The experience in 1967 (Chart 5) testified to the fact that interest rate relationships cannot be taken for granted. While a considerable overlap exists among the portfolios of different lenders and considerable arbitrage occurs in financial markets, the mix of credit demands can importantly affect the relationships among interest rates and result in significant deviation from "normal" patterns. COMMERCIAL BANK PERFORMANCE IN 1967 Deposits. Deposits at insured commercial banks advanced by a record $43 billion in 1967-more than 12 percent. A substantial increase in the reserve base of member banks contributed importantly to a record $19 billion-9.8 percent-gain in demand deposits. Sizeable increases were experienced by banks in their IPC, public and bank demand deposits. While most banks shared in the increases, large banks and banks located in financial centers experienced greaterthan-average growth in demand deposits. Time deposits rose by more than $24 billion in 1967-approximately double the 1966 advance. Two-thirds of the total gain was recorded during the first half of the year. As short-term market rates of interest rose in the second half of 1967, time deposit gains slackened, in part because of attrition in large-denomination certifi cates of deposit, but also because of reduced gains in consumeroriented time deposits. During 1967 gains occurred in all categories of time deposits. Savings deposits, which had declined in 1966 as a result of competition from other savings instruments-including bank time deposits-increased by $4.4 billion, or 4.8 percent. Large-denomination CD's, despite a decline in the latter part of the year, increased by about $4 billion. Other IPC time deposits, excluding negotiable CD's, increased $12 billion, or about 30 percent. During 1967 a growing number of commercial banks attempted to bid for a larger share of savings dollars through open book accounts. Such accounts have enabled commercial banks to offer an instrument similar in form and competitive in rate with savings instruments offered by thrift institutions. The 5 percent ceiling applicable on such accounts of less than $100,000 was generally the prevailing rate on these savings instruments during the second half of 1967. Starting from a relatively low base, time deposit open accounts under $100,000 experienced the largest percentage gain of the various time deposit categories in 1967. A number of factors contributed to the favorable performance of time and savings deposits at commercial banks in 1967. These included the high personal savings rate, the desire of spending units to rebuild their liquidity and the relatively attractive rates offered on time deposits compared with short-term money market rates—at least during the first half of the year. During the early months of 1967 the number of banks lowering their rates on consumer-oriented time deposits exceeded the number of banks raising such rates, but, as market interest rates began to climb, the number of rate increases on time deposits rose. By the latter part of 1967 most of the larger banks were offering the 5 percent maximum permissible rate on at least one time-deposit instrument of less than $100,000. Rates on negotiable CD's followed roughly the same pattern, although they moved more uniformly in line with money market rates. In September Congress extended for one year the interest rate legislation originally enacted in September, 1966, and scheduled to expire in September, 1967. The interest rate ceiling remained at 512 percent for time deposits in denominations of over $100,000 and 5 percent for denominations of less than $100,000. While commercial banks, mutual savings banks, and savings and loan associations all competed actively for individual savings in 1967, some of the intensity of the savings competition of 1966 was gone. The savings pool was growing rapidly, rate competition from the money market was less intensive; and there was only limited opportunity for rate changes, although there continued to be some experimentation with new or modified instruments. In addition, the most rate-sensitive funds posed less of a problem because they had already been largely withdrawn from banks and thrift institutions in 1966. Both mutual savings banks and savings and loan associations experienced sizeable savings gains-about 8 percent in the case of mutuals and about 9 percent in the case of savings and loan associations. Loans and investments. Loans of insured commercial banks increased by $18 billion in 1967, slightly more than in 1966, but below the increase experienced in 1965 and 1964. Bank investments rose by $19 billion, the largest annual gain since World War II. As a result, bank liquidity as measured by the loan-deposit ratio increased for the first time in several years. In the light of the abundant volume of funds available to banks in 1967 and the fact that there probably existed a backlog of unsatisfied loan demand from 1966, the 8.4 percent loan increase in 1967 was modest. The dollar gains in commercial and industrial, real estate, and consumer loans approximated the gains in 1966. The percentage gain in consumer loans was pulled down by a relatively small gain in automobile loans, which resulted from a high level of loan repayments and reduced new car sales. The larger banks had greater-than-average percentage gains in deposits, but less-than-average gains in loans. While the 20 largest banks in the country showed a loan increase of 6 percent, all other banks showed a gain of almost 10 percent. In part, the performance of the largest banks may have reflected the fact that they entered 1967 under a somewhat greater pressure to rebuild liquidity than did those banks more removed from money centers. At the same time, high rates of return on municipal and Federal agency securities probably discouraged larger banks from reaching for loans. Investments. Banks posted substantial gains in 1967 in Treasury, State and local government, and Federal agency securities. Their holdings of Treasury securities, which had declined during the four previous years, increased by $6.3 billion or 11 percent. Bank purchases of Treasury securities were largely confined to the short end of the market-maturities of three years and under. Bank options were limited somewhat by the fact that Treasury financing was concentrated, in all but one instance, in relatively short maturities. While banks were concentrating new purchases in the short end of the market during 1967, existing holdings of long and intermediate-term Treasuries were, of course, becoming a year shorter in maturity. The result was a general shortening in maturities and, combined with the increase in the holdings of Treasury securities, a considerable increase in bank liquidity (Chart 6). FIGURES ARE FOR COMMERCIAL BANK SAMPLE IN TREASURY OWNERSHIP SURVEY, AND ACCOUNT Banks raised their investments in State and local government securities by about $9 billion in 1967 to bring their holdings of such securities to approximately $50 billion-more than double their holdings of 5 years earlier (Chart 7). Banks raised their holdings of other securities, principally Federal agency securities, by $3.7 billion, or almost 50 percent. A considerable share of this increase resulted from bank purchases of participation certificates. Bank earnings. Operating revenue in 1967 increased approximately in line with the rise in bank assets. Operating expenses, however, advanced more rapidly and, as a result, net operating earnings increased less than proportionately to the increase in assets. Comparisons of 1967 to 1966, however, provide a somewhat deceptive picture of bank performance. They show only a 5.6 percent gain in net operating earnings, but a very substantial 16.3 percent gain in net income before taxes and a 17.0 percent increase in after-tax income. Actually, net operating earnings after taxes-the figure most used by commercial banks to report their earnings for statement purposes-appear to have increased by more than 8.5 percent in 1967-somewhat less than the percentage increase in bank assets and operating revenue. The substantial expansion in bank holdings of tax-exempt securities had the effect of restraining the before-tax return on bank earning assets, although it probably raised the taxable-equivalent yield on earning assets. This also tended to depress the level and percentage gain in operating revenue and net current operating earnings. The shift to tax-exempt income has a much greater relative impact on net current operating earnings than on operating revenue. A reduction of one percent in operating revenue, other things equal, would result in about a 4 percent reduction in net current operating earnings. Even if the advance in operating revenue is adjusted upward to reflect the effect of the substantial increase in tax-exempt securities, the 1967 increase in operating revenue would still be less than the increase in operating expenses. Salaries and employee benefits advanced by about 10.9 percent in 1967. The number of bank employees rose about 5.2 percent and the rise in salaries, wages and benefits was slightly more. The other major component of bank expenses-interest on time and savings deposits-increased 18 percent compared with a 15 percent advance in time and savings deposits. As a result, interest payments on time and savings deposits continued to account for a growing share of bank operating expenses. Larger banks tended to experience greater percentage increases in |