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posted on 31 July 2016

How The Federal Reserve System Was Formed - Part 2 Of 3

from the St Louis Fed

The Federal Reserve System was created to address dissatisfaction with the banking system at the time. When the cities that would be receiving a Reserve bank were announced, there were surprises regarding which cities were chosen, including the selection of both St. Louis and Kansas City.

The research article "Economics and Politics in Selecting Federal Reserve Cities: Why Missouri Has Two Reserve Banks" discussed the process used in selecting Reserve bank cities.

Guidance in Selecting Reserve Bank Cities and Boundaries

The article's author, Vice President and Deputy Director of Research David Wheelock, noted that the Reserve Bank Organization Committee (RBOC) was given little guidance on structuring this network of banks. Among the guidance actually given:

  • Each Reserve bank needed a minimum capitalization of $4 million, paid by member banks.

  • Eight to 12 Reserve banks would be established.

The RBOC also established criteria to guide its selections:1

  • "Fair and equitable division of the available capital for the Federal Reserve banks among the districts created"

  • Importance of the "mercantile, industrial and financial connections existing in each district and the relations between the various portions of the district and the city selected for the location of the Federal Reserve bank"

  • Importance of "the general geographical situation of the district, transportation lines and the facilities for speedy communication between the Federal Reserve bank and all portions of the district"

Wheelock noted that the capital requirement helped explain why districts in the Northeast cover much smaller areas than those in the West and South. Since the Northeast had many banks and some of the largest banks, less area was needed for a district that could meet the capital requirements. Conversely, more area was needed in the West and the South.

Banker Preferences for Reserve Cities

The RBOC also conducted a survey of national banks to help with its decisions. Banks were asked for their top three choices for the location of their Reserve bank and for eight to 12 recommendations for Reserve bank locations across the country.

Wheelock noted that the committee cited banker preferences as a dominant consideration in selecting Reserve bank locations. For example, 4,576 responses (out of 7,471 banks contacted) said New Orleans would be a proper location for a Reserve bank. However, only 222 of these responses were from banks located around New Orleans.

Wheelock also pointed to several studies espousing the belief that that banker preferences heavily influenced the selection of Reserve bank cities and district boundaries.2 (For a more detailed breakdown of banker preferences for Reserve bank locations, see Wheelock's article "Economics and Politics in Selecting Federal Reserve Cities: Why Missouri Has Two Reserve Banks.")

Selection Controversies

Soon after the announcement, the RBOC issued a report explaining the criteria behind the committee's decisions, including addressing some of the most controversial. As Wheelock wrote: "The report, not surprisingly, claimed that economic considerations alone had guided the committee's decisions."

Still, Wheelock also noted that "the view that politics had unduly influenced the selection of cities for Reserve Banks has remained widely held ever since." The final post in this series will examine some of the claims of political influence, as well as the reasons behind why Missouri received two Reserve banks.

Notes and References

1 Reserve Bank Organization Committee. Decision of the Reserve Bank Organization Committee Determining the Federal Reserve Districts and the Location of Federal Reserve Banks Under Federal Reserve Act Approved December 23, 1913, April 2, 1914, With Statement of the Committee in Relation Thereto, April 10, 1914. Washington, DC: Government Printing Office, 1914

2 See, for example, Odell, Kerry A.; and Weiman, David F. "Metropolitan Development, Regional Financial Centers, and the Founding of the Fed in the Lower South." Journal of Economic History, March 1998, Vol. 58, Issue 1, pp. 103-25; McAvoy, Michael. "Bankers Preferences and Locating Federal Reserve District Bank Locations." Essays in Economic & Business History, 2004, Vol. 22, pp. 143-69; and Jaremski, Matthew; and Wheelock, David C. "Banker Preferences, Interbank Connections, and the Enduring Structure of the Federal Reserve System." Federal Reserve Bank of St. Louis Working Paper No. 2015-011A, June 2015.

Follow the Series

Additional Resources

Note

This is the second post of a three-part series discussing the founding of the Federal Reserve System. Today's post examines how the Fed's structure came to be.

Source

https://www.stlouisfed.org/on-the-economy/2016/july/how-federal-reserve-system-formed

Disclaimer

Views expressed are not necessarily those of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.

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