The Structure and Functions of the Federal Reserve System

The Federal Reserve System is the central bank of the United States. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded. It performs five general functions to promote the effective operation of the U.S. economy and, more generally, the public interest.

The Federal Reserve:

• Conducts the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy;
• Promotes the stability of the financial system and seeks to minimize and contain systemic risks through active monitoring and engagement in the U.S. and abroad;
• Regulates the safety and soundness of individual financial institutions and monitors their impact on the financial system as a whole;
• Supports payment and settlement system safety and efficiency through services to the banking industry and the U.S. government that facilitate U.S.-dollar transactions and payments; and
• Fosters consumer protection and community development through consumer-focused supervision and examination, research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations.

In establishing the Federal Reserve System, the United States was divided geographically into 12 Districts, each with a separately incorporated Reserve Bank. District boundaries were based on prevailing trade regions that existed in 1913 and related economic considerations.

The U.S. Approach to Central Banking

The framers of the Federal Reserve Act purposely rejected the concept of a single central bank. Instead, they provided for a central banking “system” with three salient features: (1) a central governing Board, (2) a decentralized operating structure of 12 Reserve Banks, and (3) a combination of public and private characteristics.

Although parts of the Federal Reserve System share some characteristics with private-sector entities, the Federal Reserve was established to serve the public interest. There are three key groups that make up the Federal Reserve System: the Board of Governors, the Federal Reserve Banks (Reserve Banks), and the Federal Open Market Committee (FOMC). Collaboratively, these three entities make decisions that help promote the health of the U.S. economy and the stability of the U.S. financial system.

Board of Governors

The Board of Governors, also known as the Federal Reserve Board, is located in Washington, D.C. and provides the leadership for the System. The Board of Governors is the national component of the Federal Reserve System. The board consists of the seven governors, appointed by the president and confirmed by the Senate. Governors serve 14-year, staggered terms to ensure stability and continuity over time. The chairman and vice-chairman are appointed to four-year terms and may be reappointed subject to term limitations.

Within the System, certain responsibilities are shared between the Board of Governors and the Federal Reserve Banks and Branches, which constitute the System’s operating presence around the country. Among the responsibilities of the Board of Governors are to guide monetary policy action, to analyze domestic and international economic and financial conditions, and to lead committees that study current issues, such as consumer banking laws and electronic commerce.
 
The Board also exercises broad supervisory control over the financial services industry, administers certain consumer protection regulations, and oversees the nation’s payments system. The Board oversees the activities of Reserve Banks, approving the appointments of their presidents and some members of their boards of directors. The Board sets reserve requirements for depository institutions and approves changes in discount rates recommended by Reserve Banks.
 
The Board’s most important responsibility is participating in the Federal Open Market Committee (FOMC), which conducts our nation’s monetary policy; the seven governors comprise the voting majority of the FOMC with the other five votes coming from Reserve Bank presidents. The tools of monetary policy have expanded over the years. Find out more about monetary policy and how it works.
 
As an agency of the federal government, the Board reports to and is directly accountable to Congress. Board members are called to testify before Congress, and they maintain regular contact with other government organizations as well. The chairman reports twice a year to Congress on the Fed’s monetary policy objectives, testifies on numerous other issues, and meets periodically with the Secretary of the Treasury. While the Federal Reserve has frequent communication with executive branch and congressional officials, its decisions are made independently.

 
The Board funds its operations by assessing the Federal Reserve Banks rather than through Congressional appropriation. Its financial accounts are audited annually by a public accounting firm, and these accounts are also subject to audit by the General Accounting Office.

Federal Reserve Banks

A network of 12 Federal Reserve Banks and 24 branches make up the Federal Reserve System under the general oversight of the Board of Governors. Reserve Banks are the operating arms of the central bank. Each of the 12 Reserve Banks serves its region of the country, and all but three have other offices within their Districts to help provide services to depository institutions and the public. The Banks are named after the locations of their headquarters – Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco.

The Reserve Banks serve banks, the U.S. Treasury, and, indirectly, the public. A Reserve Bank is often called a “banker’s bank,” storing currency and coin, and processing checks and electronic payments. Reserve Banks also supervise commercial banks in their regions. As the bank for the U.S. government, Reserve Banks handle the Treasury’s payments, sell government securities and assist with the Treasury’s cash management and investment activities. Reserve Banks conduct research on regional, national and international economic issues. Research plays a critical role in bringing broad economic perspectives to the national policymaking arena and supports Reserve Bank presidents who all attend meetings of the Federal Open Market Committee (FOMC).

Each Reserve Bank’s board of directors oversees the management and activities of the District bank. Reflecting the diverse interests of each District, these directors contribute local business experience, community involvement and leadership. The board imparts a private-sector perspective to the Reserve Bank. Each board appoints the president and first vice president of the Reserve Bank, subject to the approval of the Board of Governors.

All member banks hold stock in Reserve Banks and receive dividends. Unlike stockholders in a public company, banks cannot sell or trade their Fed stock. Reserve Banks interact directly with banks in their Districts through examinations and financial services and bring important regional perspectives that help the entire Federal Reserve System do its job more effectively.

Federal Open Market Committee

The Federal Open Market Committee, or FOMC, is the Fed’s monetary policymaking body. It is responsible for formulation of a policy designed to promote stable prices and economic growth. Simply put, the FOMC manages the nation’s money supply.
 
The voting members of the FOMC are the Board of Governors, the president of the Federal Reserve Bank of New York and presidents of four other Reserve Banks, who serve on a rotating basis. All Reserve Bank presidents participate in FOMC policy discussions. The chairman of the Board of Governors chairs the FOMC.
 
The FOMC typically meets eight times a year in Washington, D.C. At each meeting, the committee discusses the outlook for the U.S. economy and monetary policy options.
 
The FOMC is an example of the interdependence built into the Fed’s structure. It combines the expertise of the Board of Governors and the 12 Reserve Banks. Regional input from Reserve Bank directors and advisory groups brings the private sector perspective to the FOMC and provides grassroots input for monetary policy decisions.

Two other groups play important roles in the Federal Reserve System’s core functions:

depository institutions–banks, thrifts, and credit unions; and Federal Reserve System advisory committees, which make recommendations to the Board of Governors and to the Reserve Banks regarding the System’s responsibilities.

Depository Institutions

Depository institutions offer transaction, or checking, accounts to the public, and may maintain accounts of their own at their local Federal Reserve Banks. Depository institutions are required to meet reserve requirements–that is, to keep a certain amount of cash on hand or in an account at a Reserve Bank based on the total balances in the checking accounts they hold. Depository institutions that have higher balances in their Reserve Bank account than they need to meet reserve requirements may lend to other depository institutions that need those funds to satisfy their own reserve requirements. This rate influences interest rates, asset prices and wealth, exchange rates, and thereby, aggregate demand in the economy. The FOMC sets a target for the federal funds rate at its meetings and authorizes actions called open market operations to achieve that target.

Advisory Councils

Four advisory councils assist and advise the Board on matters of public policy.

Federal Advisory Council (FAC). This council, established by the Federal Reserve Act, comprises 12 representatives of the banking industry. The FAC ordinarily meets with the Board four times a year, as required by law. Annually, each Reserve Bank chooses one person to represent its District on the FAC. FAC members customarily serve three one-year terms and elect their own officers.

Community Depository Institutions Advisory Council (CDIAC). The CDIAC was originally established by the Board of Governors to obtain information and views from thrift institutions (savings and loan institutions and mutual savings banks) and credit unions. More recently, its membership has expanded to include community banks. Like the FAC, the CDIAC provides the Board of Governors with firsthand insight and information about the economy, lending conditions, and other issues.

Model Validation Council. This council was established by the Board of Governors in 2012 to provide expert and independent advice on its process to rigorously assess the models used in stress tests of banking institutions. Stress tests are required under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The council is intended to improve the quality of stress tests and thereby strengthen confidence in the stress-testing program.

Community Advisory Council (CAC). This council was formed by the Federal Reserve Board in 2015 to offer diverse perspectives on the economic circumstances and financial services needs of consumers and communities, with a particular focus on the concerns of low- and moderate-income populations. The CAC complements the FAC and CDIAC, whose members represent depository institutions. The CAC meets semiannually with members of the Board of Governors. The 15 CAC members serve staggered three-year terms and are selected by the Board through a public nomination process.

Federal Reserve Banks also have their own advisory committees. Perhaps the most important of these are committees that advise the Banks on agricultural, small business, and labor matters within their district.

Source: federalreserveeducation.org