Influence of Reserve Banks in United States

Influence of Reserve Banks on Banking and Business

The influence of reserve banks upon business conditions in the United States is seen in the results of their effort to establish more uniform discount rates throughout the country, in their success in harmonizing commercial paper practices, in their relief of banks which would otherwise have been obliged to close on account of inability to rediscount paper, and in a variety of other less important ways. The question how far the reserve banks have succeeded in establishing a discount market or in providing a basis for financing foreign trade, both points which had been much under discussion prior to the passing of the Act, were in 1921 still matters of controversy.

The provision of the Reserve Act which was intended to aid in the promotion of foreign trade authorized member banks to make bank acceptances and reserve banks to rediscount and buy such acceptances. It was natural that some time should elapse before much practical effect could be given to this provision, but it would probably have gone into operation as the result of a gradual and normal evolution had it not been for financial necessities caused by the war. In general the effect of the war was to disorganize all financial methods and systems previously in use, and this was as true in the field of commercial paper as in any other. Early in the war American foreign trade was placed upon a credit basis, and due to the difficulty of selling the obligations of belligerent Governments there was a strong temptation to obtain as much credit as possible upon a pure banking basis.

The result was the lengthening of the maturity of the bankers’ acceptance by every possible means and eventually the introduction of the so-called “renewal acceptance,” whereby groups of banks entered into agreements which involved the making of acceptances for financing American exports to belligerents and others, at the same time that other groups agreed to buy or discount these acceptances, the first groups in return undertaking to discount acceptances made by the second group and used to take up the first issue. This was, of course, a sheer perversion of the intent of the acceptance, and when after the close of the war there developed a widespread practice of inflation and “kiting,” followed eventually by an effort on the part of some accepting banks to repudiate acceptances because of the fact that heavy reductions in prices had occurred, the result was to impair confidence in American acceptances and to retard considerably the movement for their development. However, so far as gross volume is concerned, the new type of paper maintained a very substantial development until 1921 when the total amount in existence was estimated by the Federal Reserve Board as approximately six hundred million dollars, but during the first half of 1921 the value declined largely.

Financing of foreign trade has been on so abnormal a basis and the trade itself has been so one-sided that it would be difficult to form a conclusive estimate of the effect of reserve banking in that connexion further than to say that without the general underlying strength which had been afforded by the system it would probably have been impossible for the United States to finance any such enormous volume of trade as it actually took care of. The effect of the Reserve System upon interest and discount rates has undoubtedly been to stabilize and harmonize them. Not only has there been a narrower variation of rates in different parts of the country than had been expected but the system has on the whole held the rates down. During the war this stability was partly due to wartime control. Subsequent to the close of the war there was a rebound to much higher rates of discount, but even these were probably by no means as high as they would have been, had it not been for the existence of the system.

See Also

• Expansion of Reserve Banks
• Federal Reserve System
• Supervision of Banking Organizations