absence of cost-accounting figures to guide us, we shall give the commercial bank the benefit of the doubt insofar as the argument that the income tax reduces the interest on deposits is concerned. Exhibit No. 2, which is attached, explains how the published figures for the insured commercial banks in 1949 were broken down so as to develop the earnings, expenses, and profits for stockholders allocable to the time and savings deposits of the commercial banks. As evidence of the fairness of the analysis, it may be said that whereas the time and savings deposits amounted to 25.7 percent of total deposits, they are given credit in the analysis for 30.3 percent of the gross operating income, are charged with only 20.8 percent of the operating expenses (exclusive of interest on deposits), are charged with 27.3 percent of the Federal income tax paid, and are given credit for 27.3 percent of the aggregate profits made by the banks for their stockholders. In 1949, the interest paid by the commercial banks on their average time and savings deposits was $328,010,000, or 0.92 percent. The insured mutual savings banks in 1949 paid on their average savings deposits $235,800,000, or 1.84 percent-just exactly twice the rate paid by the commercial banks. The commercial banks, as shown by the analysis in exhibit No. 2, paid $83,140,000 in Federal income taxes allocable to their time and savings deposit operations. Upon the assumption that the Government, in order to remove the income tax as a competitive factor, remitted this amount of tax to the commercial banks and upon the assumption that the commercial banks would have added the tax so remitted to the interest paid on the time and savings deposits, the interest rate on those deposits could have been raised from 0.92 to 1.15 percent. The rate paid by the savings banks would still have been 60 percent in excess of the rate that could have been paid by the commercial banks if there had been no Federal income tax levied on their savings and time deposit operations. This 60-percent differential shows that there are other factors, rather than the Federal income tax, which are responsible for the higher interest rate paid to depositors by the savings banks. But the assumption that the commercial banks would have passed such a remission of income taxes on to their depositors is questionable. Those taxes represented a part of the profits belonging to the stockholders and any funds representing the remission of such taxes would belong to the stockholders. The directors of the commercial banks, being responsible to the stockholders, would not likely pay out the remitted taxes to the depositors. The proof of this statement is evident from what follows. Exhibit No. 2 shows that, after paying a Federal income tax of $83,140,000 allocable to time and savings deposit operations, commercial banks in 1949 earned on those deposits for stockholders $227,085,000. This was equal to 8.51 percent on the capital funds allocable to those deposits. They paid to stockholders a dividend of 11.36 percent on the capital stock allocable to those deposits. Had the directors so desired, they could even without any remission of the income tax have increased the interest to depositors by $83,140,000 (the amount of the income tax) and still have earned nearly 64 percent on the allocated capital funds and could still have paid a dividend of nearly 8% percent on the capital stock so allocated. It is clear from these figures that it was not the $83,140,000 of income taxes which held down the interest paid time and savings depositors, but the fact that the directors wanted to retain for the stockholders from the earnings on those deposits $227,085,000, an amount equal to nearly 24 times the sum paid as Federal income tax. In addition to the very important part played by the profit factor (not the income tax factor) in holding down the interest paid depositors, there were also the two other factors we have discussed: the gross earnings on the time and savings deposits and the operating expenses allocable to those deposits. Exhibit No. 2 shows that the insured commercial banks had gross operating income of 3.07 percent on average time and savings deposits, assuming for this purpose that all of the earnings from high yield, long term securities are attributable to such deposits. Contrast this with 3.40 percent for the insured savings banks. The exhibit also shows that the operating expenses (exclusive of interest) of the commercial banks amounted to 1.144 percent of average time and savings deposits as compared with 0.811 percent for the savings banks. Further proof that the Federal income tax is not the cause of the lower interest paid by commercial banks on the time and savings deposits may be found in a 1948 survey made by the American Bankers Association covering operations in the year 1947. The survey covered 21 mutual savings banks with $10,000,000 of deposits or less and 26 commercial banks with $10,000,000 or less in savings deposits; 23 mutual savings banks with deposits between $10,000,000 and $30,000,000 and 10 commercial banks with savings deposits between $10,000,000 and $25,000,000; and 11 savings banks with deposits between $30,000,000 and $100,000,000 and 12 commercial banks with savings deposits over $25,000,000. The survey is an attempt to determine how profitable the savings deposits were to the commercial banks. In general, the survey shows that the three factors already discussed are responsible for the higher interest paid by the savings banksthose factors being the higher gross earnings, the lower operating expenses, and the absence of profit for stockholders, characteristic of the savings banks. The survey also shows that, with few exceptions, the diversion of the entire net profit in the case of the commercial banks as an addition to the interest paid depositors would not have covered the gap between the interest rate paid by the commercial banks and the interest rate paid by the savings banks. Clearly the full remission of the income tax on those profits would have fallen far short of closing the gap. Exhibit No. 3 which is attached, sets out for comparative purposes the median banks (with respect to gross earnings) in each deposit-size group with comparable amounts of savings deposits. The exhibit also sets out similarly the banks with the highest amounts of gross earnings. E. The commercial banks are not losing ground relative to the savings banks in the growth of their time and savings deposits.-For the 8-year period ended December 31, 1949, the relative growth in the three most important savings bank States, New York, Massachusetts, and Connecticut, of time and savings deposits was as follows: 1 Source: The figures for 1941 and 1945 are from the Annual Reports of the Comptroller of the Currency. The figure for 1949 is from the 1949 Annual Report of the FDIC. 2 Source: The figures for 1941 and 1945 are from the Annual Reports of the Superintendents of Banks. The figure for 1949 is from the National Association of Mutual Savings Banks. It will be seen from the foregoing figures that whereas the savings deposits in the savings banks in the three States in question increased by 84.4 percent from 1941 to 1949 and 28 percent from 1945 to 1949, the relative increases for those periods in the case of the commercial banks in those three States were, respectively, 144.6 percent and 43.7 percent. It is, therefore, clear that the commercial banks as a whole in the three States are easily holding their own against the savings banks. RISK ASSETS HELD BY THE SAVINGS BANKS ARE INCREASING It has been stated that the savings banks do not need as much of a margin of protection for depositors at the present time as they needed in former years, because their assets, in large measure, are composed of Government bonds and Government guaranteed or insured mortgages and because most of the savings banks have their deposits insured with the FDIC or with some self-constituted insurance fund. During the war, the ratio of Government bonds to total assets expanded rapidly. This was due to the fact that war conditions made for a short supply of other types of investment and created a large supply of Government bonds growing out of the need for financing the war. Also, by virtue of war conditions, savings deposits expanded rapidly. This increase in deposits grew out of the greatly expanded money supply due to the Government's own deficit financing and out of the fact that rationing and controls made it more difficult for people to spend their increased money incomes. These same factors led to a rapid liquidation of conventional mortgages and to a relative decrease in the supply of corporate securities. The savings banks did their part in assisting the Government by buying heavily of the bonds that were issued and have assisted the whole economy by absorbing large amounts of the people's increased incomes by encouraging them to save rather than spend. Spending under those conditions would have added greatly to the forces of inflation. During and subsequent to the war, the principal outlet for mortgage money was in home financing. Homes were badly needed, and this was particularly true in the case of veterans. The savings banks performed a useful public service in making their funds available for the financing of these homes. The Government itself encouraged this. The heavy concentration of investments by the savings banks in Government bonds and the growing investment in guaranteed and insured mortgages is not a permanent situation. The banks are seeking opportunities on every hand to bring back the more normal distribution of their assets which existed before the war. The percentage of total sssets of the savings banks invested in United States Government bonds has declined from 63.2 percent in 1946 to 48.5 percent in 1950. The percentage of total assets invested in other securities has increased from 7.4 percent in 1945 to 10.5 percent in 1950, and the percentage of total assets invested in mortgage loans has increased from 23.7 percent in 1946 to 35.8 percent in 1950. At the end of 1949, the savings banks had 70 percent of their total mortgage holdings in the form of conventional mortgages. Only 13.8 percent of the loans were FHA insured and only 16.2 percent were partially guaranteed by the Veterans' Administration. In this connection, it should be noted that the savings banks are paying for the FHA insurance and for the guaranty of the Veterans' Administration by accepting relatively low yields on this type of mortgage. Likewise, of course, they have had to be satisfied with a very low return on their investment in Government securities. A savings bank would need a margin of safety to protect its deposits even if the great bulk of its assets were represented by Government credit of one kind or another. FHA and VA mortgages could not be sold in quantity to meet withdrawals without the risk of a substantial loss in market price. The same would be true, though in less degree, if the banks were forced to sell large blocks of Government securities. We are experiencing at this moment substantial uncertainty in the prices of Government securities. In the early 1920's 44 percent Government bonds sold in the 80's. The FDIC, which insures more than half of the deposits of the mutual savings banks, has commented in its annual reports upon the proposition that banks do not need an adequate cushion because of their large holdings of so-called riskless assets. For example, in the Annual Report of 1949 on page 9, the FDIC had the following to say: "Although the ratio of bank capital 1 to assets other than cash and Government obligations needs to be studied in determining general public policy, it is not an appropriate standard for the supervision of individual banks. Bankers may at any time convert a substantial portion of their holdings of cash and United States Government obligations into other types of assets with a resultant decline in the ratio. The ratio, therefore, is subject to unpredictable fluctuations and for this reason it does not furnish a satisfactory standard for bank supervision. Furthermore, such a standard places a premium upon ultraconservative banking. It would encourage the banks to freeze their resources in cash and Government obligations, and thus they might be unable to satisfy the legitimate credit needs of their communities. As a result, it might become necessary for the Government to assume the responsibility for financing private business enterprise. This Corporation wishes to see the banks so organized that they can meet the needs of their communities without recourse to Government assistance." FDIC AND OTHER DEPOSIT INSURANCE DOES NOT ELIMINATE THE NEED FOR ADEQUATE RESERVES AND SURPLUS The Federal Deposit Insurance Corporation stated on page 10 of its Annual Report for 1946: "The Federal Deposit Insurance Corporation has been given the responsibility by Congress of protecting bank deposits. The first line of protection for deposits in any one bank is the capital of that bank. * * The resources of the * Federal Deposit Insurance Corporation are mobile and are available to supplement the protection given depositors by bank capital whenever any bank is unable to meet the claims of its depositors. The capital funds of the Corporation, therefore, add to the protection afforded by bank capital. Maintenance of complete conconfidence of depositors in the banking system is necessary to prevent panic withdrawals or deposits." [Italics ours.] 1 In the case of mutual savings banks, this would be the surplus or guaranty fund or general reserve. 79120-51-pt. 2-20 * * * In its annual report for 1944, the FDIC spoke as follows on page 12: 16* * * Banks should not only have adequate capital but should also follow a policy of making periodic additions to reserves for losses. These reserves should be accumulated in amounts which reasonable expectation and loss experience indicate will be adequate to cover operating losses, while the capital of the bank should be strong enough to provide a protection against extraordinary and unforeseen hazards. It is desirable that each bank should make provision on a systematic basis for losses, which can be expected to develop in periods of readjustment, on assets acquired during the prosperous periods. Where banks do not already follow such a practice, reserves for losses should be set aside annually in the form of valuation allowances, or unallocated charge-offs, or in some manner, against those groups of assets from which losses ordinarily arise. Such reserves should, of course, not be regarded as a part of the capital accounts." It is the fact that a savings bank has adequate surplus and reserves which makes it an insurable risk with the FDIC. The FDIC would refuse to insure the deposits of a savings bank which did not have adequate surplus and reserves, and it could refuse to continue the insurance of such a bank's deposits if it failed to maintain adequate surplus and reserves. EXHIBIT No. 1 Effect of Federal income tax upon dividend or interest credited and upon dividend or interest rate NOTE. The aggregate earnings in column 3 above differ from the actual aggregate earnings in column 2 because of the fact that the lower dividend credited as a result of the tax reduces the amount of funds available for investment. The actual rate of earnings to average deposits in this table is the same as that rate which the banks actually experienced. In other words, for each year the ratio of earnings to average de posits which the banks actually experienced was determined. Then the earnings for that year on a tax basis were determined by applying that rate to what average deposits would be for that year on a tax basis. The average deposits were taken as one-half the sum of the deposits at the beginning of the year plus the deposits at the end of the year. The earnings on a tax basis were then determined by multiplying the resulting figure by the rate of earnings actually experienced. The unknown factor that was to be determined for the purposes of this exhibit was the dividend that could be paid after taxes. The formula for determining that factor is attached hereto as exhibit 1-a. 1 In the case of mutual savings banks, this would be the surplus or guarantee fund or general reserve. EXHIBIT No. 1-A FORMULA FOR DETERMINING THE DIVIDEND IN THE EXHIBIT SHOWING THE EFFECT OF THE INCOME TAX UPON THE DIVIDEND S surplus at the beginning of the year D=deposits at the beginning of the year I net inflow of deposits during the year R increase in allocated reserves during the year R'actual rate of earnings which the banks experienced on the average of their actual deposits at the beginning and at the end of the year. The following are the unknown factors: S' surplus at the end of the year t=amount of the income tax D' deposits at the end of the year Then: E earnings available after expenses, losses, and charge-offs and after giving effect to the reduced amount of deposits available for earnings as the result of the impact of the income tax upon the dividend or interest and, therefore, upon the deposits d=amount of dividend or interest paid or credited to depositors S'=rD' S' E-d-r+S—R S' E-d-r' (E-d)+S-R We know that R' is the ratio of the earnings which the banks actually experienced to the average of the actual deposits at the beginning of the year and the actual deposits at the end of the year. Since the earnings (E in the above formula) will bear the same relationship to the deposits at the beginning and end of each year (D and D' in the above formula) as the actual earnings bore to the actual deposits at the beginning and end of each year, then: ANALYSIS FOR PURPOSE OF DETERMINING EARNINGS AND EXPENSES ALLOCABLE TO TIME AND SAVINGS DEPOSITS OF INSURED COMMERCIAL BANKS IN 1949 The figures that follow are from pages 146, 147, 148, 160, 161, 162, and 163 of the FDIC Annual Report for 1949 or they are based upon figures appearing on those pages. We assign to time and savings deposits all of the Government bonds held by commercial banks with maturities in excess of 10 years, half of all corporate bonds, notes, and debentures, and all of the real estate mortgages. It is found that such Governments would amount to 19.1 percent of those deposits, such corporate securities would amount to 41⁄2 percent of those deposits, and the real estate mort |