member bank in connection with its routine collection for its depositors of checks drawn on other banks cannot be considered a payment of interest, within the terms of the interest regulations of the Federal Deposit Insurance Corporation, in the absence of facts or circumstances establishing that the practice is resorted to as a device for the payment of interest." In the specific case with which this Board dealt in its September 1943 ruling the facts were that the bank had absorbed exchange charges for customers keeping so-called compensating balances; that in 1942 it had absorbed for such customers $18,000 out of $25,000 exchange charges paid; that in the first 3 months of 1943 it had absorbed for such customers $4,600 out of $5,600 exchange charges paid; that in some instances the amount absorbed for some customers amounted to as much as 2 or 3 percent of their balances; that its total correspondent bank deposits had increased from less than $7,000,000 at the end of 1941 to nearly $18,000,000 in 1943, a ratio far greater than the increase in its total demand deposits or of the corresponding increases of other banks in the same area; that exchange charges were not absorbed but were charged back when, because of a lack of a compensating balance, the bank had "no way of making it back"; that, on occasion, the bank had written to its correspondent banks suggesting that they par items sent to such banks in return for the parring by the subject bank of items received from such banks; and finally that, in at least one instance, accounts had been shifted from a competing bank to the subject bank because of its willingness to absorb such charges. In these circumstances, the Board expressed the view that the bank in question was violating the prohibition against the payment of interest on demand deposits. The Board believes that it would be difficult to conceive of clearer "facts or circumstances establishing that the practice is resorted to as a device for the payment of interest." The bill before the committee would legalize a practice such as described in the Board's September 1943 ruling and would permit a member bank to reward or compensate its customers for the use of their demand funds so long and only so long as the reward or compensation consisted of absorbing exchange charges. "Exchange" is the name applied to charges exacted by some banks for paying checks drawn upon them by their customers when presented through the mails for payment. There has been so much misunderstanding as to what is meant by "exchange charges," particularly by some Members of Congress from sections or communities where the practice does not exist, that it may be worth while to describe the practice in some detail. Let us assume that a bank in Forest, Miss., charges exchange on its checks presented through the mails. A customer of the bank, John Jones, wishes to settle a transaction in Louisville, Ky., and to do so he sends his check drawn on the Forest bank for $1,000 to Smith Mail Order Corporation in Louisville. Smith Mail Order Corporation deposits the check in its bank in Louisville. The Louisville bank sends the check to the Forest bank for payment but the Forest bank remits only $999. The dollar which the Forest bank has retained is the "exchange charge." The use of the $1 figure is not to be construed as meaning that the charge made is at the rate of $1 per $1,000. Such charges are fixed by exchange-charging banks individually and vary. The Board's September 1943 ruling does not prohibit the Forest bank from making the charge; but it does deal with the question whether a member bank may pay the charge as a means to compensate a depositor for the use of his funds. This latter question can arise in a number of different ways. In the first place it may be that Smith Mail Order Corporation maintains a balance with the Louisville bank deemed to be sufficiently large to justify an arrangement whereby the Louisville bank is willing to absorb all or a part of the exchange charges. This case probably would arise only in the event Smith Mail Order Corporation did enough business at points where there are exchange-charging banks to cause the amount of exchange charged to be a factor. Secondly, it may be that the Louisville bank has an account with a New Orleans bank with an arrangement under which the Louisville bank will send the checks it receives on exchangecharging banks in the New Orleans area to the New Orleans bank, maintaining with the New Orleans bank a compensating balance deemed sufficient by the New Orleans bank to justify it in absorbing all or a part of the exchange charges exacted by the Forest bank. In this case Smith Mail Order Corporation would deposit the check with the Louisville bank; the Louisville bank would send it to the New Orleans bank; and the New Orleans bank would send it to the Forest bank for payment. The Forest bank would pay only $999 but the New Orleans bank would credit the Louisville bank with $1,000 and the Louisville bank in turn would credit Smith Mail Order Corporation with $1,000. Thirdly, it may be that the New Orleans bank and the Forest bank will have an arrangement whereby the Forest bank will maintain a compensating balance with the New Orleans bank and the New Orleans bank will absorb all or a part of the exchange charges which the Forest bank has exacted on checks sent it by the New Orleans bank. Here again, the Forest bank would remit only $999 on the $1,000 check drawn by John Jones, its customer, in favor of Smith Mail Order Corporation. The New Orleans bank would absorb the $1 exchange charge; and the Louisville bank, and in turn, Smith Mail Order Corporation would receive the full amount, $1,000. Since the transaction which the $1,000 check was to settle was between John Jones and Smith Mail Order Corporation, one would think that the $1 charge should be paid either by John Jones for services rendered by the Forest bank or at least by Smith Mail Order Corporation as a charge for transferring the funds from Forest to Louisville. By no stretch of the imagination could the obligation to pay such charges be that of either the New Orleans or Louisville banks, and this committee can be sure that they are not so paid gratis. The absorbing bank pays the charge only because it is getting the use of someone's funds and it would not pay them otherwise. Considering that there is a statute prohibiting the payment of interest on demand deposits, it is plain to see what could be done competitively by the use of the device which the bill before the committee would sanction. It is small wonder, therefore, that already one outlying suburban bank by using this device to reward correspondent banks spread its business even into surrounding States and ran its deposits from $800,000 to over $8,000,000 in less than a year. Of this, over $6,800,000, or 82 percent, was represented by correspondent bank accounts and, mind you, this is a small outlying suburban bank. Another bank, hailed as a $150,000,000 country bank, the largest individual or unit bank in any city with a population of 110,000 or less, has $90,000,000 correspondent bank balances as against $38,000,000 individual deposits. Obviously, demand bank balances would not be concentrated in such amounts at such points if there were not some corresponding reward or compensation for their use. That this is the fact is further substantiated by the current fear that the balances will not be maintained as they now are unless the absorption of exchange is continued. It is inconceivable to the Board that the Congress would continue the statutory prohibition against the payment of interest on demand deposits and at the same time legalize a practice which partakes of the characteristics of the old secret rebates by railroads and which would accomplish for a limited few and by indirection the same result as though interest were being openly and directly paid. It is appropriate also to analyze the proposal under consideration to ascertain to whom it would apply and the favors it would grant. There are some 2,500 exchange-charging banks. These are known as nonpar banks, because they do not remit at par. Other banks which remit at par are known as par banks and total in number about 11,500, of which about 4,800 are not members of the Federal Reserve System. From the charts attached to this report, the committee will note that there are 20 States and the District of Columbia in which no banks charge exchange and in which all of the 4,763 banks remit at par. These States are Arizona, California, Colorado, Connecticut, Delaware, Idaho, Iowa, Maine, Maryland, Massachusetts, Nevada, New Hampshire, New Jersey, New Mexico, New York, Ohio, Pennsylvania, Rhode Island, Utah, and Vermont. noteworthy that in Illinois only 12 out of 828 banks are nonpar banks; in Indiana, In addition, it is 3 out of 496; in Kansas, 2 out of 627; in Kentucky, 10 out of 389; in Michigan, 1 out of 443; in Oklahoma, 12 out of 384; in Oregon, 1 out of 69; in West Virginia, 6 out of 180; and in Wyoming, 1 out of 56. Iowa has required its banks to remit at par. The proposed legislation would permit a practice tantamount to the payment of interest on demand deposits but its application would be limited to those having checks on exchange-charging banks and to the amount of the exchange charged on such checks. In practice it would be limited still further because banks would not be willing to absorb the exchange except for depositors maintaining compensating balances, and only depositors having enough checks on nonpar banks to justify the maintenance of compensating balances would keep such balances. The practical result would be that, with few exceptions, the amendment would be applicable only to correspondent banks and large national accounts. The Board has a further objection to the proposed legislation. In the hearings before the Banking and Currency Committee in the House the Board's September 1943 ruling has been characterized as an attempt to enforce par clearance. This charge is not in accordance with the facts. The Board has repeatedly stated that it favors par clearance and it is, of course, a fact that the question of absorption of exchange is inextricably involved in the question of par clearance, as it is also with other questions. On the other hand, to charge that the ruling was directed at the 2,500 nonpar banks disregards the fact that the ruling applied to a member bank which was absorbing the exchange, not charging it, as well as the fact that the ruling could result in causing member banks desirous of resorting to the practice to decide to withdraw from the Federal Reserve System. The Board recognizes that the final determination of the question of par clearance is one for appropriate legislative bodies. Congress has already enacted legislation which requires remission at par of all checks collected by Federal Reserve banks. The legislation to which the Board refers is known as the Hardwick amendment to section 13 of the Federal Reserve Act. It was enacted in 1917 and reads as follows: "Provided, further, That nothing in this or any other section of this act shall be construed as prohibiting a member or nonmember bank from making reasonable charges, to be determined and regulated by the Board of Governors of the Federal Reserve System, but in no case to exceed 10 cents per $100 or fraction thereof, based on the total of checks and drafts presented at any one time, for collection or payment of checks and drafts and remission therefor by exchange or otherwise; but no such charges shall be made against the Federal reserve banks." [Emphasis supplied.] It will be noted that, by virtue of this provision of law, about 6,700 member banks are prohibited from charging exchange on checks presented by Federal Reserve banks. Checks on some 4,800 nonmember banks are collected through the Federal Reserve collection facilities which, under this amendment, involves remission at par. Since a fair estimate would be that 90 percent or more of the amount of all out-of-town checks are collected through the Federal Reserve collection system, the practical effect of the Hardwick amendment is to prohibit all member banks from charging exchange and to require all nonmember banks wishing to avail themselves of Federal Reserve collection facilities to forego making any such charges. In the current discussion of the Board's September 1943 ruling at the hearing it has been stated that many of the nonpar banks will be forced to close if member banks are not permitted to absorb the exchange charges which they make. This is on the theory that if member banks do not absorb the charges but pass them back to their customers, the pressure from these customers will result finally in the abandonment of exchange charges. The Board makes no such prediction. It does aver, however, that there are in the same States, in the same counties, and often in the same towns equally small national or State member banks which, for all practical purposes, cannot charge exchange and which are living and competing with nonpar banks which do. Now it is proposed that member banks be authorized to absorb the exchange the nonpar banks charge. Here again it is inconceivable to the Board that the Congress would authorize member banks to absorb exchange charges for small nonpar banks when equally small member banks are prohibited from making such charges. For the reasons stated the Board is opposed to the enactment of S. 1642 and the companion bill, H. R. 3956. Since the Board has also received a request for a report on this legislation from the Banking and Currency Committee in the House of Representatives, a similar report is being sent to it. Very truly yours, CHESTER MORRILL, Secretary. Number of banks on par list and not on par list, by States, on Dec. 31, 19341 1 Excludes 56 industrial banks and 54 nondeposit trust companies on which no checks |