4.0 Understand the Role of
Finance in Business
Competency 4.02
Understand the Banking System
Objective 4.02-A
Analyze the roles/responsibilities of the Federal Reserve.
http://www.federalreserveeducation.org/, go to website, learn
more about Fed, visit Richmond, visit the bank, tour virtual
money museum.
The Federal Reserve System

What is the Federal Reserve System?

Why does it exist?

Who participates?

How is it organized?
The Federal Reserve (The Fed)
A Centralized Banking System
Federal Reserve Act signed into law by President Woodrow
Wilson
Organized by the Federal Government in 1913
Why have “ The Fed” ? Purpose:



To establish and maintain confidence in the US monetary
system

To ensure and safe, healthy and stable economy

To supervise and regulate member banks and help serve the
public efficiently.
* Prior to the Federal Reserve Act anyone could issue currency or coin
money

Who Participates in Federal Reserve?
All National Banks are required to be part of the Fed
1)
1)
2)
3)
4)
5)
Optional for state banks
Divisions are called DISTRICTS
There are 12 DISTRICTS in the United States
Every state comes under a district
Each Federal Reserve Bank is a corporation, owned by its
member banks
NC is in
District 5,
the
Richmond
District.
Charlotte has
a regional
office.
The Federal Reserve

What are the two arms of “The Fed”?

Board of Governors


Represents the government (public) sector
District Federal Reserve Banks

Represents the business (private) sector
Board of Governors



Usually meet about
twice a week, ordinarily
on Mondays and
Wednesdays
Public is invited to look
into the meetings of the
Board of Governors
Usually discuss
monetary policy such
as lowering and raising
interest rates
The Board Room at the Federal Reserve in Washington, DC
Members of the Board
of Governors

Ben S. Bernanke, Current Chairman

Alan Greenspan, Retired Chairman

Chairman is appointed by President and
confirmed by Senate

Similar to procedure for Supreme Court Justices
Purpose of Federal Reserve

Established to supervise and regulate
banks
1.
2.
3.
4.
5.
Known as the “Bank’s bank”
The central bank of the United States
Assists banks with serving the public more
efficiently
All national banks are required to join the Federal
Reserve System
State banks have the option of joining the system
The Federal Reserve System Services
1.
2.
3.
4.
5.
6.
7.
8.
Supervision of banks
Agent for the federal government
Regulates monetary policy
Lends money to member banks
Acting as a clearinghouse
Participation in open market activities
Sets loan limits & standards
Supplies currency
1. Fed Supervision: Set Reserve
Requirements


Member banks are required to keep a
certain percentage (10% for many years) of
all deposits in the bank’s vault or on deposit
with the district federal reserve bank
Reserves: funds set aside for emergencies


Example: a rush of withdrawals by customers
Purpose: to reduce risk of bank panics and
protect depositor’s money
1. Fed Supervision: Audits Member
Banks
Inspects banks by auditing financial records
 Audit -an inspection of records to verify the:
1. accuracy of books (records) of the bank
2. bank is complying with banking laws
Similar to Individuals/corporations who are
audited by the IRS to review the accuracy of
a tax return.
1. FED Supervision: Approves Bank Mergers
Q: Why do banks merge?
To be more competitive
-to offer customers more locations (local, regional, national, international)
-to offer a variety of services more efficiently
-to compete with a growing array of other financial service companies
such as:
*money market and other mutual funds
*mortgage companies
*credit unions and
*credit arms of industrial firms (General Electric and Ford Motor)
Here are some recent bank mergers approved by “The Fed” in 2007-2008

Bank of New York bought Mellon Financial Corporation for $18.3 Billion

JPMorgan Chase bought Bear Stearns for $1.1 Billion

Bank of America bought Merrill Lynch Bank of America for $50 Billion

Wells Fargo bought Wachovia for $15.1 Billion
2. Fed Acts as Agent for Federal
Government

The Fed holds a checking account for the
US Treasury


Disburses social security benefits and other
transfer payments using the direct deposit system
Accepts some types of federal tax money
Example: Federal tax depositories
Payroll taxes - federal income tax, FUTA,
and social security taxes are deposited
using federal deposit coupon into a national
bank
3. FED Regulates Monetary Policy


What is Monetary Policy?
When the Federal Reserve influences money and
credit conditions in the economy to achieve
economic goals
How? The Fed determines amount of money in
circulation and available for loans, then either
increases or decreases to stabilize/stimulate the
economy


Tight money- policy when less money is available at
higher interest rates, slows (stabilizes) economy
Loose money- policy when more money is available at
lower interest rates, increases (stimulates) economy
4. FED Lends Money to Member
Banks
Monitors the discount rate of interest - rate used by the Fed to loan
money to member banks

Compare banks to intermediaries (go-betweens) trading in
money at “wholesale” prices
The Fed changing interest rates affect borrowers (member banks)
who pass rates to consumers

Raising rate - discourages borrowing

Reducing rate - encourages borrowing

Note: the Federal Reserve does not loan money to individuals or businesses
(only member banks) HOWEVER, rates the Fed charges member banks
“trickle down” and affect the interest rates for consumers
5. FED Acts as Clearing House
Clears/Processes/Settles checks for
member banks



Federal Reserve uses the Automated
Clearing House (ACH) to electronically
complete fund transfers (check
settlements) between banks
Interdistrict Settlement Fund in
Washington, DC used for between
district transfers
Checks/deposit slips have MICR coding


Magnetic Ink Character Recognition
Scanners read MICR on checks to
electronically process data accurately
and rapidly through the ACH and
Interdistrict Settlement Fund
6. FED Participates in Open Market
Participates in open market operations by buying and
selling government securities
Q: What are government securities?
A: Treasury bills and bonds – loans to government in various
denominations (amounts) and for various time periods

Advantages and Disadvantages
+ offer a fixed rate of interest over a fixed period of time
+ attractive because not subject to income taxes
- cannot be easily transferred and are non-negotiable
Open Market Operations
Government securities are sold at a discount (from face
value), but are redeemed (cashed in) for face value on
the maturity (due) date
Examples:
 Purchase treasury note for $7500 (discount price),
redeem at maturity date for $10,000 (face value)
 Purchase Series EE savings bond for $25, redeem
in 7 years at maturity for $50
Government Securities

Savings bonds - Example Series EE



Denomination minimum $25
Payable after 6 months
Earns interest up to 30 years
Short-term obligation of the U.S. Treasury
Treasury bill – maturity in one year or less


Issued to mature in 13 weeks, 26 weeks, 52 weeks
Long-term obligation of the U.S. Treasury


Treasury note – maturity at 1 to 10 years, minimum $1000
Treasury bond - maturity at 10 + years
Open Market Operations
Bank discount rates encourages borrowing by
member banks, and therefore encourages
borrowing by consumers
 Purpose of open market operations
1.
Regulate money supply
Most frequent method of controlling the
economy
 Who controls open market operations?
Federal Open Market Committee (FOMC)A committee within the Federal Reserve

7. The FED Sets Lending
Standards
Sets standards for
consumer legislation
dealing with lending
and credit


Sets limits for loans
and investments by
member banks
News: Federal
Reserve revised bank
lending rules since
banking crisis
Ex: Lower % of total
loans for land/acreage
8. The Fed Supplies Currency

Money defined:

a medium of exchange for value

US money = currency and coins
Federal Reserve supplies paper currency


Legal Tender for all debts, public and private
Paper currency supplied is “Federal Reserve Notes”
Printing currency (paper money, bills)


Bureau of Printing and Engraving
Counterfeiting - federal crime
Coinage

Minting supplied and regulated by the Department of
Treasury, US Mint