Question

Please discuss the role of the Federal Reserve Bank in the U.S. banking system. Describe the Fractional Reserve System and the Federal Reserve Bank’s involvement in it.

Answer 1

The Federal Reserve System ( FRS) is the central bank of the United States. The FRS is comprised of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the U.S.A. It provides the country with a flexible,safe and stable monetary and financial system. The Federal Reserve Bank has 3 primary functions:

1. Monetary Policy - Monetary policy refers to the actions taken by the Federal Bank to influence the amount of money and credit in the U.S economy. The major tools of the monetray policy are :

• Open Market Operations - This function involves buying and selling of government securties. When the Federal bank wants to increase bank reserves, it buys securities and sells when it wants to reduce the reserves.
• Discount Rate - The discount rate is the interest rate charged by the Federal Reserve Banks to depository institutions on short term loans.
• Reserve Requirements - These are the portions of deposits that banks must maintain either in their vaults or on deposit at a Federal Reserve Bank.

2. Banking Supervision - The Federal Reserve Bank supervises and regulates a wide range of financial institutions and acitivities. The Federal Reserve Bank ensures that financial institutions safely manage their operations and provide fair services to consumers.

3. Financial Services - The Federal Reserve Bank is called Bank for Banks as it provides financial services to depository institutions like credit unions and banks. The services include collecting checks, electronically transfering funds and distributing and receiving cash.

Fractional Reserve System - Fractional Reserve Banking occurs when the bank lends or invests some of its depositor's funds and reatains only a fraction of deposits in cash. This cash is the bank's reserve.

The Federal Reserve Bank sets these reserve requiremnets for all commercial banks, savings bank, credit unions and U.S branches and agencies of foreign banks. The Federal Reserve bank can influence the money supply by modifying these reserve requirements. By lowering the reserve requirements, banks are able to loan more money, which increases the overall supply of money in the economy and reverse happens when reserve requirements are raised by the Federal Reserve Bank.