What is the Federal Reserve System?

The Federal Reserve System looks after the financial activities and operations of the banking system. It is the apex body that has complete control over the banking regulations. All the guidelines regarding the banking system, money supply, and formulation of the monetary policy come under the purview of the Federal Reserve System. The New York Fed also helps in drafting the monetary policy and supervising the financial system.

Structure of the Federal Reserve System

The Federal Reserve System is made up of the Federal Reserve Board of Governor, Federal Reserve Bank, and the Federal Open Market Committee.

• The Federal Reserve Board of Governor sets the goals and targets of the Federal Reserves. It helps the Federal Reserve System to achieve its targets under the specific Federal Reserve Act. It allows the Federal Reserve to achieve its goal and complete all the responsibilities. It provides the guidelines for conducting the activities and operations to the Federal Reserve. It also helps to set the monetary policy.
• The Federal Reserve Bank helps formulate the monetary and financial policies for the financial institutions and banking system. The Federal Reserve Bank helps to make the payments and liabilities of the financial and banking institutions. The Federal Reserve Bank helps to supervise and regulate the financial transactions and operations of the banking system. There are 12 Federal Reserve Banks under the Federal Reserve System. One of them is the New York Fed.
• The Federal Open Market Committee consists of twelve members. It inspects and monitors the financial situation and economic operations of the financial system and banking institutions. It also identifies the risk and maintains stability. It assesses the risks and helps to minimize them. It helps in sustainable development and economic growth.

Central bank

The power and control to monitor, inspect, and supervise all the banks' activities and operations, such as commercial banks, cooperative banks, regional rural banks, foreign banks, private banks, public banks, etc., are under the central bank. It is the bank of all the banks. All the banks must follow the guidelines provided by the central bank. It is the topmost bank that looks into the affairs of the banking system. The central bank aims to enhance the growth and development of the banking sector.

Functions of the Federal Reserve System

All the above functions of the Federal Reserve System are discussed below in detail.

Preparing the monetary policy

Monetary policies prepared and conducted by the central bank are known as the Federal Reserve System.

• It deals with fluctuations in the rate of interest.
• It also helps to make changes and adjust the monetary policy as per the rules and regulations.
• It is not dependent on the process of politics.
• It monitors the effects of target inflation, exchange rates, etc.
• It helps to generate employment and currency exchange rates.
• It ensures an adequate money supply in the economy.

Providing financial services

• Federal Reserve System provides various types of financial services to the public.
• Insurance services help the public to protect the losses and damages by insuring the property.
• Credit services provide credit to small businesses, industries, and the general public to fulfill their requirements.
• Transaction services include lending and depositing financial transactions between the customers and banks.
• Retail banking services help to make payments easily and quickly in the retail sector. It provides loans to the retail industry and maintains efficiency in the transactions related to retailing.
• A financial market helps the buyer and seller to buy and sell the financial securities. Investors invest in different financial investments such as instruments, currency, stocks, etc.
• The capital market provides benefits to the investors and helps them to mobilize and save the funds.

Regulating banking institutions

• It helps regulate different banking institutions such as community banks, internet banks, credit unions, investment banks, brokerage firms, etc.
• It also provides guidelines to the banking institutions while providing loans to the public and businesses and charging them interest on it. It helps to generate revenue in the banking institutions.
• It provides an opportunity for the banking institutions to accept the money from the public and businesses as deposits and pay interest on it.
• It maintains the free flow of funds in the banking services with the help of financial activities and operations.

Protecting customers' rights

• It provides the legal regulations where the banking institutions and financial institutions should treat the customers fairly and adequately.
• The needs and requirements of the customers should be taken into consideration and must be fulfilled.
• The customers should be provided with the loans and credits when they require them.
• They should receive interest on the deposits.
• They should not be cheated and provided with clear and complete information before selling any banking and financial products to them.

Stability in the financial system

• Federal Reserve System helps to maintain stability in financial transactions.
• It also provides various services under the financial system such as mutual funds, advisory services, etc.
• It also helps in financial and wealth management.
• The financial system also deals with financial service institutions.
• It acts as an intermediary to maximize the surplus and minimize the debts.
• It compromises financial services, financial markets, financial institutions, financial securities, and financial transactions.

Monitoring deposit insurance

• Federal reserve also provides the advantage of depositing insurance to the banking system and financial institutions.
• It helps to insure the deposits of the banks and financial institutions.
• It helps the bank during the period of bankruptcy or insolvency.
• The banking system having deposit insurance allows the investors to invest or deposit the money in the bank.
• It helps the bank to maintain the deposits during the period of illiquidity.

Facilitates settlement of payment

• The Federal Reserve System helps to make the payments of the various financial institutions and banking institutions.
• It helps to reduce the debt obligations and liabilities of the financial market and institutions.
• It helps to make the necessary payments and avail the benefits from it.
• It also helps to clear the debts of the customers having in the banking and financial institutions.

Policies regarding interest rates

• The Federal reserve system provides the guidelines and rules for charging the interest rates on the loans to the customers.
• There is a specific prescription for charging interest.
• The bank should charge the interest rate in such a way that it should result in a gain for it.
• It also provides the guidelines to set the interest rates on deposits in the bank.

Facilitates economic development

• The Federal Reserve System aims at real estate to promote the economic growth and development of the economy.
• It provides various financial services to increase the level of revenue and income.
• It also provides investments opportunities to the investors by investing in different activities such as infrastructural activities, financial investments, real-estate investments, etc.
• It provides the regulations for the banks and promotes their growth and development in the economy.
• It also develops the financial market, capital market, financial institutions, banking institutions, services, etc., which results in economic development and growth.

Federal Reserve System and Commercial banks

The Federal Reserve System regulates the entire banking sector, including the bank holding companies. The Gramm-Leach-Bliley Act of 1999 has vested the Federal Reserve System with the power to regulate the non-banking finance companies as well. It provides the banking guidelines and procedures to the commercial bank to conduct the banking transactions and services. It also sets the targets and norms for commercial banks. The central bank decides the interest rates for various loans given to the customers and deposits accepted from the public. Additionally, it designs the monetary policy for the commercial banks, including private banks, public banks, foreign banks, etc. The monetary policy mentions the financial regulations of commercial banks.

Context and Applications

This topic is significant in the professional exams for both undergraduate courses & postgraduate courses and competitive exams, especially for:

• Bachelor of Business Administration (Banking and Finance)
• Bachelor in Economics
• Masters of Business Administration (Banking and Finance)
• Masters in Economics

Practice Problems

Common Mistakes

Students get confused between the Federal Reserve System, Federal Reserve Board of Governors, Federal Reserve Bank. They make mistakes in understanding the functions of the federal reserve's systems and procedures of the banks and financial institutions.

Related Concepts

While studying this topic, it is important to read the following topics to get a better knowledge:

• Functions of Commercial Bank
• Federal Reserve Bank
• Financial and banking institutions
• Financial market and capital market