Part 2 of 2
When it comes to compliance, sometimes knowing the “why” can make all the difference. In this two-part series, Ken Agle provides some background on how the gold standard, historical wars, economic development, and other events have impacted modern transaction limitations.
In Part 1 of this series, Ken gave a brief overview of how the metal standards have played their role. In Part 2, he addresses how the reserve requirements factor into the equation and how the pieces fit together.
Reserve Requirements Play Their Role
Reserve requirements have long played a role in our nation’s financial system as movement away from gold standards evolved. When bank notes were first issued in the 19th century, few individuals outside the very narrow geographic area of the issuing bank would rely on those notes. Eventually arrangements between banks allowed for the expanded geographic use of bank notes, but largely on the basis that such banks maintained reserves sufficient to cover the amounts, thereby increasing their liquidity.
With the Civil War came the first reserve requirements on a national bank for deposit accounts. The National Bank Acts of 1863 and 1864 provided the opportunity for national banks by creating a network of institutions whose notes could circulate more easily throughout the country.
Reserve requirements were critical to ensuring the liquidity of the national bank notes and promoting them as a medium of exchange. It was only a matter of time that the role of deposits, enhanced by partial reserves, supplanted bank notes as the primary medium exchange for many transactions.
1890s – 1910s
A series of bank runs and financial panics in the late nineteenth century were instrumental in identifying the limitation of partial reserves in meeting variations in the public’s demand for liquidity. The Federal Reserve Act of 1913 created a system whereby Reserve Banks could act as lenders of last resort for liquidity needs. The act, however, still required reserve requirements of varying amounts depending on where funds were held and the type of accounts represented.
1920s – 1950s
Throughout the 1920s and certainly the 1930s, the Federal Reserve began a gradual expansion of its original, reactive role of lender of last resort and guarantor of liquidity to more of a proactive player in influencing economic and monetary policy. Reserve requirements would play an ineffective role in the 1920s expansion, but the use of reserve requirements in the 1930s during the Great Depression provided a means of contracting and expanding credit capacity within the nation through heightened and reduced reserve requirements levels.
1960 – 1970s
The use of reserve requirements as a supplemental tool of monetary policy was significant during the 1960s and 1970s. Changing the reserve requirements for new products to influence institutions decisions and to guide economic policy were common. Counters to this included withdrawal of non-member (state-chartered banks) institutions from the Federal Reserve, increasing fears that the use of reserves as a means of influencing monetary policy might diminish.
1980s – 1990s
These and other Federal Reserve strategies through the 1960s and 1970s were undertaken, but membership in the Federal Reserve continued to decline. The Monetary Control Act of 1980 was largely targeted at ensuring the continued monetary policy control of the Federal Reserve by mandating universal reserve requirements for all insured depository institutions regardless of membership status.
The core strategy of reserves through the 1980s focused on reserve levels over an average two-week period that would preclude day-to-day fluctuations and promote greater leverage over monetary controls. Changes in reserve requirements were observed in the 1990s, when the reserve requirements for non-transaction accounts were cut from 3 percent to zero, resulting in approximately 2,500 depository institutions having sufficient vault cash to meet reserve requirements.
By 2008, the much-sought payment of interest on required reserve balances and excess balances finally happened, at least theoretically. Annually adjusted reserve requirements from $2 million in 1980 have adjusted now (as of 1/22/2015) to $14.5 million, with a 3% reserve requirement, and with a second tranche adjusted annually at $103.6 million, with a reserve requirement of 10%.
Why This History Is Important
It doesn’t take much knowledge of financial history to recognize that traumatic events play a major role in perception of trust and confidence in our nation’s financial system. Wars, financial collapses, political maneuverings and the like have shaped financial decisions and regulatory response. Just look at today’s regulatory environment and its genesis in the meltdown of 2008, and you can clearly see the cause and impact of major events.
Underlying all of these decisions and outcomes is the core element of banking: trust. The need for trust is foundational to an industry where internal reserves (capital in all its forms) leverage an institution’s market capacity. Gold/silver standards were about maintaining trust, as were required reserves. While the use of reserves has evolved to other purposes, including helping to guide monetary policy, they remain anchored in establishing and maintaining the all-important principle of trust. These elements remain in place as a foundational tool. This is unlikely to change any time soon.
So, all of this leads us back to the question (which is usually a complaint) we hear quite frequently: Why does any one care about transaction limitations on non-transaction accounts?
The answer is, at least in part, that transaction limitations are about control in the event of a chaotic event. These types of controls have been used since the days when people started using greenbacks, and that goes back now over 200 years. Are such limitations necessary in this day and age? They may not be necessary today, but that doesn’t mean that they won’t be in the future.
So, financial institution personnel have some responsibility to understand history and to ensure that their customers/members understand how accounts are to be used. With this information, you can better guide your customers/members into proper usage of accounts. Of course, explaining that lengthy history might be a bit like the parent trying to explain to the child why they have to use a car seat, even though the neighbor child doesn’t. Eventually, if the child keeps pressing the matter and there isn’t enough time to explain it, the parent pulls out the trump card: Because I told you so, that’s why. That said, when time permits, a bit of history can be beneficial.
Hopefully the day that a customer needs their funds sooner than an institution can provide them won’t ever come. But should circumstances arise, the reserve requirement is designed to help make sure our nation’s financial system maintains the trust of its depositors.
Ken Agle, President of AdvisX, brings more than 25 years of experience covering almost all facets of financial institution risk management operations. He has conducted more than 350 compliance reviews and has assisted more than 200 financial institutions throughout the United States. He has developed and implemented systems and training programs on all phases of banking risk management, including, but not limited to BSA/AML, fair lending, loan review, HMDA, CRA, BSA, operational compliance, TILA, and RESPA. He has written numerous regulatory responses and appeals and has been instrumental in assisting institutions with challenging circumstances while facing regulatory enforcement orders. He has partnered with McGladrey & Pullen, RSMI, Promontory, Sheshunoff and other multi-region firms to provide support services to financial institutions. Mr. Agle specializes in strategic regulatory response and in developing and implementing both proactive and reactive tools and systems to preempt and resolve issues affecting today’s financial institution.