What is the Federal Reserve System?

Published by Thomas Herold in Banking, Economics

'Federal Reserve System' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

The Federal Reserve System is the United States’ central banking system. It is made up of the Federal Open Market Committee, the Federal Reserve Board, 12 regional Federal Reserve Banks, and state and national member banks.

Seven members make up the Board of Governors. These the President appoints to 14 year terms upon approval by the Senate.  The reason this system became established was to manage the movement of credit and money in the U.S. Congress set up this system in 1913. The U.S. had experienced a variety of central banks since 1791. The country needed a more stable banking system to help encourage a stronger economy.

Practically every bank in the U.S. participates in the Federal Reserve System. The program requires these institutions to keep a set amount of their assets deposited with their area Federal Reserve Bank. The Board of Governors determines how much these reserve requirements will be. The Board of Governors changes these required reserves in order to significantly influence the money supply that is circulating in the economy.

This Federal Reserve System provides a few different functions to the country. It is a bank for all the banks. A great number of interbank transactions go through this system. Banks may also borrow money from the Federal Reserve if they can not get credit from anywhere else. The system only gives them credit in emergencies or as it is unavailable on the open markets.

The Federal Reserve also functions like the bank of the government. The inbound and outbound payments of the tax system process via a checking account at the bank. The Fed further supplies the currency of the United States even though they do not produce it. They also purchase and sell government securities like Treasury Bills and Bonds.

Among the more important functions of this system is its purpose as a regulatory agency. They act as policeman to the banking sector to protect consumers’ rights and to ensure smooth functions. They are also the main resource for banks and the public in times of financial crises or a panic surrounding the banks.

National banks have to be members of the system. In order to qualify, they are made to deposit the reserve requirements from their customer checking and savings accounts in their regional Federal Reserve bank. They must also keep mandatory reserve levels with this bank. Every nationally chartered bank has to be a member of the system. State chartered banks are also encouraged to join as members of the system.

The need for this Federal Reserve System became apparent after several failed attempts at establishing a uniform banking system in the United States. The first central bank was the First Bank that existed from 1791 to 1811. The Second Bank took over this role from 1816 to 1836. These two outfits proved to be the U.S. Treasury Department’s only official representatives. This meant that they were the only organizations issuing and promoting the official U.S. currency.

Every other bank in the country ran under private auspices or as a state chartered organization. Each bank had its own bank notes which competed against the two U.S. banks as currency that could be redeemed for face value.

The first National Bank Act that Congress passed in 1863 allowed for a regimen of National Banks that would be supervised. Banks had to abide by certain operating practices, rules for making and issuing loans, and capital amount minimums kept in the banks. The Act effectively killed the non national individual bank currencies by creating a 10% tax on all state level banknotes.

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The term 'Federal Reserve System' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.