banks to absorb exchange if they desire to do so, but places them under no compulsion so to do. The banks which are adversely affected, therefore, are entitled to greater consideration by Congress than those which have only an academic interest in the problem as is the case with most of the banks which have opposed passage of this legislation.

We call the attention of the committee to the fact that the Federal Deposit Insurance Corporation has adopted a formal ruling which holds that the law (49 Stat. 702, ch. 614) prohibiting payment of interest on demand deposits by nonmember insured banks does not prohibit absorption of exchange. This ruling restates in codified form the position which the Corporation has taken on this issue since 1935 when the law was first passed and reads as follows:

"The absorption of normal or customary exchange charges by an insured nonmember bank, in connection with the routine collection for its depositors of checks drawn on other banks, does not constitute the payment of interest within the provisions of Section 304.2 (a) of Part 304 of the Corporation's Rules and Regulations."

For the foregoing reasons, we recommend that the bill (H. R. 3956) be voted out by your committee and passed by the Senate. A memorandum dealing with the principles of law involved is enclosed, for the information and use of the committee.

By direction of the Board:

FRANCIS C. BROWN,
General Counsel.

GENERAL COUNSEL'S MEMORANDUM RE H. R. 3956

REASON FOR FAVORING LEGISLATION

The proposed bill reverses an administrative ruling of the Board of Governors of the Federal Reserve System which, we believe, goes beyond the field of regulation authorized by Congress and which, under the pretense of regulating interest, is designed to discourage and eliminate the practice of charging exchange. Our support of the measure stems principally from our opposition to the practice of circumventing the legislative authority of Congress by administrative regulation, and, secondarily, from our interest as insurer of a large group of banks, not members of the Reserve System, which feel the full impact of the ruling although without legal right to contest its validity, and, finally, from our apprehension of the consequences of the campaign to compel these institutions to discontinue their practice of charging exchange-a practice expressly authorized both by Congress and by many State legislatures.

THE PRESENT LAW

We observe a common and single legislative purpose in the laws prohibiting the payment of interest on demand deposits administered, as to member banks of the Federal Reserve System, by the Board of Governors of the Federal Reserve System (sec. 19 of the Federal Reserve Act, as amended by sec. 11 (b) of the Banking Act of 1933, and sec. 324 (a) of the Banking Act of 1935) and, as to nonmember insured banks, by the Federal Deposit Insurance Corporation (sec. 12B of the Federal Reserve Act, as amended, subsection (v), paragraph (8), added by sec. 101 of the Banking Act of 1935). Although some differences in the two laws exist, it is evident that Congress used the word "interest" in the same sense in each provision. Because of the absence of legislative standards circumscribing the power of the Reserve Board under section 324 (a) of the 1935 act, to determine what shall be deemed to be a payment of "interest," the asserted delegation to it of legislative power to broaden the common legal meaning of the term is of doubtful validity under decisions of the Supreme Court of which Panama Refining Co. v. Ryan (1935) (293 U. S. 388, 79 L. ed. 446) is a typical example. There the Court said that executive regulations "become, indeed, binding rules of conduct, but they are valid only as subordinate rules and when found to be within the framework of the policy which the legislature has sufliciently defined" (p. 428). Therefore the law under which the Reserve Board operates is necessarily on a parity with that governing the Federal Deposit Insurance Corporation, which does not expressly contain such delegation. Regardless of the validity of the delegation, however, the Reserve Board has not currently exercised its power to define interest to include the practice of absorbing exchange.

It has issued a ruling in a specific case and has published general discussions of the subject which constitute administrative "case law" on the question of absorption of exchange applicable to member banks. The Board explained before the House Banking and Currency Committee that its recent action was based not on its power of definition but on its application of the word "interest" to the practice of absorbing exchange. Although applicable only to member banks, the adverse impact of this ruling operates directly and almost exclusively upon nonmember institutions, since principally member banks act as clearing or collecting agents or correspondents on items forwarded for collection from nonmember banks (2.529 in number) which charge exchange on out-of-town remittances.

HISTORY OF PAR CLEARANCE CONTROVERSY

To understand the true significance, social and economic, of the question of absorption of exchange, it is necessary briefly to review the history of the fight for and against compulsory and universal par clearance through the Federal Reserve System. The banks which now charge exchange are located principally in 16 States of the South and Middlewest. These institutions are primarily small, independent, locally owned banks in important agricultural areas which have been providing local credit accommodations and banking facilities to their communities. The revenue which these banks derive from exchange has been a substantial, and in many cases a vital, part of their income. They have adhered steadfastly to their age-old practice of charging exchange on remittances out of town, notwithstanding recurrent efforts on the part of the Federal Reserve Board in past years to force them to remit at par on collections by member banks through the Federal Reserve banks.

After the Federal Reserve System was set up certain Federal Reserve banks instituted compulsory par remittance by member banks on checks sent through them. In 1915 the Federal Reserve Board instituted a voluntary par remittance plan. However, this failed in a number of areas because of the small percentage of banks (25%) which agreed to remit at par. In 1916 the Federal Reserve Board instituted compulsory par remittance which was put into effect in the face of intense opposition on the part of many national banks in country areas, and the efforts of a committee of the American Bankers Association to obtain postponement of the compulsory plan failed. Although many of the larger banks favored the compulsory plan because they were already remitting at par, the then (1916) president of the American Bankers Association declared his sympathies with the country banks in these words: "The transfer of funds is a service which is as much entitled to compensation, when made by a bank, as it is when made by an express company or by the postal official." A committee of the American Bankers Association reported at the 1917 convention that it had sounded the opinion of bankers and that over 75 percent opposed the par collection plan. However, as the Federal Reserve Board had observed in the preceding year, the force of competition with par clearing member banks was driving many nonmember banks onto the par list.

In 1917 section 13 of the Federal Reserve Act was amended expressly to permit banks to make reasonable exchange charges on collections otherwise than against the Federal Reserve banks. In accepting this amendment the nonpar banks, supported by an opinion of the general counsel of the American Bankers Association, had understood that the amendment would permit nonmember banks to charge exchange on collections which the Federal Reserve banks were handling in the customary agency capacity. However, the Attorney General in 1918 (31 Op. Atty. Gen. 245, 251) issued an opinion to the contrary, so that nonmember banks were prohibited from charging exchange not only on collection items owned by the Federal Reserve banks but also on those which they were handling in an agency capacity. This deprived banks of the clearing facilities of the Federal Reserve banks for checks drawn on nonpar banks and the situation in this respect has since remained unchanged.

The struggle, however, between the conflicting economic philosophies raged unabated. The Reserve Board continued its pressure upon the nonpar banks by first persuading as many banks as possible in a district to remit at par, and then, when a majority had so agreed, announcing that all banks in the district would, on a specified date, be put on the par list, enforcing the pronouncement by presenting checks over the counter by messengers, or by postal officials, or by par banks located in the same towns, and demanding cash settlements at par. In Brookings, Oreg., for example, it maintained an agent for practically a year at an expense of $3,542 for the purpose of presenting such

checks on the Brookings State Bank.

Brookings State Bank v. Fed. Res. Bank (D. C. Oreg., 1922) 281 Fed. 222, 227. Some nonpar banks claimed that checks were accumulated and presented in large amounts to harass them and that this made it difficult, if not impossible, for them to meet the payments because of the large amount of vault cash required for such purpose. Charges of coercion and oppression were flung at certain Federal Reserve banks and recriminations abounded. From 1920 to 1927 six suits were instituted against Federal Reserve banks in an effort to stop this practice. Others were avoided only by the Federal Reserve abandoning the practice. Many nonpar banks, however, yielded to this persuasion and the number of nonpar banks was gradually reduced.

After unsuccessful efforts by certain banks to enjoin judicially a Federal Reserve bank from presenting checks over the counter, State legislatures enacted laws permitting their banks to settle by draft for such checks. These laws led to the decision in Farmers & Merchants Bank of Monroe v. Federal Reserve Bank of Richmond (1923) (262 U. S. 649, 67 L. ed. 1157), in which the Supreme Court, speaking through Justice Brandeis, held that the Federal Reserve had no authority to enforce universal par clearance, and said (pp. 664–666):

Congress did not in terms confer upon the Federal Reserve Board or the Federal Reserve banks a duty to establish universal par clearance and collection of checks; and there is nothing in the original act or in any amendment from which such duty to compel its adoption may be inferred. The only sections which in any way deal either with clearance or collection are 13 and 16. In neither section is there any suggestion that the Reserve Board and the Reserve banks shall become an agency for universal clearance. On the contrary § 16 strictly limits the scope of their clearance functions. It provides that the Federal Reserve Board: 'may at its discretion exercise the functions of a clearing house for such Federal Reserve banks * * and may also require each such bank to

exercise the functions of a clearing house for its member banks.'

"There is no reference whatever to 'par' in § 13, either as originally enacted or as amended from time to time. There is a reference to 'par' in § 16; and it is so clear and explicit as to preclude a contention that it has any application to nonmember banks; or to the ordinary process of check collection here involved.

"Moreover, the contention that Congress has imposed upon the Board the duty of establishing universal par clearance and collection of checks through the Federal Reserve banks is irreconcilable with the specific provision of the Hardwick Amendment which declares that even a member or an affiliated nonmember may make a limited charge (except to Federal Reserve banks) for 'payment of checks and * * * remission therefor by exchange or otherwise.' The right to make a charge for payment of checks, thus regained by member and preserved to affiliated nonmember banks, shows that it was not intended, or expected, that the Federal Reserve banks would become the universal agency for clearance of checks."

The importance of this issue is cogently summed up in the following quotation from Deterrents to Membership in the Reserve System, an article by B. Magruder Wingfield, the then assistant general counsel for the Reserve Board, published by the Reserve Board in a volume on Banking Studies (1941), at page 277:

"To many smaller banks, exchange charges are a source of substantial revenue they are reluctant to do without and, in many instances, state they cannot do without. In view of these facts and the differences in Federal and State laws with respect to par clearance, it is clear that the requirement that checks be paid in full by member banks is an important obstacle to membership in the Reserve System, particularly since no such requirement is applicable to nonmember insured banks." [Italics supplied.]

In 1920 and again in 1932 committees of Congress held hearings at which the par clearance controversy was aired.1 At each of these hearings numerous references were made to the practice of charging exchange and absorption of exchange and its inextricable relationship to par clearance was apparent. However, prior to the hearings on the present bills, the par clearance issue had not been directly reopened since the Supreme Court decided the Richmond case.. Today whether a bank remits at par is essentially a matter of policy with the bank's management. In many communities, however, this policy is largely governed by the necessities of meeting the competition of banks which, to a large extent, do

1 House Hearings. Committee on Banking and Currency, Par Collection of Checks, 66th Cong., 2d sess.; House hearings, Committee on Banking and Currency, to provide a guaranty fund for depositors in banks, 72d Cong., 1st sess.

remit at par. The force of this competition, in many instances, has extended into communities adjoining the locations of the par institutions, and as the infiltration of national banks and State member banks into nonpar areas increases, the nonpar list probably will further contract. City banks are now generally par remitting banks, whereas in many States nonpar banks are confined to rural communities.

The forces of competition are at work. These forces have, for many years past, led to arrangements between banks and their depositors whereby the former have absorbed the exchange charges imposed by nonpar banks on items which are collected through their facilities. Correspondent banks have made similar arrangements with their bank customers whereby they absorb exchange charges imposed on remittances by nonpar banks to the extent that the balances of their customers justify. The correspondent banks have been able and willing to absorb this expense, as well as the other costs of collection, and to render other services, because banks for whom they act as correspondents maintain with them deposits of part of their available reserves—and deposits being the banker's principal stock in trade, these funds have been so invested as to warrant the correspondent banks making these arrangements. Moreover, these deposit accounts have been so maintained not only to obtain these services but also because interbank balances are a necessary part of the entire banking system; they are required to enable a bank to furnish its customers the full measure of banking facilities. These absorbing arrangements, in many instances, have been confined to local areas. So far as the public is concerned and from a practical standpoint, the result of these arrangements is that the nonpar banks operate on a par basis and thus have been able to meet the competition of nearby par banks. The issue of absorption of exchange for this reason is inextricably mingled with the whole issue of par clearance. Indeed, the Board of Governors of the Federal Reserve System, in a letter dated October 14, 1942, addressed to the Honorable Preston Delano, Comptroller of the Currency, dealing with the bank at Lincoln, Nebr., which appears in the record of the hearings on the present measure before the House Banking and Currency Committee, made the following significant statement (p. 592):

"The Board does not believe that the problem of exchange absorption can be considered alone. It is only a part of the whole question of par clearance with its many involved and related questions."

Moreover, that the question of exchange absorption cannot logically nor practically be divorced from the paramount issue of par clearance is made clear beyond doubt by the recent action of a State bankers association which issued a circular containing the following significant passage: "If all banks will cease absorbing these charges, it is predicted that it will be only a matter of time until all banks throughout the United States will be on a par-clearance basis.” In the face of this very p'ain understanding by bankers as to the consequences which will flow inevitably from the enforcement of the Federal Reserve Board's recent ruling outlawing the absorption of exchange and the Board's continuing pressure upon exchange-charging banks, we have been unable to accept unreservedly the Board's statement that its ruling was not motivated by the hope of achieving universal par clearance but only by the desire to enforce the law prohibiting the payment of interest on demand deposits. The literal acceptance of its disclaimer is rendered even more difficult in view of the letter sent out to banks by the Reserve Board on February 18, 1944, encouraging opposition to the pending bill and containing the following quotation: "This matter of exchange charges is nothing but a 'gouge,' a kind of racketeering against the depositors of banks, and, against the commerce and industry of the Nation." Nor can the statement readily be reconciled with the pressure campaign against the pending

2 The Board is even more surprised at the statement in your letter that as you view the proposed ruling it is simply another attempt to force par clearance upon nonmember banks. The Board does favor Nation-wide par clearance, but it agrees with you that the final determination of the question is one for appropriate legislative bodies. Consequently it must most emphatically disagree that forcing par clearance was the motive of the Board's ruling. To the contrary, the Board was confronted with the unhappy possibility that, by making such a ruling, member banks resorting to the practice in question would feel that they should withdraw from the Federal Reserve System. It must reiterate that its purpose in making the ruling was solely to carry out what it believes to be its responsibility under the law, in response to a request from the Office of the Comptroller of the Currency for a ruling in the particular case disclosed by reports of examination made by National bank examiners." (From letter of L. P. Bethea. Assistant Secretary, Board of Governors of the Federal Reserve System, to Hon. Leo T. Crowley, Chairman, Federal Deposit Insurance Corporation, dated September 9, 1943, Hearings on H. R. 3956, before House Committee on Banking and Currency, 78th Cong., 2d sess., p. 601.)

bill which has been carried on by the Reserve Board controlled Federal Reserve banks, one of which, on March 10, 1944, wrote all of the operating banks in its district stating: "If the Senate joins the House in enacting this legislation within the next week or two, the progress made in the past 30 years in building a parcollection system will be reversed. The two Senators from your State as well as the members of the Senate Committee on Banking and Currency undoubtedly will wish to understand the significance of the Maybank bill (S. 1642). No one is better able to interpret its possible effects than you. As for ourselves, it is our considered judgment that this legislation is not in the public interest." Moreover, the Board's disclaimer must be viewed in light of the past history of its attitude toward absorption of exchange. In 1936, the Board of Governors requested the Federal Advisory Council for its opinion as to whether the promulgation and enforcement of regulation Q, with the inclusion therein of the definition outlawing absorption of exchange as a payment of interest, would have an adverse effect upon membership in the Federal Reserve System; and the Federal Advisory Council replied that it would not (1936 Annual Report of the Federal Reserve Board, p. 233). If the motive of the Federal Reserve Board was enforcement of the law and not the achievement of par clearance, why, it is fair to ask, was it concerned with the effect of its ruling forbidding absorption of exchange upon membership in the Federal Reserve System? If the law prohibiting interest upon demand deposits compelled such a ruling, then whether membership in the Federal Reserve System was affected or not it would seem that the Reserve Board was required to make that ruling. We may justly ask, would the Federal Reserve Board have persisted in its attitude had it been advised by the Federal Advisory Council that such a ruling would have a detrimental effect upon membership in the System? Moreover, the Federal Advisory Council's reply is not consistent with the Board's present statement that it was confronted with the unhappy possibility that such a ruling would result in member banks withdrawing from the System.

The ruling of the Board has singled out absorption of exchange charges alone, of all expenses identifiable with a depositor's account, for classification as a prohibited interest payment; while other rulings hold that other expenses, equally identifiable, such as intangible property taxes against depositors based upon their bank balances, bond premiums and expenses of clearing checks, may be absorbed without violation of the law. Thus, for example, the Federal Reserve Board has held that member banks may pay and absorb intangible property taxes upon depositor's bank balances such as those levied in the States of Michigan, Indiana, and Kentucky without violating the interest statute. It is to be noted. that these taxes are laid on the depositors and not on the banks and are in every sense “out-of-pocket” expenses insofar as the bank is concerned. Nevertheless, the Federal Reserve Board has ruled that the term "interest" includes the payment or absorption of exchange and collection charges "but does not include the payment or absorption of taxes upon deposits whether levied against the bank or the depositor" (Federal Reserve Bulletin (1935), p. 864; id. (1944), p. 13).

INTERPRETATION OF INTEREST-PROHIBITION STATUTE

Mindful of this turbulent history of the par-clearance issue, we pass to consideration of the question whether Congress intended that absorption of exchange be deemed the payment of interest.

What did Congress mean by the term "interest" as used in the laws prohibiting payment of interest on demand deposits? The laws themselves contain no definition.

The Banking Act of 1933 became law on June 16, 1933. The Senate bill contained a provision prohibiting interest payments on demand deposits; the House bill contained only a provision for regulating interest rates on savings and time deposits. The reports on these bills cast no light on the question under consideration here, but we do learn from the Congressional Record that the purpose of the Senate provision was to attract surplus bank money away from the large money markets, where it had been used for speculative purposes, and return it to the home communities of the banks where it could be loaned out. It was thus explained to the Senate: The payment of interest on demand deposits has resulted for years and years in stripping the country banks of all their spare funds, which have been sent to the money centers for stock-speculative purposes. * * If they have abundant funds and credits they can lower the rate of interest in order to stimulate business and industry and farming activities.

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