Penalty for deficiency of reserves. Under the Federal Reserve Act a Federal Reserve bank may impose upon members whose reserve accounts are below the required minimum a penalty for such deficiency, which they must meet. This penalty is prescribed by the board and is at a rate equal to the ninety-day discount rate plus 2 per cent. Free collection service. The member must undertake to collect without charge to the Reserve bank all local items sent it by the Reserve bank.

X. Loss oF MEMBERSHIP.

A non-national member of a Federal Reserve bank may return to its original status as a non-member or outside institution in any one of several ways. It may consolidate with another under a new charter, or it may be called upon by the Reserve Board to forfeit its membership because of failure to comply with law or regulations, or it may simply withdraw. In the last-named event it gives notice to the board six months in advance, and in the ordinary course its stock is canceled and it receives back an amount equal to its paid-up subscription, plus one-half of one per cent per month from the date of the latest Reserve bank dividend (not exceeding book value) plus the net worth of its reserve account. Some small companies have already gone into and out of the Reserve system one or more times, as they felt that their interests seemed to dictate. The operation involves little or no difficulty or apparent loss of credit. It has thus far never been necessary to expel a member, but some institutions which have withdrawn probably could not regain admission without further changes in their methods or their holding of paper. As in most organizations, it is easier to remain a member than to withdraw and later regain membership.

CHAPTER XXVIII

RESULTS OF THE FEDERAL RESERVE SYSTEM

I. BEGINNINGS.

THE organization of the Federal Reserve banks followed immediately after the adoption of the Act and resulted in the establishment of twelve institutions each of which was assigned to a district whose boundaries were determined by a committee which had been entrusted with this work. Twenty-three branches were later created. The Committee in question eventually determined the outlines of the twelve districts, and succeeded in bringing about, with the collaboration of the national banks therein situated, a tentative organization. This organization followed along the lines mapped out in the Act, and in general provided for a board of nine directors at each bank, six chosen by the banks of each district, voting in separate groups, two to a group, while three were named by the Government, one of the latter three being chairman of the local institution. In order to complete the organization as an operating concern, the Board of Directors of each bank selected a governor, who performs very much the same general functions that are discharged in the commercial bank by the active president of such an institution. Such governors were assisted in each bank by other officers designated as deputy governors or otherwise and authorized in a general way to discharge all duties of administration and operation connected with the management of the banks, according to local requirements. In the accompanying chart (p. 429) is afforded a general view of the official organization of a reserve bank from which can be seen the skeleton outline of the system of management which has been developed in the course of

the ten years during which the Reserve banks have been operated. The Federal Reserve Board exercises with reference to each of the institutions the general powers already described elsewhere.

II. GRADUAL DEVELOPMENT.

The earliest duties of the Federal Reserve banks were quite different from those that they had been expected to perform. The Act had been passed late in 1913, but the details of organization had required some eight months before the Board itself could be brought into existence. When the Board finally took office on August 10, 1914, it found itself confronted with problems growing out of the war which had then recently been opened in Europe. War conditions had brought about a bank suspension in the United States and necessitated the issue of emergency currency under the Aldrich-Vreeland law of 1908 which was speedily extended and revised in such a way as to provide the necessary authority. So the Reserve banks, immediately upon their organization, in the autumn of 1914, found themselves under the necessity of devoting first attention to the retirement of this currency when once the emergency had passed, and of instituting various needful changes and emergency measures designed to reassure the community and to bring about a restoration of confidence and stability. All this required many months, but eventually the organization was completed and the reserve banks took over the reserve deposits from the members whose transfer had been ordered in the original act.

The war, however, brought about a very great change in American banking conditions. This was first seen in the development of a large foreign trade which brought in specie and tended to strengthen the member banks. The latter had already been provided with extra loaning power through the reduction of the older reserve requirements, so that they did not need to fall back upon rediscounting or get much help from the Reserve institutions themselves. One result of these conditions was to leave the Reserve banks largely isolated during the years 1915 and 1916 and several of

them received so little business that they were unable to pay their expenses. During these years, one or two important amendments were made in the Federal Reserve Act, the most significant being found in a provision adopted in 1916, whereby banks authorized to engage in foreign trade were provided for. These banks were to be jointly owned by the member banks which themselves (when holding national charters) were permitted to invest not over 10 per cent of their capital and surplus in the stock of such foreign trade banks. A few such banks were brought into existence and assisted in the financing of the new foreign trade movement which had become a dominant factor in American business life. Meantime, however, the growth in the assets of the system continued slowly and its major importance was seen in the establishment of regulations covering the rediscount process and defining types of paper, including bankers' acceptances, as well as providing for the institution of a national clearance system. The latter system was set on foot under the provision of the act that authorized each Reserve bank to act as a clearing house and at the same time authorized the Board itself to act as an extra system clearing house for the twelve Reserve banks themselves. This national system was based upon a deposit of gold known as the Gold Settlement Fund and placed in the hands of the Board at Washington which kept the actual metal in the vaults of the Treasury. There was a weekly telegraphic settlement (later changed to a daily settlement), the effect being to cancel obligations between Reserve banks and to bring about an adjustment of relationships through the shifting of ownership in the fund at Washington. When this fund was deficient due to the exhaustion of the balance held by any bank, such bank was required to deposit more gold to make its balances good.

With this central system in operation a local clearance plan was put into effect in each district and provided for the settlement of debts between the member banks in each of the various districts. At first this settlement took place by the voluntary transmission on the part of the members of checks and drafts which were then cleared on the books

of the Reserve bank, but the system proved unsatisfactory, due to the lack of support it received, and a so-called involuntary system was put into effect, whereby each member was called upon to provide for the cashing, without charge, the claims on it sent in by other members for collection through the Reserve bank. This local system was placed upon a so-called "deferred basis" which represented a delay in crediting the proceeds of checks and drafts equal to the mailing time required to transmit such items to the banks on which they were drawn for payment. The system grew slowly at first, but soon proved its worth, and was recognized as of fundamental importance to the entire Reserve banking plan.

During the years 1915-1916, moreover, considerable aid was rendered in the moving of crops through the institution of improved methods of advancing funds on farm paper as well as against commodities stored in warehouse. But, as already stated, the operations of the Reserve banks grew slowly, and their influence over rates of discount was small. This was due to the fact that their own rates were continuously above those of the open market while, as already stated, there was little rediscounting with them because of the abundance of funds in the hands of members. Toward the close of 1916, and during the early months of 1917, a good deal of reliance was beginning to be placed upon the reserve banks by their members, and several institutions were decidedly more active than they had previously been. They were thus able to put out into circulation a considerable quantity of reserve notes, while they also began the retirement of the old national bank notes by buying the bonds upon which the latter rested and making provision for the cancellation of the national notes themselves as they came into the banks.

III. WAR CHANGES.

These conditions were greatly changed with the entry of the United States into the war in the spring of 1917. Congress soon after passed an act, June 21, 1917, providing for the transfer of all reserves to Reserve banks. State insti