee of one-tenth of 1 percent, or 5 cents. The collection transaction took place between Chattanooga and Anytown and not elsewhere. All the other transactions comprised only debit and credit entries upon the books of the respective holders. The Chattanooga bank benefited by actually receiving $49.95 additional cash at a cost of 5 cents and the expense rightfully fell where the advantage lay. Certainly it cannot be said that the Lincoln bank paid interest to the mail-order company, nor to the Louisville bank. Nor can the payment of 5 cents to the Bank of Anytown be called interest on a demand deposit because the Bank of Anytown did not have an account with either the Chattanooga or the Louisville bank.

Fourth, as to gouging: As in the case of all expenses of handling accounts, banks absorb exchange charges only so long as the customer's balance with the bank justifies the bank in doing so. The Federal Reserve requires that no matter how profitable an account may be, the particular cost of exchange must be charged back to the customer. My bill, which permits banks to absorb this cost if it chooses to do so, is characterized by the Federal Reserve as permitting a "gouge." Perhaps, however, the Federal Reserve is referring to the exchange charge itself. The banks are required by law and banking necessity, as well as convenience, to keep deposits with other banks and thus are put to some expense in providing funds at distant points. The Federal Government is put to no cost whatsoever in transferring money but its charges for postal money orders are far in excess of exchange charges. Yet no charges of gouging are made against the Post Office Department. Many, if not most, banks furnish drafts on distant points without charge to customers.the income from whose balances cover the expense, but under the ruling these banks may not absorb that expense for their customers if the charge happens to be levied by another bank. Why, out of all the expenses of doing business, single out only the interbank charge which is absorbed within the industry and affects no one outside the banking system for the epithet of "gouging"?

Under the Federal Reserve ruling: Under the Federal Reserve ruling the Chattanooga bank would no longer be allowed to bear that particular expense, no matter how profitable the Louisville account was, even though it could bear any other type of expense. Therefore, the Louisville bank would have to be charged 5 cents. In turn, the Louisville bank would have to charge the mail-order company 5 cents no matter how profitable the latter account was. The check, which heretofore was worth $50 to the mail-order company, is now worth only $49.95, because of the Federal Reserve ruling. And the Federal Reserve accuses the Bank of Anytown of "shaving the currency."

The Federal Reserve's ruling strikes at the very heart of the whole system of service charges. If the Federal Reserve's contention is sustained that it is an illegal payment of interest to absorb a particular type of service charge exchange charge then some day a Federal Reserve lawyer will discover that it is an illegal payment of interest to absorb any expense. If Congress sustains the Board's present ruling, an adequate precedent will have been established for this next ruling and every business house will then be required to pay service charges to the banks regardless of the size of the accounts, for the Supreme Court of the United States has defined the exchange charge as a service charge (Farmers and Merchants Bank of Monroe, North Carolina, et al. v. Federal Reserve Bank of Richmond, 262 U. S. Rep. 649).

The whole basis of relationship between banks and their customers revolves about the profitability of the customer's account. The bank does favors and bears expenses in servicing customers' accounts as compensation for use of the customers' funds. Favored customers are even granted preferential rates of

interest on borrowings. If we permit the Federal Reserve to open up this field of regulation and sustain them in it, then they can regulate every banking practice having to do with the serving of customers, including rates of interest on notes.

It is now denied that there is any such intention to extend the present interpretation, but we must remember that in 1937 it was also announced publicly that the finding or specification that payment or absorption of exchange or collection charges is a payment of interest was being removed from regulation Q "In view of widespread differences of opinion in the law-making and administrative branches of the Government as to the intent of the law. * * *""

It is my understanding that your group is taking an active part in the campaign to force all banks to conform to the real objective of the Federal Reserve ruling regardless of the pending action of Congress, namely to join the Federal Reserve System, to agree to clear through the Federal Reserve banks, or to go out of business. I should appreciate your confirmation or disavowal of this. In view of the fact that you have probably already circularized your members, I should appreciate your sending a copy of this letter to each of your members also, in order that the motives and the actions of my associates and I in supporting this legislation will not be misunderstood by our business constituents.

Very truly yours,

PAUL BROWN.

STATEMENT OF J. W. LATHAM, STATE COMPTROLLER, STATE OF MISSISSIPPI

My name is J. W. Latham, and I am comptroller of banks in Mississippi. Prior to becoming comptroller in May 1942, I was connected for 25 years with a small country bank located in Lexington, Miss.

So much material regarding this bill has already been placed on the record, that I shall not attempt to repeat the material brought out when I appeared before the committee in the House, but in the interest of brevity, shall first confine my testimony to three points; namely:

1. The need for clarification of the confusion which now exists regarding the rulings of the Federal Reserve Board on regulation Q.

2. How the current ruling of the Federal Reserve in fact forces par clearance.

3. The need of small banks for the income derived from exchange charges. 1. The need for clarification of the confusion which now exists regarding the rulings of the Federal Reserve Board on regulation Q.-There are all sorts of rumors floating around about absorption of exchange and the adjustments which have been made because of the altered interpretation of regulation Q. I do not know what the situation is in other parts of the country, but in Mississippi the current interpretation is not being enforced. Memphis banks, with whom many of our country banks have deposits, at first refused to absorb any exchange, but now they have gone back to their old formulas for absorbing exchange. The New Orleans banks on the other hand, as far as I know, are not absorbing any exchange at the present time.

The arbitrary changing of rules such as happened last year when the Federal Reserve published a ruling on a particular case in the September Bulletin is. absurd. Although the ruling as printed applied only to a particular case, the Federal Reserve banks immediately began to apply it vigorously in a manner which in fact made it a general ruling. Until this time, the banks-both the country banks and the correspondents-thought they were obeying the law. The prohibition against payment of interest on demand deposits had been in the law since 1933 and had been reenacted in the 1935 law, and in 1937 the Federal Reserve Board had concurred in a ruling which provided that the absorption of exchange was not a payment of interest. Then, suddenly, the banks were told that it was illegal to absorb exchange and that the law was not what we thought it was at all. Naturally, this created a great deal of resentment, and later the Federal Reserve told banks that it was all right for them to absorb a little exchange--which is an odd position. The law provides that the payment of interest in any amount is illegal, and if the absorption of exchange is payment of interest, then it must be illegal to absorb any exchange at all. Such a situation is absurd, and should be clarified. We have a right to know what the law is, and what the rules of the game are.

The absorption of exchange was a time-honored practice of which Congress was well aware, and if they intended to outlaw this practice, the law certainly

would have said so explicitly. One of the major characteristics of the banking system today is the absorption of expenses in connection with demand deposit accounts. Each such account causes expenses to the bank concerned, but the banks do not charge that expense to the depositors if the account is of sufficient size. I would like at this point to introduce a leaflet picked up in one of the Washington banks:

To Our Depositors:

Beginning with the month of June 1943 a slight change in our method of analyzing accounts will be made.

The effect of this change on our measured service charges is as follows:

These item allowances include both checks issued and items deposited. Items in excess of the above allowances will be charged for at the rate of 5 cents each, with a minimum charge of 50 cents whenever a charge is necessary. Accounts with minimum balances above $1,000, or any account showing unusual activity, will be subject to an analysis on the same basic principle which is explained on the reverse side.

In making a detailed analysis, we shall allow monthly earnings of 12 cents for each $100 or $1.25 for each $1,000 of the minimum balance during the statement month.

There will be no change in the cost of checks drawn and checks deposited. Other items handled and special services rendered will, as in the past, be charged for in amounts sufficient to compensate the bank for the services rendered.

WASHINGTON, D. C., April 27, 1943.

HAMILTON NATIONAL BANK.

If a

This bank is willing to absorb expenses as a reward for an account. bank refuses to absorb expenses in connection with a profitable account, some other bank will be willing to do so and the account will be transferred to the second bank. So far as I know, no one is proposing to prohibit the banks from absorbing expense connected with demand deposits of individuals, firms. or partnerships. The Board of Governors of the Federal Reserve System has thus chosen to rule that the absorption of one particular kind of expense is a payment of interest, but the absorption of other types of expenses is not a payment of interest. This is contradiction and the law should either provide that no expense may be absorbed, or any expenses may be absorbed without violation of the law.

2. How the current ruling of the Federal Reserve in fact forces par clearance.The current interpretation of regulation Q in fact forces par clearance. As long as exchange charges were absorbed by correspondent banks the public was more or less unaware of their existence, but when these relatively small fees began to be charged all the way back to the depositors, they became nuisances and created ill will against the banks. Banks simply cannot afford customer ill will and if the ruling of the Federal Reserve is enforced they will be forced on to the par list.

If Congress feels that par clearance should be forced upor. the banks of the country, it should do so explicitly. The answer is, of course, that Congress would not enact such a law, and I feel that Congress should zealously guard its prerogatives and should not allow its authority and responsibility to be usurped by an administrative ruling which without rhyme or reason judges one bit of expense to be payment of interest while allowing the absorption of other expenses. 3. The need of small banks for the income derived from exchange charges.— The small banks, and I know about small banks because we have many of them in Mississippi, need the income provided by exchange charges badly. A great deal has been said about the increased earnings of banks, but this is not in the

group of small banks-those with deposits of a million dollars and less. The earnings of these banks are down. They feel the loss of earnings due to the drop in the volume of loans. The deposits of the small banks with correspondent banks are worth something, and the current interpretation of regulation Q has the result of siphoning the income away from the small banks and giving it to the large banks. Of course I understand why the big banks would like to get the deposits for nothing. It seems to me that the Board of Governors has certainly put itself in an awkward position. It has put itself on record, even before this committee, as wanting to assist small business, and here we have the Board very definitely pushing the defeat of a bill which would in fact aid small banks and small businesses. The small banks of the Nation are the ones which supply the credit for small business. Moreover, the position of the Federal Reserve bank by this "squeeze act" can jeopardize the earnings of the small country banks to the extent that the country banks in haste to overcome their losses from exchange will make unwise investments that may later affect the solvency of the banks.

I should like to digress at this point to comment upon some of the testimony that you heard here yesterday. You have heard, and it is true, that the Federal Reserve has tried to justify its regulation Q upon the statute prohibiting the paying of interest on demand deposits. You have also heard that we believe that the motive behind this ruling is an attempt on the part of the Federal Reserve to put all banks on a par clearance basis—although the Reserve Board has vehemently denied that this is its purpose. Nevertheless, yesterday two of the most vigorous opponents of this bill-Congressman Crawford and the Federal Reserve bank officials-attacked not so much the absorption of exchange as they did the practice of exchange charges, particularly called clipping the currency. Is not this proof enough that the real issue is par clearance and not absorption of exchange?

It was asked by Senator Hawkes: "Why don't the nonpar banks join the Federal Reserve and thus avoid the entire problem." There are two answers. In the first place, State bankers who do not join, want to run their businesses in their own, individual, free enterprise way, and they do not want to be dictated to and told that they have to join the Federal Reserve or else. In the second place, many small banks that do furnish ample and sufficient facilities in their communities, do not have the minimum capital requirements for joining the Federal Reserve System. It was also asked whether the nonpar banks now have service charge schedules against their depositors-the inference being that if they did so they would not have to charge exchange. This is not the fact. The nonpar banks do maintain service charge schedules and do charge their customers just as the par banks do, but in addition, they rely upon exchange for enough revenue to continue in business. If they had to forego exchange charges they would have to increase their service charges to their depositors far beyond the amount that the traffic can bear. In this way they would be unable to compete with the par banks whose service-charge schedule would be less, and therefore, in a position to attract depositors away from the nonpar banks.

In this connection, I call your attention to the testimony of the banker from North Carolina who testified that he was a par bank in the midst of a forest of nonpar banks-and yet he is able to survive and stay in business. Does this prove that small par banks cannot exist against the competition of exchangecharging banks? It proves the reverse. Furthermore, you will notice that his net earnings were almost the same as the nonpar banks. If that is so, then if you take away the exchange from the nonpar bank, its net earnings will be so reduced as to make it impossible for it to stay in business as against the par banker. The reason for this comes out of the fact that the gross earnings of the nonpar bank, as he testified, were greater than the par bank-but the expenses of the nonpar bank reduced this gross to a net, equal to that of his par bank. This is because the expenses of running the nonpar bank is greater, since the expenses he faces are expenses that the Federal Reserve System absorbs for the par bank. You recall, for instance, that the par bank gets its currency shipped to and from the Federal Reserve bank for nothing-the System pays for it, but the nonpar banker pays for this-and pays plenty. Is it fair then to subsidize the par bank, through the Government-controlled Federal Reserve System and leave the nonpar bank to shift for itself, and then add to that a prohibition against exchange absorption, and ultimately against exchange.