Study of Banking Laws, Hearing Before ..., 84:2 ....

acquisition and temporary holding by any such bank of any such bank stock if disposition thereof occurred prior to November 9, 1956."

Reasons

In the past the Board of Governors of the Federal Reserve System has looked with disfavor upon acquisition of bank stocks by member banks even when the acquisition was for only a temporary purpose and the bank stock was to be disposed of promptly. We feel that the present prohibition should be relaxed to the extent indicated in the foregoing recommendation and that the Congress should set the record straight as to any such acquisitions which were disposed of prior to a given date, which date we suggest should not be later than November 9, 1956, and might be as far back as January 1, 1956.

Existing law

4. ESTABLISHMENT OF RESERVES FOR BAD DEBTS

Permission was granted the banks in 1947 to establish reserves for bad debts. Although tax revenues of the Government are deferred by the reserve method, no eventual loss of revenue results therefrom.

The majority of the larger banks adopted the reserve method of providing for future losses, and have thereby added materially to the strength and stability of the banking system and to the system's usefulness to the public. The complicated formula, however, has deterred most smaller banks from adopting the reserve method.

Recommendation

It is urged that appropriate revisions be made in the Internal Revenue Code to simplify and liberalize the formula for the establishment of reserves for bad debts.

Reasons

The capital of the banking system is primarily a buffer of safety for the benefit of depositors. The amount of an individual bank's capital is not directly related to profit potentials, as is the case in most other types of business, and there is a natural reluctance on the part of an individual bank to expand its capital beyond the minimum requirements.

The recent resurgence of demand for bank loans, the likelihood that loan risks are high, and the reduced liquidity of the banking system point to the need for enlarging bank capital beyond the accretions from retained earnings and the relatively moderate additions which are obtainable through the sale of additional stock.

Reserves for bad debts, which in a practical sense may be considered to be a part of bank capital, would be expanded rapidly and substantially if the formula for the establishment of such reserves were simplified and liberalized. The benefits of expanded bank capital would thereby be obtained.

Existing law

5. UNDERWRITING OF REVENUE BONDS

Banks, which are a major and indispensable factor in the underwriting and distribution of State and municipal bonds, are restricted in these operations to full faith and credit, general obligation bonds.

Recommendation

The differentiation which exists as between general obligation bonds and revenue bonds with respect to underwriting by banks should be removed. Reasons

In recent years so-called revenue bonds and dedicated-tax bonds have become increasingly popular with issuing bodies. Such bonds of acceptable investment quality are customarily purchased and held by banks in their investment portfolios, and the restriction against bank underwriting of such bonds is unrealistic and unnecessary.

A wider interest in the underwriting of revenue bonds and increased competition to purchase them will result in lower borrowing costs for issuers.

6. REAL-ESTATE LOANS BY NATIONAL BANKS UNDER SECTION 24 OF THE FEDERAL RESERVE ACT

Existing law

Under the present statutory provision (12 U. S. C. 371) national banks are authorized to "make real-estate loans secured by first liens upon improved real estate" and no such loan may exceed 66% percent of the appraised value of the real-estate security.

Recommendation

It is desirable that a clarification be made in the statute so that loans which are based primarily on the credit of the borrower are separated from those which are based primarily on the security afforded by the real estate itself and that the former be expressly freed from the present statutory provision.

Reason

Whenever a loan is made to a business corporation and a mortgage on its plant is taken as security, if the amount of the loan exceeds that limited by the statute, a question is presented whether this may not constitute a violation of the statute, notwithstanding the fact that the loan is predicated primarily on the ability of the borrower, demonstrated by its financial condition and past performance, to repay the loan out of earnings or the proceeds of assets other than real estate. In such cases the appraised-value requirements has no real significance and the mortgage is taken merely out of abundance of caution on the part of the bank. However, if, in order to avoid the possibility that the propriety of the loan may be subjected to question because of the existence of the mortgage, the bank makes the loan without the mortgage security or splits the loan so that only a portion of it is secured by the mortgage, it thereby gives up the added protection which it might otherwise require.

It seems evident that this statutory limitation on loans secured by mortgages on real estate was designed to be applicable only to those situations where the real estate itself is considered the primary source of payment of the loan.

Existing law

7. CONTRIBUTIONS

Under the present statutory provision (12 U. S. C. 24), contributions by national banks are authorized "to community funds, or to charitable, philanthropic, or benevolent instrumentalities conducive to public welfare" and no such contributions may be made by a national bank located in a State whose laws expressly prohibit State banking institutions from making such contributions.

Recommendations

It would seem that the statutory authorization governing contributions should be broadened and, at the same time, that the restriction regarding the provisions of State laws should be eliminated.

Reasons

The scope of contributions presently authorized seems unduly limited. Not only are educational institutions excluded but also other organizations which benefit banks as well as other corporations and individuals in the community.

Existing law

8. CUMULATIVE VOTING

Under the present statutory provision (12 U. S. C. 61), shareholders of national banks may vote their shares cumulatively in the election of directors.

Recommendation

We recommend the elimination of the present statutory requirement of cumulative voting and the substitution of a provision authorizing such voting if required by the articles of association of the individual bank.

Reasons

The prime purpose of cumulative voting is to enable a shareholder or group of shareholders to assure themselves of representation on the board of directors so that their personal interests as shareholders may be protected and advanced. Provision for cumulative voting may therefore not be objectionable in the case of business corporations where the interests involved are primarily those of the shareholders.

However, in the case of financial institutions which involve the interests of depositors and the general public as well as those of the shareholders, a different treatment seems appropriate. In the interests of public confidence, a method of electing the members of the boards of directors of banks which will most likely assure a unified approach by them would seem desirable, particularly in view of the fact that banks are subject to governmental supervision.

9. STOCK OPTIONS FOR BANK-MANAGEMENT PERSONNEL

While time has not permitted an exhaustive study of how the problem might be approached, it would seem desirable for the committee to develop a method whereby management personnel could acquire the stock of their banks under an option plan. Such an incentive would greatly facilitate the recruitment and retention of qualified management personnel in competition with companies in other industries which have such plans.

Existing law

10. BANK MERGERS

No express statutory provision exists requiring the regulatory agencies, in approving a bank merger, to consider the competitive effect of that merger. Recommendation

The appropriate Federal regulatory agency having the responsibility for approving a bank merger should be expressly required to take into consideration and weigh all the various financial and economic features of the merger, including whether it will unduly affect competition. (The enactment of the Fulbright bill, S. 3911, 84th Cong., would accomplish this purpose.) Reasons

The various legislative measures recently proposed indicate that some express statutory provision is regarded as necessary in the public interest in order to avoid undesirable effects on competition which may result from bank mergers. Some of these measures would subject such mergers to provisions similar to those contained in the Clayton Act, with respect to other business corporations, prohibiting those mergers the effect of which may be substantially to lessen competition or tend to create a monopoly and, at the same time, subjecting them to regulation by agencies other than those which now supervise banks.

Through long experience the Federal regulatory agencies, which now supervise banks, have acquired a familiarity with their affairs, the functions which they perform in their respective communities, and the problems which are peculiar to them as financial institutions operating in such communities. There is no indication that these agencies are not qualified to discharge the responsibility for determining the propriety of bank mergers. Other agencies charged with administration of the antitrust laws have no such qualifications. Furthermore, the standards which may be applicable in determining the propriety of mergers of other business corporations are not necessarily those which should be applied to bank mergers, and the approach customarily taken by such other agencies might well be inappropriate. There is, therefore, no conceivable reason to inject such other agencies into mergers involving financial institutions.

Existing law

11. STANDARDS OF CONDUCT

Over the years, out of experience certain traditions become established in the banking business serving to protect bank depositors and stockholders, as well as the general public, from improper or unethical conduct on the part of banks and their officers and directors.

Voluntary adherence to these traditions could not, however, always be counted on to be sufficiently protective; many of them, therefore, were enacted into law, often with the aid and approval of bankers. Among prohibitions of this kind, which have been incorporated into the Federal statutes, are the following:

1. No bank belonging to the Federal Reserve System may purchase from any of its directors or affiliates any securities or other property without being subject to making full disclosure to the Federal Reserve Board of commissions and other considerations paid.

2. No person may serve as an officer or director of two banks in the same community.

3. Banks belonging to the Federal Reserve System are strictly limited in the amount they may lend to any of their officers.

4. Banks belonging to the Federal Reserve System may not pay a greater rate of interest on deposits to their directors, officers, or employees than is paid to the general public.

5. With certain exceptions, national banks may not have as officers or directors brokers or dealers in securities.

6. Directors of banks who violate certain key banking laws (or who condone such violation) may be held personally liable for such action.

7. It is a criminal offense for an officer or director of a bank to give or lend money to any public employee who is involved in making examinations of banks, and for such a public employee to accept such a gift or loan.

8. It is a criminal offense for an officer or director of a bank to accept a fee, commission, or gift for procuring a loan from that bank.

As stated above, rules of this type were enacted in an attempt to control the standards of business conduct in the banking business and for the protection of the general public.

Recommendations and reasons

In recent years, there has been a rapid growth in savings-and-loan associations and in credit unions, both Federal and State chartered. Anything which might discredit the activities of these institutions could have unfortunate repercussions on the banking system and the entire economy.

There are no specific statutory provisions applying to these organizations corresponding to those above enumerated regarding banks. The general public is entitled to assurance by means of Federal statute that the standards of conduct of the officers and directors of savings-and-loan associations and credit unions will be on the same plane as applies to their counterparts in banks.

EXHIBIT A

(Supporting American Bankers Association recommendation No. 4)

1. RESERVE FOR BAD DEBTS

A. The necessity of reviewing the adequacy of existing reserves for bad debts It is apparent that any broad inquiry of banking legislation should include an examination of our banking system and an appraisal of the ability of the system and its individual component elements to serve its two most important functions-that is:

(i) to protect the safety of depositors' funds; and

(ii) to provide necessary individual and business credit.

Based upon the reports of supervisory officials as well as our own appraisal, we are convinced that there is no question of the safety of our banking structure in the face of today's conditions. We likewise find that the banks presently have adequate resources to meet the legitimate credit demands of the Nation within the framework of the sound money policies now in effect. American bankers are fully discharging their responsibilities in both respects at present. However, we are equally convinced that it is precisely in a time of prosperity, such as the present, that we should appraise our probable ability to provide depositor safety and adequate credit in any possible future depression.

In approaching this duty we must acknowledge that the strength of the banks affects the lives of all of our people, the great majority of whom maintain bank accounts and virtually all of whom depend, directly or indirectly, upon the availability of credit to provide business activity and employment.

We also must recall that in the last depression we fell short on both counts. In 4 years over 9,000 banks closed and failed to reopen,2 and our citizens lost

1 A Study of Consumer Banking Harbits, prepared by J. Walter Thompson Co. in November of 1955 reported that 96.3 percent of all families in the United States use one or more banking services. It is probable, however, that this survey did not adequately cover the very lowest income groups.

2 Historical Statistics of the United States, 1789-1945, U. S. Department of Commerce, Bureau of the Cen

• 273.

over a billion dollars at a time when, for many, such losses were absolute disaster. That must not happen again.

It is because of the great public interest in the safety of, and credit extension by, our commercial banks that such banks are subject to such careful regulation, supervision, and examination. It is for the same reasons that the Congress should be prepared to take whatever action may be necessary in order to enable the banks adequately to prepare themselves to offer both safety and credit in any future period of economic disaster.

B. Only by provision of adequate bad debt reserves can the banks properly discharge their responsibilities in a depression

The principal means of avoiding these two inadequacies (inadequate safety and inadequate credit) are: first, prevent future severe depression and second, strengthen the banks in order that they may withstand substantial losses without impairing their safety or without reducing their ability (or courage) to provide the credit so necessary to reduce, and ultimately overcome, the stagnation of a depression.

Both of these protective steps require the cooperative efforts of the Government and the banks. However, just as the first (the avoidance of future depressions) is primarily the responsibility of the Government, so is the second (the strengthening of the bank) primarily the responsibility of the individual bank.

The Congress by the passage of the Employment Act of 1946 and similar legislation has declared the promotion, to the extent possible, of full employment to be the responsibility of the Government. Administrative and legislative action taken early in 1954 demonstrated the effectiveness of such action to ease a temporary decline. We now have many more accurate and earlier indexes of consumer and busines income and expenditures. We are better informed and more wary than we were 30 years ago. Yet there are few so courageous as to believe that "it cannot happen again." We are all prayerful that it will notjust as we are prayerful that there will never be aonther war. But, until we are much more certain on both counts, we must proceed on the basis that either may happen.

(i) Each bank's own responsibility

It is the banker's responsibility to prepare his bank for any eventuality—even another depression. The provision of FDIC insurance was intended to make the bank's responsibility somewhat easier through the increase in public confidence, but it was never intended, nor is it wise or practical, to build the insurance fund up to a point where it would substitute for adequate bank capital and

reserves.

The adequacy of bank capital and bank reserves remains the primary responsibility of the management of each individual bank. The Nation's bankers have responded very well to their responsibility in respect of capital funds. Such funds have been increased dramatically from $6,834 millions in 1940 to $17,015 millions at the end of 1955, nearly a threefold increase.

Federal Deposit Insurance Corporation, annual report, 1940, p. 66, provides the following additional information on depositor losses: