In 1913, the Federal Reserve Act established the Federal Reserve System, an independent governmental entity that would serve as a central bank to the U.S. government. In addition to the board of governors, the board of directors and the Federal Open Market Committee, the act formed 12 Federal Reserve Banks spread out across the United States. Together, the banks’ mission is to provide the nation with stable monetary policy and a safe and flexible financial system, but what do the Reserve Banks really do?
The 12 Reserve Banks oversee the regional member banks, protect regional economic interests, and ensure that the public has clout in central bank decisions. Although Federal Reserve Banks don’t operate for profit, they generate income from interest on government securities acquired through Fed monetary policy actions and financial services provided to depository institutions. Each year, after accounting for operational expenses, the regional banks return any excess earnings to the U.S. Treasury. Overall, these regional banks are involved with four general tasks: formulate monetary policy, supervise financial institutions, facilitate government policy, and provide payment services.
Facilitating Monetary Policy
Regional banks enforce the monetary policies that the Board of Directors sets by ensuring that all depository institutions – commercial and mutual savings banks, savings and loan associations and credit unions – can access cash at the current discount rate.
They also assist the FOMC and the Federal Reserve by contributing to the formulation of monetary policy. Each regional bank has a staff of researchers that collects information about its region, analyzes economic data, and investigate developments in the economy. These researchers advise regional bank presidents on policy matters who then publicize the information to their constituencies in order to survey public opinion.
Supervising Member Institutions
The Board of Governors delegates most supervisory responsibilities over member institutions to the Reserve Banks, which are charged with conducting on-site and off-site examinations, inspecting state-chartered banks and authorizing banks to become chartered. They also ensure that depository institutions maintain the proper reserve ratio – the requirement outlining the proportion of deposits that must be held on reserve as cash. In addition, Reserve Banks are responsible for writing regulations for consumer credit laws and ensuring that communities have access to sufficient credit from banks.
Servicing the Government
Reserve Banks also engage in financial services to the federal government by acting as the liaison between the Department of Treasury and depository institutions. The regional banks collect unemployment and income tax, excise taxes to deposit to the Treasury and issue and redeem bonds as well as T-bills in the specified allotments to retain the desired level of bank reserves.
Additionally, Reserve Banks maintain the Treasury Department’s transaction and operating accounts by holding collateral for government agencies to secure funds currently on deposit with private institutions. The banks also make regular interest payments on outstanding government obligations.
Servicing Depository Institutions
Distributing paper money to chartered depository institutions is another one of the Reserve Banks duties. Excess cash is deposited at the Reserve Banks when demand is light; when demand is heavy, institutions can withdraw or borrow from the banks. The regional banks have the electronic infrastructure in place to handle wire transfers, moving funds between its 7,800 depository institutions.
In addition, the Reserve Banks are a check-clearing system that processes 18 billion checks annually and routes them to the correct depository institution. The Reserve Banks also provide automated clearinghouses that allow depository institutions to exchange payment in order to carry out payroll direct deposits and mortgage payments.
The Bottom Line
Often called a bank for banks, the network of Reserve Banks carries out the orders of the Fed, provide support for member banks around the country, and cultivate safe banking practices. Many of the services provided by these banks are similar to the services that ordinary banks offer, except the Reserve Banks provide these services to banks rather than individuals or business customers. Reserve Banks hold cash reserves and make loans to depository institutions, circulate currency, and provide payment services to thousands of banks.
Without these regional banks, the Federal Reserve wouldn’t be able to sanction its policies across the nation, govern the thousands of depository institutions, or ensure that the central bank hears the voices of people from each region when making policy judgments. They are the fiscal agents and the operating arms of the central bank.