Collier's New Encyclopedia (1921)/Banks, Federal Reserve

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BANKS, FEDERAL RESERVE, the Federal Reserve system is primarily a result of the currency disturbances of 1907-1908 which were promptly followed by the passage of the Aldrich act providing for an emergency circulation not to exceed $500,000,000. The conditions of this bill were so strict, however—having been framed just after an extreme crisis and suitable only for such an emergency—that no issue was ever undertaken under its provisions. It had stirred up legislative agitation of the subject, however, and in 1910 a commission under Senator Nelson A. Aldrich of Rhode Island, its original promulgator, set seriously to work on the whole question of banking reform.

This National Monetary Commission spent three years in expert investigation of banking conditions here and in Europe.

Senator Aldrich meanwhile offered in 1911 a reorganization plan the chief feature of which was a National Reserve Association, consisting of a central bank—whose stock should be distributed to other banks through the country—which should have the control through the election of a majority of the directors. Associate or local systems were to be formed, also controlled by the local banks which were members.

This measure assigned to the National Reserve Bank—which should hold a reserve from all the banks, and rediscount the paper of the local associations—the function of controlling the credit of the whole system and thus limiting local panics. It also has the power to issue notes on general assets to promote elasticity of the currency. It can also take up the bonds of the local banks which the government will gradually refund in 3 per cent. bonds that will find buyers in the general market. The National Monetary Commission offered a bill the year following which was essentially the same.

The measure was taken up by the Special Session of Congress in 1913, and discussed in all its bearings till it was finally passed with some change on Dec. 23, 1913.

Under this enactment the United States is divided for facilitating the banking inter-relations of the country into twelve districts whose headquarters are in twelve principal cities of the country under the control of a Central Reserve Board. This board is composed of the Secretary of the Treasury (ex-officio), the Comptroller of the Currency (ex-officio), and five bankers appointed for terms of ten years by the President. A Federal Advisory Council is also provided for, consisting of twelve members, one elected by each of the twelve district Reserve banks, to confer when necessary with the Board.

Each district bank is governed by a directorate, three of whose members are the appointees of the Federal Reserve Board; the others appointed by the bank itself. Every National bank is required, and every State bank is permitted, under certain conditions, to subscribe to the stock of the Federal Reserve bank in its district to the extent of 6 per cent. of its own capital and surplus. In this way the paid-in capital of the twelve Federal Reserve banks at the date of our entering the war with Germany was about 56 millions; the largest bank, New York, having very close to twelve millions; the smallest, Atlanta, $2,414,000. The district banks have the power to create branches for dealing in Government and other securities, and to rediscount commercial paper for their associate members. They may also be called on by the Federai Reserve Board to rediscount paper for other Federal Reserve banks.

The district banks are empowered to purchase from members Government bonds held for circulation, and take out circulation on them. As an alternative these bonds may be changed to 3 per cent. bonds without circulation. This provision is for the purpose of gradually retiring the note circulation secured by bond. Treasury notes made by the Government are offered as a new circulatory element. The Federal Reserve bank requiring these must place rediscounted commercial paper in the hands of a director who is designated as a Federal Reserve Agent. The circulation of these notes is guaranteed by the bank of a reserve in gold of 40 per cent. of their face value.

The system is divided into three classes: Central-reserve cities, where the total reserves are required to be 18 per cent. of demand liabilities and 5 per cent. of time deposits; reserve cities, where the reserves are required to be 15 per cent. and 5 per cent.; and other banking centers where they must be 12 per cent. and 5 per cent. For two years after the law was passed the latter class was required to hold five-twelfths of its reserve in its own vaults; thereafter four-twelfths. The remainder of the reserves of the banks in the reserve cities were to be gradually withdrawn until five-twelfths had been so redeposited, and by the end of the third year the entire reserve must be held either in the banks' vaults or by the Federal Reserve bank. The reserves of reserve, and Central-reserve cities must be similarly readjusted until, in the former case, five-fifteenths are held in the banks' vaults, and six-fifteenths in the Federal Reserve bank—in the latter case, six-eighteenths and seven-eighteenths, respectively. At the end of a period of three years the unassigned reserve shall be either in the banks' own vaults or the Federal Reserve bank.

The Federal Reserve banks are not chartered primarily for profit. The capital of the Federal Reserve banks is owned by the member banks, subject to a cumulative dividend of 6 per cent. Profits in excess of this revert to the Government, with the provision that one-half of these excess profits shall be diverted to the creation of a surplus fund for the Federal Reserve bank until the fund shall have reached 40 per cent. of the capital of that bank. Primarily the duty of the Federal Reserve banks is to act as the custodian and guardian of the bank reserves of their member banks. Next is their duty to render a service to their member banks, and through them in turn to the general public in equalizing and stabilizing interest rates.

The Federal Reserve banks came into being in November, 1914, and notwithstanding that American bankers had gained through five years of discussion a better understanding of the deplorable defects in the American banking and currency system, the managers of the new Federal Reserve banks found that the welcome accorded them by the banks of the country at large was cool. This was because they did not really understand the new régime. The breaking out of the Great War was the immediate influence in their organization—requiring as it did the best linking talent and machinery in the country. The immense imports of gold from abroad following the outbreak of the war, and the general prosperity stimulated by war profits kept the system at once from proving its great value.

For three years, from its formation up to our own entry into the struggle, in April, 1917, it was, however, gradually finding itself. When this great test came the Federal Reserve banks were prepared for its great responsibilities. During the first year of war the system took a high place in the confidence and esteem of both bankers and business men.

Source: Collier's New Encyclopedia 1. (1921) New York: P.F. Collier & Son Company. 408-410.