Question

Describe the federal reserve system and its major functions

Answer 1

The Federal Reserve is the central bank system of the United States that includes the Board of Governors in Washington, D.C., and 12 independent regional Reserve banks. This decentralized structure ensures that the economic conditions of all areas of the country are taken into account in the making of monetary policy.

It was created on December 23, 1913, with the enactment of the Federal Reserve Act to counter financial turbulences.

The Federal Reserve performs five general functions: conducting the nation's monetary policy, regulating banking institutions, monitoring and protecting the credit rights of consumers, maintaining the stability of the financial system, and providing financial services to the U.S. government. The Fed also operates three wholesale payment systems: the Fedwire Funds Service, the Fedwire Securities Service and the National Settlement Service.

The Federal Reserve System is composed of several layers. It is governed by the presidentially appointed Board of Governors or Federal Reserve Board (FRB). Twelve regional Federal Reserve Banks, located in cities throughout the nation, oversee the privately owned U.S. member banks. Nationally chartered commercial banks are required to hold stock in the Federal Reserve Bank of their region, which entitles them to elect some of their board members. The Federal Open Market Committee (FOMC) sets monetary policy; it consists of all seven members of the Board of Governors and the twelve regional bank presidents, though only five bank presidents vote at any given time: the president of the New York Fed and four others who rotate through one-year terms. There are also various advisory councils.

Approximately 38 percent of the 8,039 commercial banks in the United States are members of the Federal Reserve System. National banks must be members; state-chartered banks may join if they meet certain requirements. The member banks are stockholders of the Reserve Bank in their District and as such, are required to hold 3 percent of their capital as stock in their Reserve Banks.

The Federal Reserve has three primary functions: Monetary Policy, Banking Supervision, Financial Services.

Monetary Policy

The term "monetary policy" refers to what the Federal Reserve, the nation's central bank, does to influence the amount of money and credit in the U.S. economy. The goals of monetary policy are to promote maximum employment, stable prices and moderate long-term interest rates. By implementing effective monetary policy, the Fed can maintain stable prices, thereby supporting conditions for long-term economic growth and maximum employment.

The Federal Reserve’s three instruments of monetary policy are open market operations, the discount rate and reserve requirements. Open market operations involve the buying and selling of government securities. Open market operations are flexible, and thus, the most frequently used tool of monetary policy. The discount rate is the interest rate charged by Federal Reserve Banks to depository institutions on short-term loans. Reserve requirements are the portions of deposits that banks must maintain either in their vaults or on deposit at a Federal Reserve Bank.

Banking Supervision

The Federal Reserve System supervises and regulates a wide range of financial institutions and activities. The Federal Reserve works in conjunction with other federal and state authorities to ensure that financial institutions safely manage their operations and provide fair and equitable services to consumers. Two major focuses of banking supervision and regulation are the safety and soundness of financial institutions and compliance with consumer protection laws. To measure the safety and soundness of a bank, an examiner performs an on-site examination review of the bank's performance based on its management and financial condition, and its compliance with regulations.

Financial Services

The Federal Reserve is a "bank for banks" and provides financial services to depository institutions such as banks, credit unions, and savings and loans. The services provided are much like those that depository institutions provide to their customers. Additionally, the Federal Reserve acts as a fiscal agent or bank to the federal government by providing financial services to the United States Department of Treasury and by selling and redeeming government securities such as Savings Bonds and Treasury bills.