Federal Reserve System structure and functions

Federal Reserve System exists as the central bank of the United States. Founded by an act of Congress on December 23, 1913, its purpose is to give the nation a safer and more stable financial system. Over the years, its role has continued to expand.

The System is supervised by the Federal Reserve Board that consists of a seven member Board of Governors with its headquarters located in Washington, D.C. The board has a broad range of regulatory powers over the money supply and controlling credit. It also regulates and oversees its member banks. The Federal Reserve Board attempts to manage the United State's economy by raising and lowering short-term interest rates and the currency supply.

federal banking system consists of twelve Federal Reserve banks, with each bank serving member banks in its particular district located in major cities throughout the United States.

Establishment of the Federal Reserve System

During the nineteenth century and the beginning of the twentieth cen-tury financial panics plagued the nation leading to bank failures and business bankruptcies that severely disrupted the economy. The failure of the nation's banking system to effectively provide funding to troubled depository institutions contributed significantly to the economy's vulner-ability to financial panics.

Short-term credit is an important source of liquidity when a bank experiences unexpected and widespread withdraw-als during a financial panic. A particularly severe crisis in 1907 prompted Congress to establish the National Monetary Commission, which put forth proposals to create an institution that would help prevent and con-tain financial disruptions of this kind to occur in the future (The Board's Publications Committee, 2005).

Federal Reserve Banks

These banks were established by Congress to be the operating components of the nation's central banking system. Many of the services provided by this network of banks are similar to services provided by banks and thrift institutions to business customers and individuals. Reserve Banks hold the cash reserves of depository institutions and make loans to them. They move currency into and out of circulation, and collect and process millions of checks each day. They provide checking accounts for the Treasury, issue and redeem government securities, and act in other ways as fiscal agent for the U.S. government (The structure of the federal reserve.., 2003)

They supervise and examine member banks for safety and soundness. The Reserve Banks also participate in the activity that is the primary responsibility of the Federal Reserve System, the setting of monetary policy.

For the purpose of carrying out these day-to-day operations, the Federal Reserve System has been divided into twelve Federal Reserve Districts, with banks in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. Twenty-five branches of these banks serve particular areas within each district (The structure of the federal reserve system, 2003).

Federal Reserve's Duties

They conduct the nation's monetary policy by influencing the financial and credit conditions in the economy in order to pursue lower levels of unemploy-ment, to help stabilize prices, and moderate long-term interest rates. By supervising and regulating banking institutions they provide consumer safety and confidence. They also make certain that consumers receive adequate information and fair treatment, ensure soundness of the banking and financial system, and protect the credit rights of the public.

The Federal Reserve banks provide monetary services to help financial institutions in U.S., such as a savings banks, that accept deposits from consumers. Federal depository institutions are also insured by the Federal Deposit Insurance Corporation (FDIC).

They help maintain the stability of the financial system and contain systemic risk that may arise in financial markets.

How the System Works

The Board and the Reserve bank's share responsibility for overseeing certain financial institutions and activities. The Federal Reserve must work within the underlying set of ideas regarding the overall objectives of monetary and economic policies set forth by the government.

A major component of the system is the Federal Open Market Committee (FOMC), which is made up of the members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve Banks, who serve on a rotating basis. The FOMC oversees open market operations, which is the main tool used by the Federal Reserve to influence overall monetary and credit conditions (The Board's Publications Committee, 2005).

The FOMC meets approximately every six weeks to establish the nation's financial policy goals and, particularly, to set the federal funds rate.

The Federal Reserve implements economic policy through its influence over the federal funds rate. This is the interest rate that banks lend their balances on at the Federal Reserve to other banks. It exercises this control by influencing the demand for and supply of these balances through the following means:

Open market operations -- the purchase or sale of securities, primarily U.S. Treasury securities, in the open market to influence the level of balances that depository institutions hold at the Federal Reserve Banks (The Board's Publications Committee, 2005).

Reserve requirements -- requirements regarding the percentage of certain deposits that depository institutions must hold in reserve in the form of cash or in an account at a Federal Reserve Bank.

Contractual clearing balances -- an amount that a depository institu-tion agrees to hold at its Federal Reserve Bank in addition to any required reserve balance.

Discount window lending -- extensions of credit to depository in-stitutions made through the primary, secondary, or seasonal lending programs (The Board's Publications Committee, 2005).

The Fed's original and ongoing function has been to organize, standardize, and stabilize the monetary system in the United States. It set up a method that could create "liquidity" in the money supply -- in other words, make sure banks could honor withdrawals for customers. It also needed to come up with a way to create an "elastic currency," meaning it had to control inflation by making sure prices didn't climb too quickly, and it needed a way of increasing or decreasing the country's supply of currency in order to prevent inflation and recession (Obringer, 2002).

Why do we need the Federal Reserve System?

To answer this question it would be relevant to go back in time and remember why it was started in the first place. Before the Federal Reserve was created there were many different currencies in use throughout the U.S. Some of the currencies were backed by silver or gold, and others by government bonds. Some of the banks at times didn't even have enough money to cover withdrawals from their own customers.

Before the Federal Reserve was created, banks were failing, and the economy had extensive up and down swings. The confidence level Americans had in the banking system was weak. Imagine yourself in today's current economic situation, how uncomfortable you would feel with your money in the banking system without the FDIC insuring your funds. Knowing today that your account is insured and you can withdraw all of your funds if you need to is the reason the Federal Reserve is needed today.