The board has adopted the policy of "preferential rates" on certain forms of paper. The lower rate on acceptances was adopted with the idea of changing our mercantile credit system from the open book account to the trade and bank acceptance system. During the war lower rates were given to war paper. Under this policy agricultural paper is also favored.
Moreover, lower discount rates are given for short-term paper, upon the principle that the security on long-term paper is not as good as on short-term, since the shorter the maturity the less the probability that the funds obtained will be used for non-com mercial and long-term financing.
The board has opposed the practice of certain clearing houses in fixing a sliding scale of rates of interest paid on deposits and using the rediscount rate as the base, inasmuch as it wishes to be free to fix its rates of discount without reference to any clearing house regulations.
The board has maintained discount rates lower than the pre vailing market rates. In this respect it has differed from the practice of all European central banks. One defendant of the system has argued that the reduction of the element of risk in its loans was sufficient warrant for the difference in rates. It is probable that a fundamental original reason was a desire to popu larize the federal reserve system, and to induce the state institu tions to join. The wide disparity between the two rates during recent years has made the facilities of the federal reserve extraor dinarily profitable for the members. Now that the system is well established and expansion has reached a dangerous degree, it seems desirable to adopt the European system, having the re discount rate higher than the market rate and making it a source of loss rather than of profit for a member bank to rediscount, and thus rendering rediscount operations rather emergency than every-day activities.
Control by Lines of Credit The urgent need of restraining bank expansion in 1920 led to an amendment of the Federal Reserve Act to the effect that the discount rates of the federal reserve banks, fixed "subject to the approval, review and determination of the Federal Reserve Board may be graduated or progressed on the basis of the amount of the advances and discount accommodations extended by the federal reserve bank to the borrowing bank." The board and reserve
banks can put this amendment into effect only through uniform rules applying to all member banks alike without discrimination. Under this device the reserve bank will establish "lines of credit" for its members, and the member banks will know in advance that funds borrowed beyond a specified figure will involve a specified penalty above the published discount rate, graded up ward as its borrowings exceed its normal line. This will stabilize the published rate and confine the fluctuations chiefly to the surcharges. This elastic limit is better than the actual refusal of the reserve bank to extend further accommodation. Certain of the reserve banks have adopted this new system; others rely upon raising the general rate level.
A reserve bank which adopts the plan of extending lines of credit sets a basic line to which the normal or basic discount rate applies. The basic line adopted (1920) by the Atlanta, St. Louis, and Kansas City banks is two and one-half times a sum equal to 65 per cent of the member bank's average reserve balance plus its paid-in subscription to the capital stock of the federal reserve bank, both calculated over a fixed period either preceding or identical with the period to which the basic line applies. For the Dallas district, however, a basic discount line is used equal to the paid-in capital and surplus of the member bank. The Atlanta and St. Louis banks apply the normal rate to all offerings for re discount, and apply a progressive " super-rate " at the end of the reserve computation period to the average borrowings in excess of the basic line. The Kansas City and Dallas banks impose the super-rate upon such part of the current offering as may, together with the outstanding borrowings, be in excess of the basic line. As a scale of rates, all four banks increase the rate by I a per cent for anything up to 25 per cent in excess of the basic line, i per cent for the second 25 per cent excess, IX per cent for the third, and 2 per cent for the final quarter. Exceptions are made for certain member bank collateral notes secured by government obligations.