What Is the Federal Reserve System?
The Federal Reserve System (FRS) is the central bank of the United States. The Fed, as it is commonly known, regulates the U.S. monetary and financial system. The Federal Reserve System is composed of a central governmental agency in Washington, D.C., the Board of Governors, and 12 regional Federal Reserve Banks in major cities throughout the United States.
Federal Reserve System (FRS)
Understanding the Federal Reserve System
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 Fed is a major force in the economy and banking.
Role and Authority of the Fed
The Fed was established by the Federal Reserve Act, which was signed by President Woodrow Wilson on Dec. 23, 1913, in response to the financial panic of 1907. Before that, the United States was the only major financial power without a central bank. The Fed has broad power to act to ensure financial stability, and it is the primary regulator of banks that are members of the Federal Reserve System. It acts as the lender of last resort to member institutions who have no place else to borrow.
Banks in the United States are also subject to regulations established by the states, the Federal Deposit Insurance Corporation (if they are members) and the Office of the Comptroller of the Currency (OCC).
FOMC Sets Monetary Policy
The Federal Open Market Committee (FOMC) is the Fed's monetary policy-making body and manages the country's money supply. It is made up of the seven members of Fed's board of governors, the president of the New York Fed and four of the remaining 11 regional Fed presidents, who serve one-year terms on a rotating basis. The FOMC meets regularly eight times a year and additionally on an as-needed basis to discuss the outlook for the national economy and review options for its monetary policy.
The FOMC adjusts the target for the overnight federal funds rate, which controls short-term interest rates, at its meetings based on its view of the strength of the economy. When it wants to stimulate the economy, it reduces the target rate. Conversely, it raises the federal funds rate to slow the economy.
The target rate was lowered to 0.25% in response to the recession in 2008 and stayed there for seven years. On Dec. 15, 2015, the Fed raised the target rate to a range of 0.25% to 0.5% – the first rate hike in almost 10 years. Since 2015, the FOMC increased the rate, saying it will continue to do so in the future.
Fed Payments System
The Federal Reserve payments system, commonly known as the Fedwire, moves trillions of dollars daily between banks throughout the United States. Transactions are for same-day settlement. In the aftermath of the 2008 financial crisis, the Fed has paid increased attention to the risk created by the time lag between when payments are made early in the day and when they are settled and reconciled. Large financial institutions are being pressured by the Fed to improve real-time monitoring of payments and credit risk, which has been available only on an end-of-day basis.