Question

Look at the history of the Federal Reserve System. Discuss the different functions of the Fed. What is meant by the “fractional reserve system”? How come it does not undermine the security and safety of bank deposits?

Answer 1

Federal Bank Ltd was incorporated on April 28 1931 with the name Travancore Federal Bank Ltd. The company was established with an authorized capital of rupees five thousand at Nedumpuram a place near Tiruvalla in Central Travancore under the Travancore Company's Act. The Bank was founded by K.P. Hormis.

Functions of FED are:

1)Manages Inflation
The Federal Reserve controls inflation by managing credit, the largest component of the money supply. This is why people say the Fed prints money. The Fed moderates long-term interest rates through open market operations and the fed funds rate.

When there is no risk of inflation, the Fed makes credit cheap by lowering interest rates. This increases liquidity and spurs business growth. That ultimately reduces unemployment. The Fed monitors inflation through the core inflation rate, as measured by the Personal Consumption Expenditures Price Index. It strips out volatile food and gas prices from the regular inflation rate. Food and gas prices rise in the summer and fall in the winter. That's too fast for the Fed to manage.

2)Supervises the Banking System
The Federal Reserve oversees roughly 5,000 bank holding companies, 850 state bank members of the Federal Reserve Banking System, and any foreign banks operating in the United States. The Federal Reserve Banking System is a network of 12 Federal Reserve banks that both supervise and serve as banks for all the commercial banks in their region

3) Maintains the Stability of the Financial System
The Federal Reserve worked closely with the Treasury Department to prevent global financial collapse during the financial crisis of 2008. It created many new tools, including the Term Auction Facility, the Money Market Investor Funding Facility, and Quantitative Easing. For a blow-by-blow description of everything that happened while it was going on, the article discussing federal intervention in the 2007 banking crisis gives a clear account

4) Provides Banking Services
The Fed buys U.S. Treasurys from the federal government. That's called monetizing the debt. The Fed creates the money it uses to buy the Treasurys. It adds that much money to the money supply. Over the past 10 years, the Fed has acquired $4 trillion in Treasurys.

Fractional-reserve banking is the most common form of banking practised by commercial banks worldwide. It involves banks accepting deposits from customers and making loans to borrowers, while holding in reserve only a fraction of the bank's deposit liabilities.