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This change in the Federal Reserve Act will be of benefit not only to the State of Maine, but to the State of Rhode Island, and other States which may establish similar guaranteed industrial loan programs. We urge that this section of H.R. 6092 receive the approval of this committee.
STATEMENT OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
WITH RESPECT TO H.R. 6092 AND H.R. 6093, 86TH CONGRESS H.R. 6092 and H.R. 6093 contain a number of provisions that relate to the "internal” functioning of the banking system created by the National Bank Act and to the supervision of that system by the Comptroller of the Currency; an example is the provision of H.R. 6092 that would increase the number of Deputy Comptrollers of the Currency from three to five. Comptroller of the Currency Ray M. Gidney has urged the enactment of these provisions, and the Board of Governors has no comment to make with respect to the provisions of this nature included in the two bills.
However, the bills also include provisions that are of special interest to the Board of Governors because of their relationship to the field of credit regulation, which is the Board's major responsibility, or because they are applicable to member State banks, which are supervised by the Federal Reserve System, or because of the Board's concern with the soundness of banking operations generally.
Except to the extent indicated herein, the Board does not oppose enactment of the two bills.
Limitation on borrowing by national banks.—Section 2 of H.R. 6092 would amend section 5202 of the Revised Statutes (12 U.S.C. 82). At present section 5202 forbids a national bank to be indebted at any time to an amount exceeding the amount of its capital stock. However, this limitation does not apply to certain categories of obligations, including liabilities incurred under the provisions of the Federal Reserve Act.
The Board is aware that the limit prescribed by section 5202—the amount of the particular bank's capital stock-may produce inequitable differences in the borrowing powers of competing banks. For example, each of two banks might have a capital structure of $5 million, but one might have $1 million of capital and $4 million of surplus and undivided profits, whereas the other might have $3 million of capital and $2 million of surplus and undivided profits. In such a situation, the latter bank could legally borrow three times as much as the former ($3 million as compared with $1 million), even though their effective capital structures are substantially equal. Such inequities result from the fact that section 5202 refers solely to "capital stock” and disregards the other elements of a national bank's capital structure. It should be noted, however, that a national bank with a relatively large surplus account can increase its borrowing limit by an increase of its capital stock.
The proposed amendment would amend section 5202 to authorize a national bank to borrow up to the amount of its capital stock plus its surplus. The surplus accounts of all national banks aggregate almost $5 billion, so that this proposal would add that amount to their potential borrowing, and lending, capacity.
This considerable expansion in the borrowing ability of national banks would, in the Board's opinion, be unnecessary and undesirable. Although bank borrowings may occasionally be necessary in limited amounts and for limited periods in order to avoid liquidation of assets that might otherwise be necessary, it is a practice that should not be encouraged because it tends to dilute the cushion of protection which is afforded depositors by a bank's capital and surplus. Enlargement of the borrowing limits as here proposed might well encourage national banks to hold smaller amounts of liquid assets and to rely unduly upon borrowings for necessary adjustments. In the case of an emergency requiring unusual borrowing, the discount facilities of the Reserve banks are available. To encourage the ability of national banks to borrow outside the Reserve banks would tend to diminish the restraining influence that the Reserve banks are directed by law to exert upon borrowing member banks which may be making undue use of credit for speculative purposes.
It is possible that any inequities inherent in the present section 5202 could be diminished without greatly expanding the aggregate borrowing power of national banks and thereby affecting adversely the existing salutary restriction on the volume of interbank borrowing. One possibility would be to base the limitation on national banks' borrowing authority on the amount of capital stock plus surplus, as recommended by section 2 of H.R. 6092, but to restrict the borrowing power of each bank to 50 percent of its capital stock and surplus. The Board recognizes that such an amendment would reduce the amount that could be borrowed by a national bank with a surplus that is less than the amount of its capital stock, but it is believed that this would not be injurious or unjust.
Loans on guaranteed installment consumer paper.-Section 3(d) of H.R. 6092 would add a new paragraph (13) to section 5200 of the Revised Statutes (12 U.S.C. 84), which prescribes limitations on the amounts that a national bank may advance to any one borrower. A proviso to this new paragraph would permit a national bank to make unlimited advances to the endorser or guarantor of installment consumer paper, if
(1) an officer of the bank certifies in writing “that the responsibility of each maker of such obligation has been evaluated and the [bank] is relying primarily upon each such maker” rather than upon the endorser or guarantor, and
(2) “the bank's files or the knowledge of its officers of the financial condition of each maker of such obligations is reasonably adequate.” Under this proviso, a national bank could purchase from a dealer, finance company, or other customer, unlimited amounts of installment paper endorsed or guaranteed by such customer. The paper could be nonnegotiable and unsecured, thereby lacking the protection that is afforded the holder of paper that is negotiable or secured. The only requirements would be (1) the above-mentioned certification by a bank officer and (2) that “the knowledge of the bank's] officers of the financial condition of each maker of such obligations is reasonably adequate."
The Board of Governors questions the advisability of this proposal. The limitations of R.S. 5200 are designed to restrict by law the extent to which a national bank may indulge in unsound and dangerous lending practices. These limitations are unnecessary with respect to a well-run bank; their function is to place an absolute legal limit on any tendency of a less well-run bank to lend excessively to particular customers and thereby to incur risks that might jeopardize its solvency or its continued operation. Under the proviso, such a bank could make unlimited advances to a single customer, provided only that an officer of the bank signed a statement that “The responsibility of each maker of these obligations has been evaluated and the association is relying primarily upon each such maker for the payment of such obligations.” In these circumstances, the certification requirement might not constitute an effective impediment to unlimited dealer financing of this character.
For the reason indicated, the Board questions the desirability of the proviso in the proposed new paragraph (13) of R.S. 5200.
Loans on real estate security.-Section 4 of H.R. 6092 would amend in a number of respects section 24 of the Federal Reserve Act (12 U.S.C. 371), relating to loans by national banks on the security of real estate. All of these proposed amendments would expand the lending powers of national banks in the real estate field. It should be noted that the general tendency of amendments to section 24 in recent years has been substantially to increase national banks' holdings of real estate loans, and a large volume of such investments is not subject to the aggregate limitations on such loans. Nevertheless, most of the proposed amendments appear to be justified, in view of the improvement in banks' real estate lending practices during the past 25 years.
However, the Board of Governors is doubtful with respect to the advisability of section 4(d) of H.R. 6092, which would permit national banks to accept real estate security for business loans without subjecting such loans to either the percentage-of-value limitations or the aggregate limitations of section 24.
This is a major departure from a basic principle of banking. It could lead to a tendency to consider all business loans supported by real estate security as loans based on the general credit of the borrowers, thereby giving rise to a substantial expansion of loans secured by real estate and yet not subject to either the specific or general limitations of section 24 with respect to real estate loans. Such business loans normally are large in amount, and a substantial volume of such liquid loans could develop free from the protective restrictions of section 24 and without public knowledge, since such loans would not be classified as real estate loans in national banks' reports of condition.
Most of the sections of H.R. 6093 appear to be peculiarly within the scope of operations of the national bank system and to have no material significance insofar as the functions and responsibilities of the Federal Reserve System are concerned.
It is observed that many of the provisions in the proposed legislation relating to national banks appear to be desirable due to changes in practice or in other legislation.
Obsolete references in existing law would be eliminated, including those concerned with Government agencies and corporations formed pursuant to Federal statutes which are no longer active, i.e., Reconstruction Finance Corporation, Home Owners' Loan Corporation and National Agricultural Credit Corporations. Other obsolete provisions include those which relate to installment payments on capital stock of national banks and liability of shareholders of national banks for debts of the bank. The board considers it desirable to eliminate these references since they serve no useful purpose and tend to mislead and confuse the reader.
The board would have no objection or comment with respect to certain other provisions of the bill which appear to be concerned only with the operation of the Office of the Comptroller of the Currency. These include section 3, which would require the approval of the Comptroller before a national bank may move its main office within its own city limits; sections 2 and 4, requiring that all capital stock of a national bank be paid in before it may commence business ; section 9, relating to the time of shareholders' meetings; section 12, relating to the time for filing reports of condition of national banks; section 14, establishing the procedures for amending the articles of association of national banks; section 16, which adds a new requirement of a two-thirds vote of shareholders if liquidation of a national bank involves the sale of its assets to another bank; section 19, which makes certain changes in the details of procedures for winding up the affairs of a national bank; section 21, relating to consolidations and mergers involving national banks; and section 23, relating to reports to the Comptroller of dividends paid by national banks.
It is noted that section 7 would repeal section 23 of the Federal Reserve Act. This repeal is desirable; the provision has been obsolete since the elimination of the individual liability of shareholders of national banks.
Restrictions on payment of dividends.-Section 22(a) of H.R. 6093 would amend the second sentence of section 5204 of the Revised Statutes (12 U.S.C. 56). That sentence now provides that
"If losses have at any time been sustained by any [national banking) association, equal to or exceeding its undivided profits then on hand, no dividend shall be made; and no dividend shall ever be made by any association, while it continues its banking operations, to an amount greater than its net profits then on hand, deducting therefrom its losses and bad
debts." Admittedly, this provision is unsatisfactory, in part because of uncertainty regarding the coverage of the expressions "undivided profits then on hand" and “net profits then on hand.”
In lieu of the quoted sentence, section 22(a) would substitute the following sentence:
"No dividend shall be paid by any such association while it continues its banking operations if all bad debts due it and all losses sustained are greater than the amount of any surplus funds in excess of its common capi
tal, plus its undivided profits and reserves.” Presumably the purpose of the proposed new sentence is to give greater freedom, with respect to dividends, to a national bank that has built up its surplus account until that account exceeds the amount of its capital stock. However, it appears that the effect of the provision, in some situations, would be to favor banks that retained earnings in "junior" capital accounts over banks that tended to transfer their accumulated earnings into "senior" capital accounts, even though the latter practice, in general, is favored by the Federal bank supervisory agencies.
The following examples may illustrate the problems presented by the proposal:
Let us assume that each of these banks has losses and bad debts totaling $200,000.
With respect to Bank A and Bank B, let is assume that each of these banks began business with capital stock of $1 million and surplus of $200,000. Bank B has been more profitable, has retained a greater amount of earnings to strength its capital position, and has transferred greater amounts from its undivided profits account to its surplus account, than has Bank A. Nevertheless, under the proposed formula, Bank A could legally pay dividends up to $100,000, whereas Bank B would be prohibited from paying any dividends whatever.
Similarly, it may be assumed that Bank D, by payment of stock dividends, has doubled its original capital stock, and it has transferred much of its remaining accumulated earnings to its surplus account. Bank C, on the other hand, has operated much less profitably, has never increased its capital stock, and has retained in its capital structure less than half as much in accumulated earnings, as has Bank D. Nevertheless, under the suggested formula Bank C could declare dividends of as much as $300,000, whereas Bank D, with a superior earnings record and a stronger financial structure in all respects, would be legally prohibited from declaring any dividend.
The foregoing examples suggest that the proposed new sentence in Revised Stautes 5204 would produce inequitable results in some situations. Such inequity may be inherent in any arrangement that restricts dividends, a phase of operating results, on the basis of the relative size of the several parts of the bank's capital structure.
In this connection, the Board notes that section 22(b) of H.R. 6093 would amend section 5199 of the Revised Statutes (12 U.S.C. 60) by prohibiting (except upon supervisory approval) payment of dividends in excess of a national bank's net profits for the current year plus retained net profits of the preceding 2 years. In the judgment of the board, this is a sound and workable limitation based on an appropriate criterion—the recent earnings record of the bank. The board is inclined to believe that, if this proposal is adopted by Congress, neither the present nor the proposed limitation in section 5204 will be necessary.
This matter is of direct concern to the Federal Reserve System because section 9 of the Federal Reserve Act (12 U.S.C. 324) requires all State-chartered banks that are members of the Federal Reserve System to conform, inter alia, "to those provisions of law imposed on national banks * * * which relate to the payment of unearned dividends." The broad purpose of this provision is to subject member State banks to restrictions that parallel those applicable to national banks with respect to the extent to which dividends may be paid from the particular bank's capital accounts. The proposed changes in both R.S. 5204 and R.S. 5199 introduce restrictive criteria with respect to payment of dividends that are not strictly matters of "unearned dividends." In the circumstances, if either proposed amendment, or both, are enacted, possible uncertainty as to the effect of the relevant provision of the Federal Reserve Act should be averted by requiring member State banks “to conform to the provisions of section 5024 [or section 5199 (b), or both, as the case may be) of the Revised Statutes with respect to the payment of dividends.” It should also made clear that, in the case of member State banks, the supervisory approval referred to in the proposed section 5199 (b) is that of the Board of Governors and not the Comptroller of the Currency.
Washington, June 5, 1959.
Washington, D.C. MY DEAR MR. CHAIRMAN: We have received from your committee a copy of the statement submitted by the Board of Governors of the Federal Reserve System with respect to H.R. 6092 and H.R. 6093. We believe it may be helpful to your committee to have our comments on the Board's statement. We shall comment upon the items in the same order in which they appear in the statement of the Board.
H.R. 6092 Limitation on borrowing by national banks.We continue to believe that the proposed increase in the borrowing authority of national banks is justified.
Loans on guaranteed installment consumer paper.-The Board questions the advisability of the proviso which would be contained in the new exception 13 to section 5200 of the Revised Statutes, apparently on the basis that under it a national bank could purchase unlimited amounts of installment paper endorsed or guaranteed by a customer, and that the certification requirement might not constitute an effective impediment to unlimited dealer financing of this character.
The fact is that enactment of this proposal would represent a considerable and, we believe, effective tightening of existing law. Under exception 2 to R.S. 5200, negotiable installment consumer paper endorsed by a customer may be taken without limit, and without any requirement of a certification that the responsibility of each maker of such obligations has been evaluated and the bank is relying primarily upon each such maker for the payment of such obligations, and without any requirement that the bank's files or the knowledge of its officers of the financial condition of each maker must be reasonably adequate. *These requirements represent a limitation not contained in existing law.
With respect to the Board's reference to the protection that is afforded the holder of paper that is negotiable, nonnegotiable conditional sales contracts, the usual type of installment consumer paper, contain provisions for the protection of the lender which cannot be included in negotiable paper, and as a practical matter the actual amount of protection in connection with conditional sales contracts is as great if not greater than that afforded by negotiable paper. For example, as a general rule property securing a conditional sales contract may be repossessed without the formalities which would be necessary to repossess property securing negotiable notes, and conditional sales contracts generally contain requirements requiring the borrower to pay any taxes assessed against the property, to keep the property insured, and not to remove the property from the State, whereas none of these requirements can be included in negotiable notes.
With respect to the Board's reference to the protection that is afforded the holder of paper that is secured, there is no requirement under exception 2 that such paper be secured, so enactment of exception 13 would not change existing law in this respect.
With respect to the Board's objection that the certification requirement might not constitute an “effective impediment” to unlimited dealer financing, it is not intended to do so and should not do so. The purpose of this requirement is to insure that in cases where a bank desires to purchase from a single dealer paper in excess of 25 percent of its capital and surplus it may do so only after having evaluated the responsibility of the maker of each obligation and in reliance upon the maker for the payment of the obligation. National banks should not be prohibited from purchasing such obligations, nor should they be included in the dealers' lines of credit since the bank would not be placing primary reliance upon the dealers for protection.
In the opinion of this office there is no doubt that the certification requirement will be effective. In this connection it must be pointed out that in clause (2)