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The Federal Reserve System

urposes

unctions

Board of Governors of the Federal Reserve System
H.
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Washington, D.C. 1994
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First Edition
Second Edition
Third Edition
Fourth Edition
Fifth Edition
Sixth Edition
Seventh Edition
Eighth Edition

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May 1939
November 1947
April 1954
February 1961
December 1963
September 1974
December 1984
December 1994

Library of Congress Card Number 39-26719

Copies of this book may be obtained from

Publications Services, Division of Support Services,
Board of Governors of the Federal Reserve System,
Washington, DC 20551.

his is the eighth edition of The Federal Reserve System: Purposes and
Functions. It has been revised by staff members of the Federal
Reserve Board to reflect the changes that have taken place in
the monetary, regulatory, and other policy areas since publica
tion of the seventh edition in 1984. It incorporates major
changes in the law and in the structure of the financial system
that have occurred over the past decade.

T he B oard 's P ublications C ommittee had overall responsibility
for the preparation of this edition. Major contributions were made by
the following:
D ivision of R esearch and S tatistics
Michael J. Prell, Thomas D. Simpson, Lawrence Slifman, Darrel Cohen,
S. Ellen Dykes, Gregg Forte, Sherrell E. Varner, Catherine H. Farnsworth,
E. Constance Kinzie, and Gwenavere G. White-Dubose
D ivision of M onetary A ffairs

Donald L. Kohn, David E. Lindsey, Brian F. Madigan,
Normand R.V. Bernard, James A. Clouse, and Joshua Feinman
D ivision of International F inance
Edwin M. Truman and David H. Howard
D ivision of Banking S upervision and R egulation
Richard Spillenkothen, Frederick M. Struble, and Virginia M. Gibbs
D ivision of C onsumer and C ommunity A ffairs
Griffith L. Garwood and Maureen R English
D ivision of R eserve Bank O perations and P ayment S ystems

Florence M. Young and Jack K. Walton, II
D ivision of Information R esources M anagement

Peter G.Thomas, Barry E. Huber, and Carol Wisdom
L egal D ivision

Oliver Ireland and Elaine M. Boutilier
O ffice of B oard M embers
Joseph R. Coyne

Contents

| Overview of the Federal Reserve System
Background

Structure of the System 3
Board of Governors 4
Federal Reserve Banks 7
Federal Open Market Committee
Member Banks 13
Advisory Committees 14

Monetary Policy and the Economy
Goals of Monetary Policy

Monetary Policy and the Reserves Market

Demand for Reserves 18
Supply of Reserves 20
Trading of Reserves 22
Effects of Monetary Policy on the Economy 23
Limitations of Monetary Policy 25
Guides for Monetary Policy 26
Monetary and Credit Aggregates 26
Short- and Long-term Interest Rates 30
Foreign Exchange Rates 31
Conclusion 32

The Implementation of Monetary Policy
Operational Approaches

Open Market Operations

Other Factors Influencing Nonborrowed Reserves 37
Techniques of Open Market Operations 38
A Typical Day in the Conduct of Open Market Operations
The Discount Window 42
Interest Rates 43
Borrowing Eligibility 45
Borrowing Procedures 46
Types of Credit 47

The Implementation of Monetary Policy—continued
Reserve Requirements

Structure of Reserve Requirements 53
Relation to Open Market Operations 55
Changes in Required Reserve Ratios 57

The Federal Reserve in the International Sphere
International Linkages

Foreign Currency Operations

Swap Network 65
Exchange Market Intervention 67
Other U.S. Foreign Currency Resources
International Banking

Supervision and Regulation
Supervisory Functions

Domestic Operations of U.S. Banking Organizations 74
International Operations of U.S. Banking Organizations 78
U.S. Activities of Foreign Banking Organizations 79
Regulatory Functions

Acquisitions and Mergers 81
Other Regulatory Responsibilities

Consumer and Community A Hairs
Consumer Protection

Writing and Interpreting Regulations 88
Enforcing Consumer-Protection Laws 88
Consumer Complaint Program 89
Community Affairs

| Reserve Bank Services

The Federal Reserve and the Payments System 94
Cash Services: Currency and Coin
Noncash-Transaction Services 98
Net Settlement Services 106

Reserve Bank Services—continued
Other Federal Reserve Bank Services
Fiscal Agency Functions
International Services

108
110

Appendixes
A

Federal Reserve Balance Sheet and Reserve Equation

B Federal Reserve Regulations

108

C Glossary o f Terms

129

D Selected Readings

145

Index

151

123

113

Overview of the Federal

Reserve System
heFederal Reserve System is the central bank of the United States.
It m s founded by Congress in 1913 to provide the nation with
a safer, more flexible, and more stable monetary and financial
system; over the years, its role in banking and the economy
has expanded.

TODAY, THE FEDERAL RESERVE'S DUTIES fall into four
general areas:
• Conducting the nation's monetary policy by influencing the
money and credit conditions in the economy in pursuit of full
employment and stable prices
• Supervising and regulating banking institutions to ensure the
safety and soundness of the nation's banking and financial
system and to protect the credit rights of consumers
• Maintaining the stability of the financial system and contain
ing systemic risk that may arise in financial markets
• Providing certain financial services to the U.S. government,
to the public, to financial institutions, and to foreign official
institutions, including playing a major role in operating the
nation's payments system.
Most developed countries have a central bank whose functions
are broadly similar to those of the Federal Reserve. The Bank of
England has existed since the end of the seventeenth century. Na
poleon I established the Banque de France in 1800, and the Bank
of Canada began operations in 1935. The German central bank
was reestablished after World War II and is loosely modeled on
the Federal Reserve.

BACKGROUND
Before Congress created the Federal Reserve System, periodic fi
nancial panics had plagued the nation. These panics had contrib
uted to many bank failures, business bankruptcies, and general

economic downturns. A particularly severe crisis in 1907
prompted Congress to establish the National Monetary Commis
sion, which put forth proposals to create an institution that would
counter financial disruptions of these kinds. After considerable
debate, Congress passed the Fed
eral Reserve Act, which President
Woodrow Wilson signed into law
on December 23,1913. The act
stated that its purposes were
"to provide for the establishment
of Federal reserve banks, to furnish
an elastic currency, to afford means
of rediscounting commercial paper,
to establish a more effective super
vision of banking in the United
States, and for other purposes."
v00
co
J Soon after the creation of the Fed
'S eral Reserve, it became clear that
©
the act had broader implications
for national economic and financial
'yoodrow Wilson signed
policy. As time has passed, further
the Federal Reserve Act
legislation has clarified and sup
at 6:02 p.m. on
plemented the original purposes.
December 23, 1913.
Key laws affecting the Federal
Reserve have been the Banking Act
of 1935; the Employment Act of
1946; the 1970 amendments to the Bank Holding Company Act;
the International Banking Act of 1978; the Full Employment and
Balanced Growth Act of 1978; the Depository Institutions Deregu
lation and Monetary Control Act of 1980; the Financial Institu
tions Reform, Recovery, and Enforcement Act of 1989; and the Fed
eral Deposit Insurance Corporation Improvement Act of 1991.
Congress defined the primary objectives of national economic
policy in two of these acts: the Employment Act of 1946 and the
Full Employment and Balanced Growth Act of 1978 (the latter
sometimes called the Humphrey-Hawkins Act after its original
sponsors). These objectives include economic growth in line with
the economy's potential to expand; a high level of employment;
stable prices (that is, stability in the purchasing power of the dol
lar); and moderate long-term interest rates.

The Federal Reserve System is considered to be an independent
central bank. It is so, however, only in the sense that its decisions
do not have to be ratified by the President or anyone else in the
executive branch of government. The entire System is subject to
oversight by the U.S. Congress because the Constitution gives to
Congress the power to coin money and set its value—a power
that, in the 1913 act, Congress itself delegated to the Federal Re
serve. The Federal Reserve must work within the framework of
the overall objectives of economic and financial policy established
by the government, and thus the description of the System as "in
dependent within the government" is more accurate.

STRUCTURE OF THE SYSTEM
The Federal Reserve System has a structure designed by Congress
to give it a broad perspective on the economy and on economic
activity in all parts of the nation. It is a federal system, composed
basically of a central, governmental agency—the Board of Gover
nors—in Washington, D.C., and twelve regional
Federal Reserve Banks, located in major cities
throughout the nation. These components share
responsibility for supervising and regulating cer
tain financial institutions and activities; for provid
Federal Reserve
ing banking services to depository institutions and
System is composed
to the federal government; and for ensuring that
o f the Board o f
Governors and
consumers receive adequate information and fair
twelve
regional
treatment in their business with the banking system.
Reserve Banks.

‘U ,

A major component of the System is the Federal
Open Market Committee (FOMC), which is made up of the Board
of Governors, the president of the Federal Reserve Bank of New
York, and presidents of four other Federal Reserve Banks, who
serve on a rotating basis. The FOMC oversees open market opera
tions, which is the main tool used by the Federal Reserve to influ
ence money market conditions and the growth of money and credit.
Two other groups play roles in the way the Federal Reserve Sys
tem works: depository institutions, through which the tools of
monetary policy operate, and advisory committees, which make
recommendations to the Board of Governors and to the Reserve
Banks regarding the System's responsibilities.

The Board of Governors of the Federal Reserve System was estab
lished as a federal government agency. It is made up of seven
members appointed by the President of the United States and con
firmed by the U.S. Senate. The full term of a Board member is four
teen years; the appointments are staggered so that one term ex
pires on January 31 of each even-numbered year. After serving a
full term, a Board member may not be reappointed. If a member
leaves the Board before his or her term expires, however, the per
son appointed and confirmed to serve the remainder of the term
may later be reappointed to a full term.
The Chairman and the Vice Chairman of the Board are also ap
pointed by the President and confirmed by the Senate. The nomi
nees to these posts must already be members of the Board or must
be simultaneously appointed to the Board. The terms for these po
sitions are four years.
The Board of Governors is supported by a Washington staff num
bering about 1,700. The Board's responsibilities require thorough
analysis of domestic and
international financial
and economic develop
ments. The Board carries
out those responsibilities
in conjunction with other
components of the Fed
eral Reserve System.
It also supervises and
regulates the operations
of the Federal Reserve
Banks and their
Branches and the activi
ties of various banking
organizations, exercises
broad
responsibility in
^ ^ / h e first Federal Reserve Board, 1914.
the nation's payments
system, and administers
most of the nation's laws
regarding consumer
credit protection.

The Federal Reserve System conducts monetary policy using
three major tools:
• Open market operations—the buying and selling of U.S.
government (mainly Treasury) securities in the open market to
influence the level of reserves in the depository system
• Reserve requirements—requirements regarding the amount of
funds that commercial banks and other depository institutions
must hold in reserve against deposits
• The discount rate—the interest rate charged commercial
banks and other depository institutions when they borrow
reserves from a regional Federal Reserve Bank.
Policy regarding open market operations is established by the
FOMC. However, the Board of Governors has sole authority over
changes in reserve requirements, and it must also approve any
change in the discount rate initiated by a Federal Reserve Bank.
The Federal Reserve also plays a major role in the supervision and
regulation of the U.S. banking system. Banking supervision—the
examination of institutions for safety and soundness and for com
pliance with law—is shared with the Office of the Comptroller of
the Currency, which supervises national banks, and the Federal
Deposit Insurance Corporation, which supervises state banks that
are not members of the Federal Reserve System. The Board's su
pervisory responsibilities extend to the roughly 1,000 state banks
that are members of the Federal Reserve System, all bank holding
companies, the foreign activities of member banks, the U.S. activi
ties of foreign banks, and Edge Act and agreement corporations
(institutions that engage in a foreign banking business).
Some regulations issued by the Board apply to the entire banking
industry, whereas others apply only to member banks, that is,
state banks that have chosen to join the Federal Reserve System
and national banks, which by law are automatically members of
the System. The Board also issues regulations to carry out major
federal laws governing consumer credit protection, such as Truth
in Lending, Equal Credit Opportunity, and Home Mortgage Dis
closure; many of these regulations apply to various lenders out
side the banking industry as well as to banks.
Members of the Board of Governors are in continual contact with
other policymakers in government. They frequently testify before

congressional committees on the economy, monetary policy,
banking supervision and regulation, consumer credit protection,
financial markets, and other matters. Under the Humphrey-Hawkins
Act, the Board of Governors must submit a report on the economy
and the conduct of monetary policy to Congress by February 20
and July 20 of each year. The Chairman of the Board of Governors
is called to testify on the report before the Senate Committee on
Banking, Housing, and Urban Affairs and the House Committee
on Banking, Finance and Urban Affairs.
The Board has regular contact with members of the President's
Council of Economic Advisers and other key economic officials,
and the Chairman meets from time to time with the President of
the United States and has regular meetings with the Secretary of
the Treasury.
The Chairman has formal responsibilities in the international
arena as well. For example, he is the alternate U.S. member of the
Board of Governors of the International Monetary Fund, is a
member of the board of the Bank for International Settlements
(BIS), and is a member, along with the heads of other relevant U.S.
agencies and departments, of the National Advisory Council on
International Monetary and Financial Policies. He is also a mem
ber of U.S. delegations to key international meetings, such as
those of the finance ministers and central bank governors of the
seven largest industrial countries—the Group of Seven, or G-7.
He, other Board members, and Board staff members share many
international responsibilities, including representing the Federal
Reserve at meetings at the BIS in Basle and at the Organisation
for Economic Co-operation and Development in Paris.
One member of the Board of Governors serves as the System's
representative to the Federal Financial Institutions Examination
Council (FFIEC), which is responsible for coordinating, at the fed
eral level, examinations of depository institutions and related
policies. The FFIEC has representatives also from the Federal De
posit Insurance Corporation, the National Credit Union Adminis
tration, the Office of the Comptroller of the Currency, and the Of
fice of Thrift Supervision.
The Board publishes detailed statistics and other information
about the System's activities and the economy in publications

such as the monthly Federal Reserve Bulletin, special announce
ments of Board actions, and separate statistical releases. Through
the Federal Reserve Regulatory Service, it provides materials relat
ing to its regulatory and supervisory functions.
The Board is audited annually by a major public accounting firm,
and the audit report is published in the Board's Annual Report.
The General Accounting Office (GAO) also audits the Board. A
complete list of audits or studies performed and under way by
the GAO is available in the Board's annual Budget Review, which
is sent to Congress during the first quarter of each calendar year.
Monetary policy, which is exempt from audit by the GAO, is
monitored directly by Congress through written reports, includ
ing the semiannual Humphrey-Hawkins reports, prepared by the
Board of Governors.

A network of twelve Federal Reserve Banks and their twenty-five
Branches carries out a variety of System functions, including op
erating a nationwide payments system, distributing the nation's
currency and coin, supervising and regulating member banks and
bank holding companies, and serving as banker for the U.S. Trea
sury. Each Reserve District is identified by a letter and a number
(see list of District offices on page 10). All U.S. currency carries the
letter and number designation of the Reserve Bank that first puts
it into circulation. Besides carrying out functions for the System
as a whole, such as administering nationwide banking and credit
policies, each Reserve Bank acts as a depository for the banks in
its own District and fulfills other District responsibilities.
The various offices and boundaries of the Federal Reserve Dis
tricts are shown on the maps on pages 8 and 9.
The Board of Governors exercises broad authority over the opera
tions and activities of the Federal Reserve Banks and their
Branches. This authority includes oversight of the Reserve Banks'
services to banks and other depository institutions and of their
examination and supervision of various banking institutions.
Each Federal Reserve Bank must submit its annual budget to the
Board of Governors for approval. Other types of expenditures—

The Federal Reserve System

Boston

■

Minneapolis ■

■ New York
■ Philadelphia

Chicago ■
Cleveland

12
■ San Francisco

Kansas City ■

■
St. Louis

Richmond

8
Atlanta

6
Dallas

Legend
Both pages

Facing Page

■
□

• Federal Reserve Branch city
— Branch boundary

Federal Reserve Bank city
Board of Governors
of the Federal Reserve System,
Washington, D.C.

Notes
The Federal Reserve officially identifies Districts by number and by
Reserve Bank city (shown on both pages) as well as by letter (shown on
the facing page).
In District 12, the Seattle Branch serves Alaska and the San Francisco Bank
serves Hawaii.
The System serves commonwealths and territories as follows: The New York
Bank serves the Commonwealth of Puerto Rico and the U.S. Virgin Islands;
the San Francisco Bank serves American Samoa, Guam, and the Common
wealth of the Northern Mariana Islands.

1-A

4 -D

3 -C

2 -B
ME

5 -E

Pittsburgh

Baltimore

^PA

|
■

— NH

1Cincinnati
Buffalo

v
\
A MA

• Charlotte

|
NJ

New York

Boston

Philadelphia

Richmond

Cleveland
8 -H

7-G
WI

MI
I IN

1 •
AR

• Memphis

Little
Rock

Chicago
9-1

St. Louis

MT
ND

• Helena

MI
WI
SD

Minneapolis

10-J

12-L

Kansas City
11-K

•
El Paso

■

Houston
•

•
N
San Antonio

Dallas

Louisville

Detroit •

San Francisco

Federal Reserve District Banks and Branches1

Number

Letter

Bank

Branch

Boston

New York

Philadelphia

Cleveland

Cincinnati, Ohio
Pittsburgh, Pa.

Richmond

Baltimore, Md.
Charlotte, N.C.

Atlanta

Birmingham, Ala.
Jacksonville, Fla.
Miami, Fla.
Nashville, Tenn.
New Orleans, La.

Chicago

Detroit, Mich.

St. Louis

Little Rock, Ark.
Louisville, Ky.
Memphis, Tenn.

Minneapolis

Helena, Mont.

Kansas City

Denver, Colo.
Oklahoma City, Okla.
Omaha, Nebr.

Dallas

El Paso, Tex.
Houston, Tex.
San Antonio, Tex.

San Francisco

Los Angeles, Calif.
Portland, Ore.
Salt Lake City, Utah
Seattle, Wash.

Buffalo, N.Y.

1. The Federal Reserve Bank of New York maintains an operations center in
East Rutherford, New Jersey. Additional offices, which serve as regional check
processing centers, are located in Lewiston, Maine; Windsor Locks, Connecti
cut; Jericho, New York; Utica, New York; Columbus, Ohio; Columbia, South
Carolina; Charleston, West Virginia; Des Moines, Iowa; Indianapolis, Indiana;
and Milwaukee, Wisconsin.

such as those for construction or major alterations of Reserve Bank buildings
and for the salaries of Reserve Bank presidents and first vice presidents—are
also subject to specific Board approval.

Congress chartered the Federal Reserve Banks for a public pur
pose. The Reserve Banks are the operating arms of the central
banking system, and they combine both public and private ele
ments in their makeup and organization. As part of the Federal
Reserve System, the Banks are subject to oversight by Congress;
and like the Board members, Reserve Bank presi
dents may testify before congressional committees.
Each Reserve Bank has a staff of full-time officers
and employees that manages and operates it.
Federal Reserve
Banks are the
Each Reserve Bank has its own board of nine direc
operating arms o f the
central banking
tors chosen from outside the Bank as provided by
system.
law. Three directors, designated Class A, represent
commercial banks that are members of the Federal
Reserve System. Three Class B and three Class C
directors represent the public. The member commercial banks in
each District elect the Class A and Class B directors. The Board of
Governors in Washington, D.C., appoints the Class C directors to
their posts. From the Class C directors, the Board of Governors
selects one person as chairman and another as deputy chairman.
No Class B or Class C director may be an officer, director, or em
ployee of a bank or a bank holding company. No Class C director
may own stock in a bank or a bank holding company. The direc
tors in turn nominate a president and first vice president of the
Reserve Bank, whose selection is subject to approval by the Board
of Governors. Each Branch of a Reserve Bank has its own board of
directors of five or seven members. A majority of these directors
are appointed by the Branch's Reserve Bank; the others are ap
pointed by the Board of Governors.

‘Uu<

Boards of directors of the Reserve Banks and Branches provide
the Federal Reserve System with a wealth of information on eco
nomic conditions in virtually every corner of the nation. This in
formation is used by the FOMC and the Board of Governors in
reaching major decisions about monetary policy. Information
from directors and other sources gathered by the Reserve Banks is
also shared with the public in a special report—informally called
the Beige Book—which is issued about two weeks before each
meeting of the FOMC. In addition, every two weeks, the board of
each Bank must recommend to the Board of Governors a discount
rate for its Bank; a recommendation for a change cannot take ef
fect unless the Board of Governors approves it.

1 2

The income of the Federal Reserve System is derived primarily
from the interest on U.S. government securities that it has acquired
through open market operations. Other major sources of income
are the interest on foreign currency investments held by the Sys
tem; interest on loans to depository institutions (the rate on which
is the so-called discount rate); and fees received
for services provided to depository institutions,
such as check clearing, funds transfers, and auto
mated clearinghouse operations.
r G . FOMC
is composed o f the
After it pays its expenses, the Federal Reserve
members o f the
turns the rest of its earnings over to the U.S. Trea
Board o f Governors
sury. About 95 percent of the Reserve Banks' net
and five Reserve
Bank
earnings have been paid into the Treasury since
presidents.
the Federal Reserve System began operations in
1914. (Income and expenses of the Federal Reserve
Banks from 1914 to the present are included in the Annual Report
of the Board of Governors.) If a Reserve Bank were liquidated for
any reason, all proceeds after the payment of bills would also be
turned over to the Treasury.
The Board of Governors audits the Reserve Banks every year, and
its staff periodically reviews operations in key functional
areas. The Reserve Banks, like the Board, are subject to audit by
the GAO, but certain functions, such as transactions with foreign
central banks and open market operations, are excluded from au
dit. Each Reserve Bank has an internal auditor who is responsible
to the Bank's board of directors.

The FOMC is charged under law with overseeing open market
operations, the principal tool of national monetary policy. These
operations influence the amount of reserves available to deposi
tory institutions (see chapter 3). The FOMC also sets ranges for the
growth of the monetary aggregates and directs operations under
taken by the Federal Reserve in foreign exchange markets.
The FOMC is composed of the seven members of the Board of
Governors and five of the twelve Reserve Bank presidents. The
president of the Federal Reserve Bank of New York is a perma
nent member; the other presidents serve one-year terms on a ro

tating basis.1All the presidents participate in FOMC discussions,
contributing to the Committee's assessment of the economy and
of policy options, but only the five presidents who are members
of the Committee vote on policy decisions. The FOMC under law
determines its own internal organization and by tradition elects
the Chairman of the Board of Governors as its chairman and the
president of the Federal Reserve Bank of New York as its vice
chairman. Formal meetings are held eight times each year in Wash
ington, D.C. Telephone consultations and other meetings are held
when needed.

As suggested previously, the nation's banks can be divided into
three types according to which governmental body charters them
and whether or not they are members of the Federal Reserve Sys
tem. Those chartered by the federal government (through the Of
fice of the Comptroller of the Currency in the Department of the
Treasury) are national banks; by law, they are members of the Fed
eral Reserve System. Banks chartered by the states are divided
into those that are members of the Federal Reserve System (state
member banks) and those that are not (state nonmember banks).

1. The rotating seats are filled from the following four groups of Banks, one
Bank president from each group: Boston, Philadelphia, and Richmond; Cleve
land and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City,
and San Francisco.

State banks are not required to join the Federal Reserve System,
but they may elect to become members if they meet the standards
set by the Board of Governors. At the end of 1993,4,338 banks
were members of the Federal Reserve System—3,360 national
banks and 978 state banks—out of 11,212 commercial banks
nationwide.
Member banks must subscribe to stock in their regional Federal
Reserve Bank in an amount equal to 3 percent of their capital and
surplus. The holding of this stock, however, does not carry with it
the control and financial interest conveyed to holders of common
stock in for-profit organizations: It is merely a legal obligation that
goes along with membership, and the stock may not be sold or
pledged as collateral for loans. Member banks receive a 6 percent
dividend annually on their stock, as specified by law, and vote for
the Class A and Class B directors of the Reserve Bank. The stock is
not available for purchase by individuals.

Advisory Committees
The Federal Reserve System uses advisory and working commit
tees in carrying out its varied responsibilities. Three of these com
mittees advise the Board of Governors directly:
•

Federal A dvisory Council. The Federal Reserve Act estab
lished the council, which consists of one member—tradition
ally a commercial banker—from each Federal Reserve District.
The council is required by law to meet four times each year
with the Board of Governors in Washington, D.C., to discuss
economic and banking matters.

•

Consumer A dvisory Council. This statutory council, which has
thirty members, meets with the Board three times a year on
matters concerning consumers and the consumer credit protec
tion laws administered by the Board. The council consists of
academics, legal specialists in consumer matters, and mem
bers representing the interests of consumers and the financial
industry.

•

Thrift Institutions A dvisory Council. After the passage of the
Depository Institutions Deregulation and Monetary Control
Act of 1980, which extended to thrift institutions the Federal
Reserve's reserve requirements and access to the discount
window, the Board of Governors established this council to

obtain information and opinions on the needs and problems
of thrift institutions. The council is made up of representatives
of savings and loan associations, savings banks, and credit
unions.
The Federal Reserve Banks also use advisory committees. Perhaps
the most important are the committees (one for each Reserve
Bank) that advise the Banks on matters of agriculture and small
business. Two representatives of each committee meet once a year
in Washington, D.C., with the Board of Governors. ■

Monetary Policy
and the Economy
sing the tools of monetary policy, the Federal Reserve can affect
the volume of money and credit and their price—interest rates.
In this my, it influences employment, output, and the general
level of prices.

THE FEDERAL RESERVE ACT LAYS OUT the goals of monetary
policy. It specifies that, in conducting monetary policy, the Federal
Reserve System and the Federal Open Market Committee should
seek "to promote effectively the goals of maximum employment,
stable prices, and moderate long-term interest rates."

GOALS OF MONETARY POLICY
Many analysts believe that the central bank should focus prima
rily on achieving price stability. A stable level of prices appears to
be the condition most conducive to maximum sustained output
and employment and to moderate long-term interest rates; in such
circumstances, the prices of goods, materials, and services are
undistorted by inflation and thus can serve as clearer signals and
guides for the efficient allocation of resources. Also, a background
of stable prices is thought to encourage saving and, indirectly,
capital formation because it prevents the erosion of asset values
by unanticipated inflation.
However, policymakers must consider the long- and short-term
effects of achieving any one goal. For example, in the long run,
price stability complements efforts to achieve maximum output
and employment; but in the short run, some tension can arise be
tween efforts to reduce inflation and efforts to maximize employ
ment and output. At times, the economy is faced with adverse
supply shocks, such as a bad agricultural harvest or a disruption
in the supply of oil, which put upward pressure on prices and
downward pressure on output and employment. In these circum
stances, makers of monetary policy must decide the extent to

which they should focus on defusing price pressures or on cush
ioning the loss of output and employment. At other times,
policymakers may be concerned that the public's expectation of
more inflation will get built into decisions about wages and
prices, become a self-fulfilling prophecy, and result in temporary
losses of output and employment. Countering this threat of infla
tion with a more restrictive monetary policy could risk small
losses of output and employment in the near term but might make
it possible to avoid larger losses later should expectations of
higher inflation become embedded in the economy.
Beyond influencing the level of prices and the level of output in
the near term, the Federal Reserve can contribute to financial sta
bility and better economic performance by limiting the scope of
financial disruptions and preventing their spread outside the fi
nancial sector. Modern financial systems are highly complex and
interdependent and potentially vulnerable to wide-scale systemic
disruptions, such as those that can occur during a plunge in stock
prices. The Federal Reserve can help to establish for the U.S. bank
ing system and, more broadly, for the financial system a frame
work that reduces the potential for systemic disruptions. More
over, if a threatening disturbance develops, the central bank can
cushion its effects on financial markets and the economy by pro
viding liquidity through its monetary policy tools.

MONETARY POLICY AND THE RESERVES MARKET
The initial link between monetary policy and the economy occurs
in the market for reserves. The Federal Reserve's policies influence
the demand for or supply of reserves at banks and other deposi
tory institutions, and through this market, the effects of monetary
policy are transmitted to the rest of the economy. Therefore, to un
derstand how monetary policy is related to the economy, one must
first understand what the reserves market is and how it works.

Demand for Reserves
The demand for reserves has two components: required reserves
and excess reserves. All depository institutions—commercial
banks, saving banks, savings and loan associations, and credit
unions—must retain a percentage of certain types of deposits to be

^aczz0===£:

held as reserves. The reserve requirements are set by the Federal
Reserve under the Depository Institutions Deregulation and Mon
etary Control Act of 1980. At the end of 1993,4,148 member banks,
6,042 nonmember banks, 495 branches and agen
cies of foreign banks, 61 Edge Act and agreement
corporations, and 3,238 thrift institutions were
subject to reserve requirements.
iV
, ultimate
targets o f monetary
Since the early 1990s, reserve requirements have
policy are specified
in law as maximum
been applied only to transaction deposits (basi
employment, stable
cally, interest-bearing and non-interest-bearing
prices, and moderate
checking accounts). Required reserves are a frac
long-term
tion of such deposits; the fraction—the required
interest rates.
reserve ratio—is set by the Board of Governors
within limits prescribed by law (see appendix A).
Thus, total required reserves expand or contract with the level of
transaction deposits and with the required reserve ratio set by the
Board; in practice, however, the required reserve ratio has been ad
justed only infrequently. Depository institutions hold required re
serves in one of two forms: vault cash (cash on hand at the bank)
or, more important for monetary policy, required reserve balances
in accounts with the Reserve Bank for their Federal Reserve District.
Depositories use their accounts at Federal Reserve Banks not only
to satisfy their reserve requirements but also to clear many finan-

• Required reserve balances
(held at Federal Reserve Banks)
• Excess reserves
(held at Reserve Banks to provide
additional protection against
reserve deficiencies and
overdrafts)

Reserve through discount
window lending)
• Nonborrowed reserves
(influenced by the Federal
Reserve's purchase or sale
of securities in open market
operations)

cial transactions. Given the volume and unpredictability of trans
actions that clear through their accounts every day, depositories
need to maintain a cushion of funds to protect themselves against
debits that could leave their accounts overdrawn at the end of the
day and subject to penalty. Depositories that find their required
reserve balances insufficient to provide such protection may open
supplemental accounts for required clearing balances. These addi
tional balances earn interest in the form of credits that can be used
to defray the cost of services, such as check-clearing and wire
transfers of funds and securities, that the Federal Reserve provides.
Some depository institutions choose to hold reserves even beyond
those needed to meet their reserve and clearing requirements.
These additional balances, which provide extra protection against
overdrafts and deficiencies in required reserves, are called excess
reserves; they are the second component of the demand for re
serves (a third component if required clearing balances are in
cluded). In general, depositories hold few excess reserves because
these balances do not earn interest; nonetheless, the demand for
these reserves can fluctuate greatly over short periods, complicat
ing the Federal Reserve's task of implementing monetary policy.
(See table 2.1 for the average amount of funds in each of these re
serve categories in 1993.)

Supplyof Reserves
The Federal Reserve supplies reserves to the banking system in
two ways:
• Lending through the Federal Reserve discount window
• Buying government securities (open market operations).
Reserves obtained through the first channel are called borrowed
reserves. The Federal Reserve supplies these directly to depository
institutions that are eligible to borrow through the discount win
dow. Access to such credit by banks and thrift institutions is estab
lished by rules set by the Board of Governors, and loans are made
at a rate of interest—the discount rate—set by the Reserve Banks
and approved by the Board. The supply of borrowed reserves de
pends on the initiative of depository institutions to borrow,
though it is influenced by the level of the discount rate and by the
terms and conditions for access to discount window credit.

O N E T A R Y

P O L I C Y

In general, banks are expected to come to the discount window
to meet liquidity needs only after drawing on all other reasonably
available sources of funds, which limits considerably the use of
this source of funds. Morover, many banks fear that their use of
discount window credit might become known to private market
participants, even though the Federal Reserve treats the identity of
such borrowers in a highly confidential manner, and that such bor
rowing might be viewed as a sign of weakness. As a consequence,
the amount of reserves supplied through the discount window is
generally a small portion of the total supply of reserves.
The other source of reserve supply is nonborrowed reserves. Al
though the supply of nonborrowed reserves depends on a variety
of factors, many of them outside the day-to-day control of the Fed
eral Reserve, the System can exercise control over this supply
through open market operations—the purchase or sale of securi
ties by the Domestic Trading Desk at the Federal Reserve Bank of
New York. When the Federal Reserve buys securities in the open
market, it creates reserves to pay for them, and the supply of non
borrowed reserves increases. Conversely, when it sells securities, it
absorbs reserves in exchange for the securities, and the supply of
nonborrowed reserves falls. In other words, the Federal Reserve
adjusts the supply of nonborrowed reserves by purchasing or sell
ing securities in the open market, and the purchases are effectively
paid for by additions to or subtractions from a depository
institution's reserve balance at the Federal Reserve.

Table 2.1
Aggregate reserve measures, 1993
Billions of dollars; quarterly averages of daily data

Quarter

Required
Required
Applied
reserves reserve balances vault cash

Required
Excess
clearing balances reserves

53.5

23.8

30.9

6.0

1.2

55.6

26.5

30.2

6.0

1.0

57.2

26.8

31.4

6.0

1.1

60.3

28.9

32.5

6.1

1.1

|l l l i ! ' ilwipl is sill |

f s iii a i i i i ^ i i i i i i i i i i i

Trading of Reserves
Depository institutions actively trade reserves held at the Federal
Reserve among themselves, usually overnight. Those with surplus
balances in their accounts transfer reserves to those in need of
boosting their balances. The benchmark rate of interest charged
for the short-term use of these funds is called the federal funds
rate. Changes in the federal funds rate reflect the basic supply and
demand conditions in the market for reserves.
Equilibrium exists in the reserves market when the demand for
required and excess reserves equals the supply of borrowed plus
nonborrowed reserves. Should the demand for reserves rise—say,
because of a rise in checking account deposits—a disequilibrium
will occur, and upward pressure on the federal funds rate will
emerge. Equilibrium may be restored by open market operations
to supply the added reserves, in which case the federal funds rate
will be unchanged. It may also be restored as the supply of re
serves increases through greater borrowing from the discount
window; in this case, interest rates would tend to rise, and over
time the demand for reserves would contract as reserve market
pressures are translated, through the actions of banks and their
depositors, into lower deposit levels and smaller required re
serves. Conversely, should the supply of reserves expand—say,

because the Federal Reserve purchases securities in the open mar
ket—the resulting excess supply will put downward pressure on
the federal funds rate. A lower federal funds rate will set in mo
tion equilibrating forces through the creation of more deposits
and larger required reserves and lessened borrowing from the
discount window.

EFFECTS OF MONETARY POLICY ON THE ECONOMY
As the preceding discussion illustrates, monetary policy works
through the market for reserves and involves the federal funds
rate. A change in the reserves market will trigger a chain of events
that affect other short-term interest rates, foreign exchange rates,
long-term interest rates, the amount of money and credit in the
economy, and levels of employment, output, and prices. For ex
ample, if the Federal Reserve reduces the supply of reserves, the
resulting increase in the federal funds rate tends to spread quickly
to other short-term market interest rates, such as those on Trea
sury bills and commercial paper. Because interest rates paid on
many deposits in the money stock adjust only slowly, holding
balances in money (that is, in a form counted in the money stock)
becomes less attractive. As the public pursues higher yields avail
able in the market (for example, on Treasury bills), the money
stock declines. Moreover, as bank reserves and deposits shrink,
the amount of money available for lending may also decline.
Higher costs of borrowing and possible restraints on credit supply
will damp growth of both bank credit and broader credit measures.
A change in short-term interest rates will also translate into
changes in long-term rates on such financial instruments as home
mortgages, corporate bonds, and Treasury bonds, especially if the
change in short-term rates is expected to persist. Thus, a rise in
short-term rates that is expected to continue will lead to a rise
(though typically a smaller one) in long-term rates.
Higher long-term interest rates will reduce the demand for items
that are most sensitive to interest cost, such as residential housing,
business investment, and durable consumer goods (for example,
automobiles and large household appliances). Higher mortgage
interest rates depress the demand for housing. Higher corporate
bond rates increase the cost of borrowing for businesses and,
thus, restrain the demand for additions to plants and equipment;

and tighter supplies of bank credit may constrain the demand for
investment goods by those firms particularly dependent on bank
loans. Furthermore, higher rates on loans for motor vehicles re
duce consumers' demand for cars and light trucks. Beyond these
effects, consumption demand is lowered by a reduction in the
value of household assets—such as stocks, bonds, and land—that
tends to result from higher long-term interest rates.
The implications of changes in interest rates extend beyond do
mestic money and credit markets. Continuing with the example,
when interest rates in the United States move higher in relation to
those abroad, holding assets denominated in U.S. dollars becomes
more appealing, and the demand for dollars in foreign exchange
markets increases. A result is upward pressure on the exchange
value of the dollar. With flexible exchange rates (rates that fluctu
ate as the supply of and demand for national currencies vary), the
dollar strengthens, the cost of imported goods to Americans de
clines, and the price of U.S.-produced goods to people abroad
rises. As a consequence, demands for U.S. goods are reduced as
Americans are induced to substitute goods from abroad for those
produced in the United States and people abroad are induced to
buy fewer American goods.
Such changes in the demand for goods and services get translated
into changes in total production and prices. Lessened demand re
sulting from higher interest rates and the stronger dollar tends to
reduce production and thereb}^ relieve pressures on resources. In
an economy that is overheating, this relief will curb inflation. Pro
duction is the first to respond to monetary policy actions; prices
and wages respond only later. There is considerable inertia in
wages and prices, largely because much of the U.S. economy is
characterized by formal and informal contracts that limit changes
in prices and wages in the short run and because inflation expec
tations, which influence how people set wages and prices, tend to
be slow to adjust. In other words, because many wages and prices
do not adjust promptly to a change in aggregate demand, sales
and output slow initially in response to a slowing of aggregate de
mand. Over a longer period, however, inflation expectations are
tempered, contracts are renegotiated, and other adjustments occur.
As a consequence, price and wage levels adjust to the slower rate
of expansion of aggregate demand, and the economy gravitates
toward full employment of resources.

LIMITATIONS OF MONETARY POLICY

Monetary policy is not the only force affecting output and prices.
Indeed, the economy frequently is buffeted by factors affecting ag
gregate demand for goods and services or aggregate supply. On
the demand side, the government influences the economy through
changes in tax and spending programs. Such fiscal policy actions
receive a lot of public attention and typically can be anticipated
well in advance. In fact, their effect on the economy may precede
their implementation to the degree that some businesses and
households may alter their spending in anticipation of the policy
change. Also, forward-looking financial markets may build such
fiscal events into the level and structure of interest rates and thus
further influence spending decisions before the government action.
Other changes in demand or supply can be totally unpredictable
and can influence the economy in unforeseen ways. Examples of
such " shocks" on the demand side are changes in households'
propensity to consume and shifts in consumer and business confi
dence. Monetary policy in time can offset such shocks in privatesector demand but, because of their nature, not as they occur. On
the supply side, matters can be even more complicated. Natural
disasters, disruptions in the supply of oil, and agricultural losses
are examples of adverse supply shocks. Because such events tend
to raise prices and reduce output, monetary policy
can attempt to counter the losses of output or the
higher prices, but cannot completely offset both.
c 5 g * * .

In practice, monetary policymakers do not have
monetary policy,
up-to-the-minute, reliable information about the
the economy is
affected by such
state of the economy and prices. Information is lim
factors as
ited because of lags in the publication of data and
government fiscal
because of later revisions in data. Also, policy
initiatives and
makers have a less-than-perfect understanding of
unforeseen events.
the way the economy works, including the knowl
edge of when and to what extent policy actions will
affect aggregate demand. The operation of the economy changes
over time, and with it the response of the economy to policy mea
sures. These limitations add to uncertainties in the policy process
and make determining the appropriate setting of monetary policy
instruments more difficult.

2 6

The central bank will have an easier time reaching its goals if the
public understands them and believes the Federal Reserve will
take the steps necessary to reach them. For example, a believable
anti-inflation policy, implemented through a deceleration of ag
gregate demand, will more quickly lead the public to expect lower
inflation, and such an expectation will itself help bring down in
flation. In that case, workers will not feel the need to demand
large wage increases to protect themselves against expected price
hikes, and businesses will be less aggressive in raising their prices,
knowing that doing otherwise would result in losses in sales. In
these circumstances, inflation will come down more or less in line
with the slowing of aggregate demand, with much less slack
emerging in resource markets than if workers and businesses con
tinued to act as if inflation were not going to slow.

GUIDES FOR MONETARY POLICY
The goals of monetary policy are spelled out in law. But how will
the Federal Reserve know whether or not its current operations in
the reserves market are consistent with those goals or whether it
needs to be more restrictive or more accommodative? The actions
taken in the reserves market affect the economy with considerable
lags. If the Federal Reserve waits to adjust rates until it sees an
undesirable change in employment or prices, it will be too late to
achieve its objectives. Consequently, people have suggested that
the Federal Reserve pay particularly close attention to guides to
policy that are intermediate between operations in the reserves
market and effects in the economy. Among those frequently men
tioned are monetary and credit aggregates, interest rates, and the
foreign exchange value of the dollar. Some suggest that one or the
other of these measures be used as an intermediate target—that is,
one with a specific formal objective. Others suggest that they be
used less formally as indicators of the longer-term effects of mon
etary policy on the economy, to be judged in conjunction with a
variety of other financial and economic information.

The Humphrey-Hawkins Act has something to say about the
guides for monetary policy: It specifies that each February the
Federal Reserve must announce publicly its objectives for growth

& = L== 3 ^ :

in money and credit and that at midyear it must review its objec
tives and revise them if appropriate. This provision of the act was
based on the presumption of a reasonably stable relation between
growth of money and credit, on the one hand, and the goals of
monetary policy, on the other—a relation that could be fruitfully
exploited in achieving those goals. Control over the money stock,
it was thought, could in effect anchor the price level in much the
same way that the former gold standard was thought to have an
chored the price level.1
Nonetheless, the law foresaw that revision might be appropriate
should, for example, the relation between the monetary or credit
aggregates and the economy—the velocity of money or credit—
change unpredictably (see the box for a description of the content
of the monetary and credit aggregates).1
2 In these circumstances,
adherence to the initial objectives for money or credit growth
would lead to an undesirable outcome for output or prices. The
Federal Reserve is not required to achieve its announced objec
tives for these financial aggregates, but if it does not, it must ex
plain the reasons to Congress and the public.
The usefulness of the monetary aggregates for indicating the state
of the economy and for stabilizing the level of prices has been
called into question by frequent departures of their velocities from
historical patterns. As can be seen in chart 2.1, the velocity of M2
had until recently been fairly stable over long periods, although it
did vary over shorter periods in ways related to the interest-rate
cycle. In the early 1990s, the velocity of M2 departed from this pat-

1. Some economists have argued that, besides serving as a longer-term anchor
for the price level, tight control over the money stock will stabilize the economy
in the shorter run. To the extent that the relation between the money stock and
the economy is very close, an overheating of the economy is associated with
stronger demand for money. If the Federal Reserve sticks to a predetermined
path for money growth and does not meet that demand, interest rates will rise
and will choke off demand and inflationary pressures. Conversely, a weakening
of the economy is associated with a decreased demand for money. If the Federal
Reserve sticks to a predetermined path for money growth, interest rates will
decline and aggregate demand will increase.
Most observers, however, have come to believe that the slippage between the
money stock and the economy, at least in the short run, is sufficiently great that
efforts to exert tight control over money may lead to less, rather than to more,
economic stability.
2. Velocity is the ratio of nominal gross domestic product (GDP) to the money
stock (or credit aggregate). If the money stock grows at the same rate as nomi
nal GDP, velocity is steady. If the money stock grows less rapidly than nominal
GDP, velocity rises; and if it grows more rapidly, velocity falls.

a a a B a a a a a a a a a a a a a

■■I HHI Hi BH

■

■■■■■■■•a

The Content of Monetary and Credit Aggregates
The Federal Reserve publishes data on
three monetary aggregates. The first, Ml,
is made up of types of money commonly
used for payment, basically currency and
checking deposits. The second, M2,
includes Ml plus balances that generally
are similar to transaction accounts and
that, for the most part, can be converted
fairly readily to Ml with little or no loss
of principal. The M2 measure is thought
to be held primarily by households. The
third aggregate, M3, includes M2 plus
certain accounts that are held by entities
other than individuals and are issued bv

banks and thrift institutions to augment
M2-type balances in meeting credit
demands; it also includes balances in
money market mutual funds held by
institutional investors.

The Federal Reserve publishes a broad
measure of credit extended to domestic
nonfinancial sectors.
The aggregates have had different roles
in monetary policy as their reliability as
guides has changed. Here are their
principal components:

Credit extended to
(debt owed by)

■
m

a
a
a
a

a
a

m
m

Currency (and
travelers checks)
Demand deposits
NOW and similar
interest-earning
checking accounts

a
a
a

Federal government

Savings deposits
and money market
deposit accounts

Large time deposits

State and local
governments

Small time deposits1
Retail-type money
market mutual
fund balances

Wholesale-type
money market mutual fund balances
Term (beyond overnight) RPs
Term Eurodollars

Overnight repurchase agreements
(RPs)

a
m

m
m

Overnight
Eurodollars

1. Time deposits in amounts of less than SI00,000,
excluding balances in IRA and Keogh accounts.

Households
Nonfinancial

businesses
m
m
a
a
a
a

■

a
a
a
a

..P... &.. 4 — 4 ... G ... ¥=

Chart 2.1
M2 velocity and opportunity cost
Ratio scale

Percentage points, ratio scale

Note. Quarterly data.
1. Two-quarter moving average of the difference between
the three-month Treasury bill rate and the average M2 rate.
2. Ratio of nominal GDP to M2.

tern and drifted upward. This upward drift occurred even as mar
ket interest rates were moving down, a change that should have
added to the attractiveness of deposits in M2 and lowered its ve
locity. Such departures from historical experience have made fore
casting velocity, and thus the rate of monetary growth needed to
achieve economic objectives, more difficult.
Many observers believe that the recent unusual monetary behav
ior is due to the growing variety of new financial assets offered to
the public, such as new kinds of mutual funds and mutual fund
services, and to changes in the way people manage their financial
portfolios. Some analysts expect that rapid financial change will
continue and will further undermine the value of the monetary
aggregates as guides to policy. Others expect the process to settle
down as people complete their shifts of investment-type balances
to assets outside M2. In this view, once the shift is fairly complete,
M2—perhaps measured somewhat differently—will again behave
in a reliable way and can again be used effectively as a guide for
monetary policy

Interest rates have frequently been proposed as a guide to policy.
Surely, some argue, changes in the provision of reserves by the
Federal Reserve can influence interest rates, and changes in inter
est rates affect various spending decisions. Moreover, information
on interest rates is available on a real-time basis.
Arguing against giving interest rates a key role in guiding mon
etary policy is the uncertainty about what level or path of interest
rates is consistent with the more basic goals. The appropriate level
or path will vary with the stance of fiscal policy, changes in pat
terns of business and household spending, the productivity of
capital, and economic developments abroad. It is difficult not only
to gauge the strength of these various forces at any time but also
to translate them into an appropriate level of interest rates. More
over, real interest rates—that is, interest rates net of expected infla
tion—drive spending decisions. Expected inflation is not readily
measured; thus, assessing what the level of real interest rates hap
pens to be is difficult. However, failing to account for inflation ex
pectations can result in misleading signals coming from nominal
interest rates. For example, if the public expected more inflation,
nominal interest rates would tend to rise, as investors sought pro
tection for the greater loss of purchasing power, and might lead to
the belief that monetary policy had become tighter and more
disinflationary when, in fact, just the reverse had occurred.
Alternatively, the yield curve—the difference between the interest
rate on longer-term securities and the interest rate on short-term
instruments—has been proposed. Whereas short-term interest
rates are strongly influenced by current reserve provisions of the
central bank, longer-term rates are influenced by expectations of
future short-term rates and thus by the longer-term effects of mon
etary policy on inflation and output. For example, a steep positive
yield curve (that is, long-term rates far above short-term rates)
may be a signal that participants in the bond market believe that
monetary policy has become too expansive and thus, without a
monetary policy correction, more inflationary. Such a curve would
be telling the central bank to provide fewer reserves. Conversely,
an inverted yield curve (short-term rates above long-term rates)
may be an indication that policy is restrictive, perhaps overly so.
However, various other influences, such as uncertainty about the

course of interest rates, affect long-term interest rates. Thus, a
steepening of the yield curve may indicate not that the thrust of
monetary policy is too expansive, but that market participants
have become more uncertain about the outlook for interest rates.
In other words, liquidity premiums embodied in long-term inter
est rates may have risen. More generally, interest rates can vary for
a variety of reasons, especially over short periods, and the Federal
Reserve must exercise considerable caution in interpreting and re
acting to their fluctuations.

Foreign Exchange Rates
Exchange rate movements are an important channel through
which monetary policy affects the economy, and they tend to re
spond promptly to a change in the provision of reserves and in in
terest rates. Information on exchange rates, like that on interest
rates, is available almost continuously throughout each day.
Interpreting the meaning of movements in foreign exchange rates,
however, is not always straightforward. A decline in the foreign
exchange value of the dollar, for example, could indicate that mon
etary policy had become more accommodative, with possible risks
of inflation. But foreign exchange rates respond to other influ
ences, such as market assessments of the strength of aggregate de
mand or developments abroad. For example, a weaker dollar on
foreign exchange markets could instead suggest lessened demand
for U.S. goods and decreased inflationary pressures. Or a weaker
dollar could result from higher interest rates abroad—making as
sets in those countries more attractive—that could come from
strengthening economies or the tightening of monetary policy abroad.
Determining which level of the exchange rate is most consistent
with the ultimate goals of policy can be difficult. Selecting the
wrong level could lead to a sustained period of deflation and high
levels of economic slack or to a greatly overheated economy. Also,
reacting in an aggressive way to exchange market pressures could
result in the transmission to the United States of certain distur
bances from abroad, as the exchange rate could not adjust to cushion
them. Consequently, the Federal Reserve does not have specific
targets for exchange rates but considers movements in those rates
in the context of other available information about financial mar
kets and economies at home and abroad.

I O N S

All of the guides to monetary policy discussed above have some
thing to do with the transmission of monetary policy to the
economy. As such, they have certain advantages. However, none
has shown a consistently close enough relationship with the ulti
mate goals of monetary policy that it can be relied upon singlemindedly. As a consequence, makers of monetary policy have
tended to use a broad range of indicators—those discussed above
along with information about the actual performance of output
and prices—to judge trends in the economy and to assess the
stance of monetary policy.
Such an eclectic approach enables the Federal Reserve to use all
available information in conducting policy. This may be especially
necessary as market structures and economic processes change in
ways that affect the usefulness of any single indicator. However,
communicating policy intentions and actions to the public can be
more difficult with the eclectic approach than with the approach,
for example, of targeting the money stock if the linkage between
the money stock and the economy were fairly close and reliable.
And, by looking at many variables, which necessarily will give
some conflicting signals, the Federal Reserve may delay taking
needed action toward restraint or expansion suggested by one or
more indicators. As a consequence, more aggressive measures may
be needed later if the ultimate goals of policy are to be achieved. ■

rhe Implementation
of Monetary Policy
heFederal Reserve uses the tools of monetary policy—open market
operations, the discount window, and reserve requirements—
to adjust the supply of reserves in relation to the demand for
reserves. In so doing, it can influence the amount of pressure
on fa p ii reserve positions and, hence, the federal funds rate.

.......

IN GENERAL, THE FEDERAL RESERVE can take one of two basic
approaches to affect reserves:
• It can target a certain quantity of reserves, allowing changes in
the demand for reserves to influence the federal funds rate.
• It can target the price of reserves (the federal funds rate) by ad
justing the supply of reserves to meet any change in the de
mand for reserves.
The Federal Reserve has used variations of these basic ap
proaches over the years.

OPERATIONAL APPROACHES
Before October 1979, the Federal Reserve's approach to affecting
reserves was designed to produce a targeted degree of ease or
tightness in reserve market conditions (that is, to achieve a de
sired cost or availability of reserves). These conditions were
gauged by the way the federal funds rate behaved as well as by
the extent to which reserves in the depository system fell short of
satisfying required reserves and institutions had to borrow from
the discount window or run down their excess reserves. Al
though the target for reserve market conditions was set so as to
be consistent with the objectives specified for money and credit,
the Federal Reserve initially accommodated any expansion of
money by providing whatever nonborrowed reserves were
needed to support that expansion. If money and credit persis
tently behaved differently from the policy objectives, the Federal
Reserve would change the pressure on reserve market conditions

by varying the extent to which it accommodated the demand for
reserves. If, for example, the growth of money and credit was
weaker than desired and additional ease was needed, the Federal
Reserve would increase nonborrowed reserves by buying securi
ties in the open market. This increase in nonborrowed reserves
lowered the amount of reserves that banks needed to borrow at
the discount window and decreased the pressure on them to bor
row in the federal funds market. As a result, interest rates in the
federal funds market, and in short-term markets generally,
tended to fall. When additional tightness was needed, the Federal
Reserve would reduce nonborrowed reserves by selling securities
in the open market or would increase reserves less rapidly than it
otherwise would have done. These actions would boost the need
to borrow at the discount window, increase demand in the federal
funds market, and raise short-term rates.
Control of money and credit under this procedure rested on the
ability to estimate the relation between the money market condi
tions that guided the provision of nonborrowed reserves and the
amount of money the public would hold at the associated levels
of interest rates. Control also depended on the Federal Reserve's
willingness to alter the relative availability of reserves, and hence
short-term interest rates, when money growth deviated from its
desired path. As inflation intensified in the late 1970s, the Federal
Open Market Committee (FOMC) changed its approach to imple
menting open market operations. In October 1979, it began target
ing the quantity of reserves—specifically, nonborrowed reserves.
A predetermined target path for nonborrowed reserves was based
on the FOMC's objectives for the Ml money stock. If Ml grew
faster than the FOMC prescribed, actual required reserves would
grow faster than nonborrowed reserves; the faster growth of re
quired reserves, in turn, would produce upward pressure on the
federal funds rate and other short-term interest rates. The rise in
interest rates would then reduce the amount of M l deposits de
manded by the public, and Ml would be brought back toward its
targeted path.
Later, however, the combination of interest rate deregulation and
financial innovation disrupted the historical relationships be
tween Ml and the objectives of monetary policy. In response, the
Federal Reserve in late 1982 shifted from controlling Ml through
a reserves-oriented approach and returned to accommodating
short-run fluctuations in reserves demand and preventing these

^Nf=0=fF E T A R Y

A T IG

fluctuations from affecting the federal funds rate. At the same
time, Federal Reserve policy decisions became conditioned on a
much wider range of economic and financial variables, including
M2 and other broad monetary and credit aggregates, that seemed
more closely linked than Ml to the long-term goals of monetary
policy Since 1982, daily open market operations have been keyed
once again to achieving a particular degree of tightness or ease in
reserve market conditions rather than to the quantity of reserves
outstanding.
In general, no one approach to implementing monetary policy is
likely to be satisfactory under all economic and financial circum
stances. The actual approach has been adapted at various times in
light of different considerations, such as the need to combat infla
tion, the desire to encourage sustainable economic growth, uncer
tainties related to institutional change, and evident shifts in the
public's attitudes toward the use of money. When economic and
financial conditions warrant close control of a monetary aggre
gate, more emphasis may be placed on guiding open market op
erations by a fairly strict targeting of reserves. In other circum
stances, a more flexible approach to managing reserves may be
required.

OPEN MARKET OPERATIONS
Open market operations involve the buying and selling of securi
ties by the Federal Reserve. A Federal Reserve securities transac
tion changes the volume of reserves in the depository system: A
purchase adds to nonborrowed reserves, and a sale reduces them.
In contrast, the same transaction between financial institutions,
business firms, or individuals simply redistributes reserves
within the depository system without changing the aggregate
level of reserves.
When the Federal Reserve buys securities from any seller, it pays,
in effect, by issuing a check on itself. When the seller deposits the
check in its bank account, the bank presents the check to the Fed
eral Reserve for payment. The Federal Reserve, in turn, honors
the check by increasing the reserve account of the seller's bank at
the Federal Reserve Bank. The reserves of the seller's bank rise
with no offsetting decline in reserves elsewhere; consequently, the
total volume of reserves increases. Just the opposite occurs when

the Federal Reserve sells securities: The payment reduces the re
serve account of the buyer's bank at the Federal Reserve Bank
with no offsetting increase in the reserve account of any other
bank, and the total reserves of the banking system decline. This
characteristic—the dollar-for-dollar change in the reserves of the
depository system with a purchase or sale of securities by the
Federal Reserve—makes open market operations the most pow
erful, flexible, and precise tool of monetary policy.
In theory, the Federal Reserve could provide or absorb bank re
serves through market transactions in any type of asset. In prac
tice, however, most types of assets cannot be traded readily
enough to accommodate open market operations. For open mar
ket operations to work effectively, the Federal Reserve must be
able to buy and sell quickly, at its own convenience, in whatever
volume may be needed to keep the supply of reserves in line with
prevailing policy objectives. These conditions require that the in
strument it buys or sells be traded in a broad, highly active mar
ket that can accommodate the transactions without distortions or
disruptions to the market itself.
The market for U.S. government securities satisfies these condi
tions, and the Federal Reserve carries out by far the greatest part
of its open market operations in that market. The U.S. govern
ment securities market, in which overall trading averages more
than $100 billion a day, is the broadest and most active of U.S. fi
nancial markets. Transactions are handled
over the counter (that is, not on an organized
stock exchange), with the great bulk of orders
placed with specialized dealers (both bank
and nonbank). Although most dealer firms are
in New York City, a network of telephone and
wire services links dealers and customers re
gardless of their location to form a worldwide
market.
The Federal Reserve's holdings of government securities are
tilted somewhat toward Treasury bills, which have maturities of
one year or less (table 3.1). The average maturity of the Federal
Reserve's portfolio of Treasury issues is only a little more than
3 years, somewhat below the average maturity of roughly
5Vi years for all outstanding marketable Treasury securities. In the
1980s, the average maturity of the Federal Reserve's portfolio

Table 3.1
Securities held in the Federal Reserve's open market account
as of June 29,1994
Billions of dollars

Remaining maturity

U.S. Treasury
securities

1 year or less

Federal agency
securities
Total

209.5

1.8

211.3

More than 1 year to 5 years

83.7

1.8

85.6

More than 5 years to 10 years

25.3

25.8

More than 10 years

33.1

Total

351.6

0
4.2

33.1
355.8

shortened somewhat, as the Federal Reserve began to emphasize
liquidity in managing its portfolio. More recently, the Federal Re
serve has slightly lengthened the average maturity of its portfolio.

Other Factors Influencing Nonborrowed Reserves
Most purchases and sales of securities are not undertaken to ad
just conditions in reserves markets as a result of a policy decision.
Rather they are made to offset other influences on reserves. Cer
tain factors beyond the immediate control of the Federal Reserve,
such as the amount of currency in circulation, the size of Treasury
balances at Federal Reserve Banks, and the volume of Federal Re
serve float, cause reserves to rise and fall. (These factors are dis
cussed in detail in appendix A.)
The movement of these factors, called technical factors, must be
forecast so that the makers of policy can determine what would
happen to reserves if the Federal Reserve were to abstain from
open market operations. Fluctuations in some technical factors
are attributable mainly to pronounced seasonal influences, and
thus their effect on nonborrowed reserves is fairly predictable. For
example, the amount of currency in circulation rises late in the
year because individuals tend to hold more currency during the
holiday shopping season. This rise in currency in circulation
drains reserves from the depository system because, when a de
positor withdraws currency from a bank, the bank turns to the

Federal Reserve to replenish its depleted vault cash and pays for
the shipment of currency by drawing down its reserve account. In
contrast, a decline in currency in circulation provides reserves.
Movements in the Treasury's balance at the Federal Reserve also
follow certain regular, seasonal patterns, which are related to cor
porate and individual tax dates, social security payments, and the
like. When the Treasury, perhaps anticipating a major spending
commitment, shifts funds from its collateralized "tax and loan"
accounts at commercial banks into its account at the Federal Re
serve, reserves are removed from the banking system. In contrast,
when the Treasury makes a payment, such as a tax refund, it re
duces its balance at the Federal Reserve and injects reserves into
the depository system.
Other technical factors are affected more by random occurrences,
such as transportation difficulties due to winter storms, and thus
are more difficult to predict. One such factor is float, which is the
difference between the total value of checks in the process of col
lection that have been credited to banks' reserve accounts and the
value of those collected but not yet credited to banks' reserve ac
counts. A rise in float increases reserves whereas a decline in float
reduces them.
Technical factors can provide or absorb a sizable amount of
reserves. If, on balance, they are adding to or drawing down
reserves in amounts consistent with the FOMC's objectives as to
the supply of reserves, the Federal Reserve will take no action. At
other times, the Federal Reserve may undertake open market op
erations to neutralize technical factors and to obtain desired levels
of nonborrowed reserves. Indeed, most of the Federal Reserve's
operations are defensive in the sense that they are intended to
offset the various market forces that are pushing the level of non
borrowed reserves in a direction at odds with the FOMC's
objectives.

Depending on the reserve situation, the Federal Reserve ap
proaches open market operations in one of two ways. When fore
casts of the factors that influence reserves indicate that the supply
of reserves will probably continue to need adjustment, the Fed-

M O n :•: g : T W -» : - T ■■■■•

......J » . g :

eral Reserve may make outright purchases or sales of securities. If
the need is to withdraw reserves, the Federal Reserve may also
redeem maturing securities held in its portfolio. (When the Fed
eral Reserve redeems the securities, the Treasury takes funds out
of its account to pay the Federal Reserve, leaving fewer reserves
in the depository system.) In general, it conducts outright transac
tions (sales, purchases, and redemptions) only a few times each
year, to meet longer-term reserve needs.
—

When projections indicate only a temporary need
to alter reserves, either because the technical factor
'pen market
affecting reserves is expected to be reversed or off
operations can be
used to meet
set or because the near-term outlook for reserves is
a
temporary
need
uncertain, the Federal Reserve may engage in
or to affect the
transactions that only temporarily affect the sup
supply o f reserves
ply of reserves—repurchase agreements, in the
over the longer term.
case of temporary additions of reserves, and
matched sale-purchase transactions, in the case of
temporary drains of reserves. These temporary transactions,
which are designed to reduce fluctuations in the overall supply of
reserves by offsetting the short-term effects of technical factors,
are used much more frequently than are outright transactions.
Market participants monitor these operations very closely for
signs of any change in the underlying thrust of monetary policy.

©,

Outright Purchases and Sales
Transactions on an outright basis occur largely through auctions
in which dealers are requested to submit bids to buy or offers to
sell securities of the type and maturity that the Federal Reserve
has elected to sell or to buy. The dealers' bids or offers are ar
ranged according to price, and the Federal Reserve accepts
amounts bid or offered in sequence, taking the highest prices bid
for its sales and the lowest prices offered for its purchases, until
the desired size of the whole transaction is reached. The Federal
Reserve also conducts securities transactions with several official
agencies, such as foreign central banks. Occasionally the Federal
Reserve reduces its holdings of securities by redeeming maturing
securities rather than rolling them over at Treasury auctions, as it
usually does (table 3.2).
Repurchase Agreements
When a temporary addition to bank reserves is called for, the Fed
eral Reserve engages in short-term repurchase agreements (RPs)

Table 3.2
Federal Reserve System outright transactions, 1990-931
Billions of dollars

Transaction

1990

1991

1992

1993

Purchases

25.2

31.4

34.1

36.9

Sales

7.6

1.6

Redemptions

5.6

1.3

2.2

1.5

38.4

32.8

37.9

38.5

Total

1. Components may not sum to totals because of rounding.

with dealers; that is, it buys securities from dealers who agree to
repurchase them by a specified date at a specified price (table 3.3)
Because the added reserves will automatically be extinguished
when the RPs mature, this arrangement is a way of temporarily
injecting reserves into the depository system.
Repurchase agreements for the Federal Reserve account may be
conducted on an overnight basis or on a so-called term basis. Most
term RPs mature within seven days, and dealers sometimes have
the choice of terminating the transaction before maturity. The ab
sorption of reserves due to premature terminations by dealers
may also suit the needs of the Federal Reserve. Such terminations
often occur when the availability of reserves to depository institu
tions is greater than anticipated, which tends to reduce the bor
rowing costs that dealers face elsewhere.
Whenever the Federal Reserve arranges RPs with dealers, the dis
tribution of the transaction among dealers is determined by auc
tion. Individual dealers may enter several offers at various interest
rates. The Federal Reserve arranges all the offers in descending
order and then accepts those offers with the highest rates up to the
dollar amount needed to meet the reserve objectives.
Matched Sale-Purchase Transactions
When the Federal Reserve needs to absorb reserves temporarily,
it employs matched sale-purchase transactions with dealers.
These transactions involve a contract for immediate sale of securi
ties to, and a matching contract for subsequent purchase from,

M O N E T A R Y

P O L I C Y

I M P L B M E N 1 A T I 0 N

Table 3.3
Federal Reserve System temporary transactions, 1990-93
Volume in billions of dollars

1990
Num. Vol.

1991
Num. Vol.

1992
Num. Vol.

1993
Num. Vol.

Repurchase
agreements1

128

189.9

142

508.7

144

533.3

163

627.6

Matched
sale-purchase
transactions

48.3

75.3

28.6

10.9

Includes all types of repurchase agreements.

each participating dealer. The maturities of such arrangements do
not usually exceed seven days. The initial sale causes reserves to
be drained from the banking system; later, when the Federal Re
serve purchase is implemented, the flow of reserves is reversed.
Matched sale-purchase transactions are typically arranged in
Treasury bills. The Federal Reserve selects a bill in which it has a
substantial holding and invites dealers to state an interest rate at
which they are willing to purchase the bills for same-day delivery
and to sell them back for delivery on a subsequent day. It then ac
cepts the most advantageous (lowest rate) bids to the point that
sufficient reserves are withdrawn.

Typical P a y

33pert

Each weekday morning, two groups of Federal Reserve staff
members, one at the Federal Reserve Bank of New York and one at
the Board of Governors in Washington, prepare independent pro
jections of the technical factors affecting reserve availability for the
next few days and for several weeks to come. At 11:15 a.m., the
Manager of the System Open Market Account and the group in
New York are linked in a telephone conference call with members
of the senior staff at the Board of Governors and with a Federal
Reserve Bank president who is currently a member of the FOMC.
Participants in the call discuss staff forecasts for reserves, recent
developments in financial markets, and the latest data on the
monetary and credit aggregates. They pay special attention to
trading conditions in the reserves market, particularly to the level

of the federal funds rate in relation to the level expected to be con
sistent with the reserve conditions specified in the policy directive.
In light of this information, they determine a program of open
market operations. After
the call, which usually
ends around 11:30 a.m.,
all FOMC members as
well as all nonmember
Bank presidents are in
formed of the actions the
Federal Reserve intends
to take during the day.
When the Federal Re
serve has decided to un
dertake a particular op
eration, members of the
staff at the Domestic
Trading Desk (the Desk)
at the Federal Reserve Bank of New York contact dealers trading in
U.S. Treasury and federal agency securities. Approximately three
dozen dealers that actively trade in U.S. Treasury and federal
agency securities have relationships with the Desk; thus, the Fed
eral Reserve normally encounters no difficulty in promptly com
pleting its large orders. Once the transaction is executed, the re
serve account of each dealer's bank is credited or debited
accordingly, and the supply of reserves to the banking system
changes.

THE DISCOUNT WINDOW
The Federal Reserve's lending at the discount window serves two
key functions:
• It complements open market operations in managing the re
serves market day to day and in implementing longer-term
monetary policy goals.
• It facilitates the balance sheet adjustments of individual banks
that face temporary, unforeseen changes in their asset-liability
structure.
The role of the discount window in the conduct of monetary
policy has changed substantially since the early years of the Fed-

eral Reserve. In the 1920s, the discount window was the primary
conduit for monetary policy and for the provision of reserves to
the depository system. As U.S. financial markets developed, how
ever, providing reserves primarily through open market opera
tions became feasible and more efficient. As a result, discount
window lending has for many years accounted for a relatively
small fraction of total reserves.
Despite the comparatively small volume of borrowed reserves,
the discount window remains an important factor in re
serves market management and in the broader implemen
tation of monetary policy. It serves as a buffer in the re
serves market against unexpected day-to-day fluctuations
in reserves demand and supply. When the demand for re
serves is unexpectedly high or the supply is unexpectedly
low, banks can turn to the window for reserves. Thus, the
availability of the window helps to alleviate pressures in
the reserves market and to reduce the extent of
unexpected movements in the federal funds rate. Moreover,
adjustments to the basic discount rate can be important in signal
ing and implementing shifts in the Federal Reserve's monetary
policy stance.
Apart from its role in monetary policy, discount window lending
enables individual banks to adjust their balance sheets. Open
market operations could not easily duplicate the discount
window's role in facilitating certain balance sheet adjustments.
Although discount window loans and open market operations
have comparable effects on aggregate reserve availability, the
loans are uniquely suited to the task of meeting the temporary
liquidity needs of individual depositories. Conversely, open mar
ket operations are better suited to implementing the short-term
adjustments to the availability of aggregate reserves that are nec
essary in conducting monetary policy.

The structure of interest rates charged on discount window credit
has changed over the years. However, the rate for adjustment
credit, which is the basic discount rate, has always been the most
significant for monetary policy. Today, separate, market-related
rates generally apply for seasonal credit and extended credit.

The basic discount rate that each Federal Reserve Bank charges on
its loans is established by the Bank's board of directors, subject to
review and determination by the Board of Governors. Originally
each Federal Reserve Bank set its discount rate independently, to
reflect the banking and credit conditions in its own District. Over
the years, however, the transition from regional credit markets to a
national credit market has gradually produced a national discount
rate. As a result, the Federal Reserve maintains a uniform struc
ture of discount rates across all Reserve Banks.
The basic discount rate is adjusted from time to
time, in light of changing market conditions, to
complement open market operations and to sup
Federal
port the general thrust of monetary policy.
Reserve maintains a
uniform structure o f
Changes in the discount rate are made
discount rates across
judgmentally rather than automatically and may
all Reserve Banks.
somewhat lag changes in market rates. The imme
diate response of market interest rates to a change
in the discount rate—the announcement effect—depends partly
on the extent to which the change has been anticipated. If rates
have adjusted in anticipation of a change in the discount rate, the
actual event may have only moderate effects on market condi
tions. Generally, the response of market rates to a change in the
discount rate will be largest when the market views the adjust
ment as signaling a basic shift in the stance of monetary policy. In
deed, given the generally small volume of discount window
credit, the direct effect of a discount rate change on the funding
costs of depository institutions is quite small. Thus, the effect of
changes in the discount rate must be interpreted in the context of
existing economic and financial conditions and in relation to other
policy actions. For example, the response of market rates will also
depend on actions taken in open market operations.
The basic discount rate is applied on all adjustment credit. Sur
charges above the basic discount rate have at times been applied
to larger institutions that relied too frequently on adjustment bor
rowing as a source of funding. In 1980 and 1981, for example, the
Federal Reserve applied a surcharge (varying between 2 and 4
percentage points) to adjustment borrowing by institutions hav
ing deposits of $500 million or more that appeared to be borrow
ing more frequently than necessary. The surcharges were intended to
encourage these institutions to adjust their portfolios more quickly.

Before 1990, the basic discount rate also applied to all loans under
the seasonal credit program. In early 1990, after careful review of
the program, the Board implemented a market-related rate on sea
sonal credit. The move was designed to eliminate the implicit sub
sidy associated with the discount rate, which is a below-market rate,
while still providing a reliable source of funds for institutions
lacking access to national money markets. The market-related rate
applied to seasonal credit is based on an average of recent federal
funds rates and ninety-day certificate of deposit (CD) rates, but it
is never less than the discount rate applicable to adjustment
credit. The market-related rate is reestablished periodically.
At the discretion of each Federal Reserve Bank, the basic discount
rate may be applied to extended credit loans for as long as thirty
days. A flexible rate somewhat above market rates, and always
50 basis points above the rate charged for seasonal credit, is ap
plied to extended credit loans that are outstanding for more than
thirty days. In practice, the flexible rate is often applied to ex
tended credit loans outstanding for less than thirty days.

Borrowing Eligibility
Before the passage of the Monetary Control Act of 1980, only
banks that were members of the Federal Reserve System enjoyed
regular access to the discount window. The Monetary Control Act
extended reserve requirements to nonmember institutions and
provided that any institution holding deposits subject to reserve
requirements (such as transaction accounts and nonpersonal time
deposits) would have the same access to the discount window
that member institutions have.
Institutions eligible to borrow at the discount window include do
mestic commercial banks, U.S. branches and agencies of foreign
banks, savings banks, savings and loan associations, and credit
unions. Many depository institutions meet the eligibility criteria
—about 11,000 banks (including U.S. branches and agencies of for
eign banks) and 16,000 thrift institutions (including credit unions)
at the end of 1993. Eligibility to borrow is in no way contingent
upon or related to the use of Federal Reserve priced services (see
chapter 7).

;

Borrowing Procedures
Institutions that expect to borrow at the discount window typi
cally execute a set of legal documents with the Federal Reserve
that specify the terms and conditions under which discount win
dow credit will be granted and the requirements for collateral
pledged to secure such loans.
All discount window credit must be secured to the satisfaction of
the Federal Reserve Bank that is providing the credit. Satisfactory
collateral generally includes U.S. Treasury and federal agency se
curities and, if of acceptable quality, mortgage notes covering oneto four-family residences; state and local government securities;
and business, consumer, and other customer notes. Although col
lateral is generally held in safekeeping at the Federal Reserve
Banks or by acceptable third-party custodians, borrowers in good
financial condition may be permitted to hold their own collateral,
appropriately earmarked; lending against borrower-held collat
eral, however, is usually of only short duration.
Federal Reserve Banks ensure that the value of collateral pledged
to secure a discount window loan exceeds the amount of the loan.
The extra cushion of collateral helps protect the Reserve Banks
against loss in the event that a borrower defaults.
Technically, discount window credit can be extended as a discount
of eligible paper (notes, drafts, and bills of exchange) or as an ad
vance secured by collateral. Although these are two distinct forms
of credit, both practices are customarily referred to as discounting,
and the interest rate charged on such borrowing is called the dis
count rate. When obtaining credit in the form of a discount, the
borrowing depository institution transfers eligible paper carrying
its legal endorsement to the Federal Reserve Bank. In return, the
borrower is credited in an amount equal to the discounted value
of the eligible paper at the current discount rate. When the dis
counted paper matures, it is returned to the borrower, and the
borrower's reserve account is debited by the full amount of the
paper. An advance is simply a loan by a Federal Reserve Bank to
the borrowing institution on its note secured by adequate collat
eral. At one time, discounts were the predominant form of dis
count window credit. From an operational perspective, however,
advances are more convenient, and thus for many years all dis
count window credit has been in the form of advances.

The Federal Reserve most often makes a loan by crediting the re
serve account of the borrowing institution. For borrowers that
do not maintain accounts with the Federal Reserve, credit is ex
tended by increasing the reserve account of the borrower's corre
spondent bank (a bank that has agreed to accept the deposits of,
and perform services for, another); essentially, the Federal Re
serve writes a check on itself, which the borrower then deposits
with its correspondent bank. All loans, whether adjustment, sea
sonal, or extended credit, are technically demand notes and hence
have no real maturity. As a matter of convenience, discount offic
ers may arrange to extend credit for a period of time without re
quiring the borrowing institution to make a formal request to re
new the loan each day.*•

The three basic types of discount window credit are adjustment
credit, seasonal credit, and extended credit.
• Adjustment credit helps depository institutions meet short
term liquidity needs. For example, an institution experiencing
an unexpectedly large withdrawal of deposits may request ad
justment credit overnight or for a few days until it finds other
sources of funding.
• Seasonal credit assists smaller institutions in managing liquid
ity needs that arise from regular, seasonal swings in loans and
deposits, such as those at agricultural banks associated with
the spring planting season.
• Extended credit may be provided to depositories experiencing
somewhat longer-term liquidity needs that result from excep
tional circumstances.
In addition, the Federal Reserve has the power to extend emer
gency credit to entities other than banks, although it has not done
so since the 1930s.
Adjustment Credit
Adjustment credit helps depository institutions meet temporary
liquidity needs arising from short-term fluctuations in assets and
liabilities. Three basic principles govern the provision of adjust
ment credit:
• The Federal Reserve Bank provides credit at its
own discretion.

• Borrowing must be for an appropriate reason.
• The borrower must seek other reasonably available sources of
funds before turning to the discount window.
No fixed rules define an appropriate reason for borrowing. Some
common situations that are appropriate for borrowing include
meeting liquidity needs arising from an unexpected loss of
deposit or nondeposit funding, avoiding unexpected overnight
overdrafts in the institution's reserve account, or meeting liquid
ity needs arising from operational problems beyond the institu
tion's control or from an external event such as a natural disaster.
Discount officers apply judgment also in determin
ing whether an institution has sought all other rea
sonably available sources of funds before turning
<v „ .
to the window. For example, most large institu
amount o f
tions are presumed to have greater access to alter
adjustment
native funding sources than small community
borrowing has
declined over the
banks have. Branches and agencies of foreign
past decade.
banks, even if they are not large, are presumed to
have access to funding in national markets and
from their foreign parents or affiliates. Depositories that are mem
bers of multibank holding companies are expected to seek funding
from affiliates before turning to the window. Institutions that have
access to a special industry lender, such as the Federal Home Loan
Bank System, are expected to use these sources before requesting
an advance from the discount window.
When reviewing a borrowing request, discount officers consider
other pertinent information at their disposal, such as information
from the institution's primary supervisor, balance sheet informa
tion, the frequency and amount of past borrowing, and the
institution's general management of its reserve account. While
borrowing under the adjustment credit program, institutions pro
vide daily balance sheet data to the Federal Reserve for monitor
ing purposes. Discount officers carefully review these data to en
sure that adjustment credit is not being used inappropriately,
such as to fund a planned increase in loans, securities, or federal
funds sales or a predictable decline in deposit funding or other
liabilities.
A significant factor that affects the level of adjustment borrowing
is the spread between the federal funds rate and the discount rate.

m r u fr s t a r y — p q l

i m

^ x e m e n t

^-f f g

(See chart 3.1 for the average annual volume of adjustment bor
rowing since 1960.) Partly because discount officers routinely
monitor banks to ensure that borrowing requests are for appropri
ate reasons and partly because the market pays close attention to
banks that might be relying on discount window credit, most
banks are generally reluctant to borrow at the discount window.
A positive spread between the federal funds rate and the discount
rate (that is, a federal funds rate higher than the discount rate)
provides a pecuniary inducement to borrow. When reserves are in
heavy demand or short supply, the spread between the federal
funds rate and the discount rate tends to widen, encouraging
more institutions to overcome their reluctance to borrow. The re
sulting injection of borrowed reserves helps to alleviate reserve
market pressures and to moderate any unexpected spikes in the
federal funds rate. In this way, adjustment borrowing serves as a
safety valve that relieves short-term pressures in the reserves market.
The level of adjustment borrowing has declined on balance since
1980. This trend reflects several factors. During a period in which
many banks were failing, banks became concerned that the mar
ket might detect borrowing at the window and interpret it as a
sign of financial weakness. Also, a relatively narrow spread be
tween the federal funds rate and the discount rate reduced the peChart3.1
Adjustment borrowing and the spread of
the federal funds rate over the discount rate
Percentage points

Billions of dollars

4 i—

1.5

1.0
+
0
0.5

1960

1970

Note. Yearly averages.

1980

1990

cuniary incentive to borrow. Finally, various measures imple
mented by the Federal Reserve in recent years to reduce risk in the
payments system have generally led depositories to monitor their
reserve account positions more closely during the day, and conse
quently they can more promptly respond to unexpected funding
losses without relying on discount window credit. The downward
trend in adjustment credit notwithstanding, the Federal Reserve
encourages banks to turn to the window in appropriate circum
stances. Only in this way can the discount window continue to
fulfill its role as a safety valve in the reserves market.
Seasonal Credit
Established in 1973, the seasonal credit program assists small in
stitutions that lack effective access to national money markets. To
qualify for the program, an institution must demonstrate a sea
sonal funding need arising from regular, intra-yearly swings in
deposits and loans that persist for at least four weeks. The pro
gram is structured so that larger institutions must meet a larger
portion of their seasonal need through market funding sources;
institutions with more than $250 million in total deposits gener
ally cannot demonstrate a need under the criteria of the seasonal
program. Also, institutions with access to a special industry
lender that provides similar assistance are expected to use that
source before using the Federal Reserve seasonal credit program.
The regular pattern in seasonal borrowing during any given year

Chart 3.2
Seasonal borrowing
Millions of dollars

500

400

300

200

100

1975

Note. Monthly data.

1980

1985

1990

M Q

"f"" j1,

fyfi

E$ Ei* $[ EE fE

f~ C) f^t

i t

is associated primarily with loan demand in the farm sector
(chart 3.2). Most seasonal borrowers are small agricultural banks
that face strong loan demand and deposit runoffs
during the planting and growing seasons over the
spring and summer months. Later in the year,
farmers reap their harvest and pay down their
bank loans. Simultaneously, banks pay down their
seasonal borrowers
seasonal loans from the Federal Reserve.
are small agricul
tural banks whose
deposits fluctuate
The amount of seasonal borrowing grew rapidly
with the seasons.
from 1986 through 1989. Most of the growth re
flected increasing use of the program by non
member banks that had not been eligible for the
program before the Monetary Control Act. In the early 1990s,
the peak volume of seasonal borrowing edged down, probably
because of somewhat weaker loan demand during a period of
sluggish economic growth and the move to a market-related in
terest rate on seasonal credit.

cU.<

Extended Credit
Extended credit may be provided when exceptional circum
stances or practices adversely affect an individual institution.
To obtain extended credit, a borrower must comply with certain
conditions: It must make full use of reasonably available alterna
tive sources of funds and have a plan in place for eliminating its
liquidity problems. The institution must report special data on its
financial condition, including data on its lending, which may be
restricted while it is borrowing from the Federal Reserve. The
Federal Reserve extends credit of this type in coordination with
the borrower's primary supervisor.
When conditions warrant, extended credit may be granted to in
stitutions experiencing difficulties adjusting to changing condi
tions in the money market. For example, during the period of
high interest rates in the early 1980s, many thrift institutions suf
fered substantial losses of deposits. In cooperation with the Fed
eral Home Loan Bank System and other supervisors, the Federal
Reserve provided temporary assistance to some thrift institutions
until they could obtain funding elsewhere or make other adjust
ments to their balance sheets.
In determining whether to lend under the extended credit pro
gram, the Federal Reserve has always reviewed the financial con-

dition of an institution. The Federal Reserve has sometimes pro
vided credit to troubled depositories to facilitate an orderly clo
sure of the institution. In the 1980s, faced with a succession of
banking crises and record numbers of bank and thrift institution
failures, the Federal Reserve, in cooperation with other regula
tors, extended a significant volume of credit to troubled institu
tions until the problem could be resolved in an orderly fashion.
In the early 1990s, Congress began seeking ways to speed the
resolution of troubled institutions in an effort to reduce the cost of
bank and thrift institution failures. The outcome of this process
was the Federal Deposit Insurance Corporation Improvement Act
of 1991 (FDICIA). The “prompt corrective action" provisions of
FDICIA place increasingly severe restrictions on depositories as
their capital positions deteriorate and creates a framework that
expedites the resolution of depositories that are close to insolvency.
Among the restrictions imposed by FDICIA on depositories in
weak capital condition are limitations on access to the Federal
Reserve's discount window. Since December 1993, FDICIA has
limited the availability of Federal Reserve credit for undercapital
ized and critically undercapitalized institutions. FDICIA stipu
lates that the Federal Reserve may not lend to an undercapitalized
institution for more than 60 days in any 120-day period without
incurring a potential liability to the FDIC; exceptions to this rule
arise if the borrower's primary federal supervisor certifies that the
institution is viable or if the Board conducts its own examination
of the borrower and certifies that it is viable. A viable institution is
one that is not critically undercapitalized, is not expected to be
come critically undercapitalized, and is not expected to be placed
in conservatorship or receivership. FDICIA states that the Federal
Reserve may not lend to a critically undercapitalized institution
for more than five days beyond the date on which it became criti
cally undercapitalized without incurring a potential liability to
the FDIC and must report any liability of this nature to Congress
within six months after it is incurred.
Emergency Credit
Section 13 of the Federal Reserve Act empowers the Federal Re
serve to lend to individuals, partnerships, and corporations un
der “unusual and exigent" circumstances. When not secured by
U.S. government securities, any loans to nondepositories under
this authority must be approved by five members of the Board of

=m =T=*= o=m

Governors. Lending under these provisions has been extremely
rare, and such loans have not been extended since the 1930s.

RESERVE REQUIREMENTS
Requirements that depository institutions maintain a fraction of
their deposits in reserve in specified assets—the third tool of
monetary policy—have long been part of our nation's banking
history. The rationale for these requirements has changed over
time, however, as the country's financial system has evolved and
as knowledge about how reserve requirements affect the mon
etary system has grown. At present, reserve requirements aid in
the conduct of open market operations by helping to ensure a
stable, predictable demand for reserves; they thereby increase the
Federal Reserve's control over short-term interest rates.
Requiring banks to hold a certain fraction of their deposits in re
serve, either as cash in their vaults or as non-interest-bearing bal
ances at the Federal Reserve, imposes a cost on the private sector,
however. The cost is equal to the amount of forgone interest on
these funds—or at least on the portion of these funds that banks
hold only because of legal requirements and not to meet the
needs of their customers.

Before 1980, only banks that were members of the Federal Re
serve System were subject to reserve requirements established by
the Federal Reserve. By the 1970s, however, it had become appar
ent that the structure of reserve requirements was becoming out
dated. The regulatory structure and competitive pressures during
a period of high interest rates were putting an increasingly oner
ous burden on member banks. The situation fostered the growth
of deposits, especially the newly introduced interest-bearing
transaction deposits, at institutions other than member banks and
led many banks to leave the Federal Reserve System. Given this
situation, reserve requirements clearly needed to be applied to a
broad group of institutions for more effective monetary control—
that is, to make the relation between the amount of reserves sup
plied by the Federal Reserve and the overall quantity of money in
the economy more likely to be close.

The Monetary Control Act of 1980 (MCA) reformed reserve re
quirements to end the problem of membership attrition and to
facilitate monetary control. Under the act, all depository institu
tions regardless of membership in the Federal Reserve System
—commercial banks, savings banks, savings and loans, credit
unions, U.S. agencies and branches of foreign banks, and Edge
Act and agreement corporations—are subject to reserve require
ments set by the Federal Reserve. The Board of Governors may
impose reserve requirements on transaction deposits and on
nonpersonal time deposits solely for the purpose of implement
ing monetary policy, and these requirements must be applied uni
formly to all similar accounts at all depository institutions. The
reserve requirement may range from 8 percent to 14 percent on
transaction deposits, which include demand de
posits and interest-bearing accounts that offer un
limited checking privileges. Reserve requirements
on nonpersonal time deposits, ranging from 0 per
^ ^ ^ onm em ber
cent to 9 percent, may be differentiated by matu
as well as member
rity. The Board of Governors may also set reserve
depository
requirements on the net liabilities of depository
institutions are
subject to reserve
institutions in the United States to their foreign af
requirements.
filiates or to other foreign banks.
Reserve requirements are structured to bear relatively less heavily
on smaller institutions. At every depository, a reserve require
ment of 0 percent is applied to a certain amount of liabilities that
are subject to reserve requirements (reservable liabilities), and
relatively low requirements are applied to such liabilities up to
another level. These levels are adjusted annually to reflect growth
in the banking system. In 1994, the first $4.0 million of reservable
liabilities were made exempt from any requirements, and transac
tion deposits up to $51.9 million were given a reserve ratio of only
3 percent. Transaction deposits of more than $51.9 million were
subject to a 10 percent reserve requirement.
The MCA also empowers the Board of Governors under extraor
dinary circumstances to establish a supplemental reserve require
ment of up to 4 percentage points on transaction accounts if such
an action is deemed essential for the conduct of monetary policy.
Unlike reserves required under the regular schedule, these
supplemental reserves earn interest. Furthermore, the Federal Re
serve Act empowers the Board of Governors, after consultation
with Congress, to impose, for periods of up to 180 days, ratios

M O W g T

A M Y .....

outside the regular bounds established by the act and to apply
requirements to other classes of liabilities.
To provide banks with flexibility in meeting their reserve require
ments, the Federal Reserve requires banks to hold an average
amount of reserves over a two-week maintenance period rather
than a specific amount on each day. The Federal Reserve also of
fers reserve carry-forward options within certain limits; that is,
excess reserves of up to 4 percent of reserve and clearing-balance
requirements during the maintenance period may be carried for
ward and used to help satisfy requirements in the next period.
Any deficiency of up to 4 percent of a bank's reserve and clearingbalance requirements during a maintenance period similarly may
be carried forward to be made up by the holding of additional re
serves in the next period. A penalty equal to the discount rate
plus 2 percentage points is levied against reserve deficiencies be
yond the carry-forward amount.

Relation to Open Market Operations
The reserve requirement structure specified in the MCA was de
signed primarily to tighten the link between reserves and Ml. At
the time the act was written, the Federal Reserve was focusing on
controlling growth in Ml to foster the nation's economic objec
tives. A tight link between reserves and Ml was considered cru
cial to the Federal Reserve's efforts to exercise precise, short-run
control of Ml. By making all Ml deposits at all depositories sub
ject to reserve requirements and by extending requirements to
some nontransaction deposits as well, the MCA broadened the
reserve base. It increased the number of institutions bound by re
serve requirements to hold balances at the Federal Reserve,
thereby strengthening the System's ability to influence aggregate
levels of deposits by manipulating the quantity of reserves. The
MCA also improved the predictability of the link between re
serves and Ml by vastly simplifying the existing reserve require
ment structure: It made the components of Ml subject to more
uniform reserve ratios so that shifts among different types of de
posits or among institutions of various sizes or types no longer
altered the money-reserves relationship.
In 1982, the Federal Reserve took another step to improve its
short-run control of Ml by switching to a contemporaneous re

serve requirement (CRR) scheme. It made the period in which
banks must maintain their reserves against transaction deposits
virtually contemporaneous with the period in which deposit lev
els are computed for determining reserve requirements. This
move tightened the real-time link between reserves and M l. In so
doing, the Federal Reserve remedied a weakness in the short-run
monetary control mechanism of the reserves-based operating pro
cedure employed at the time.
Ironically, by 1984, when the CRR scheme was instituted, the
Federal Reserve had shifted its attention away from short-run,
reserves-based control of Ml and had begun to fo
cus on M2. The latter aggregate appeared more
closely linked to the objectives of policy than did
M l, which had begun to behave much differently
eserve
in relation to the economy, in part because it had
requirements
provide a stable,
become highly sensitive to interest rates after the
predictable demand
authorization of nationwide NOW accounts and
fo r aggregate
the general deregulation of interest rates on de
reserves.
posits. Thus, the basic structure of reserve require
ments, which had been meticulously designed to
facilitate the control of Ml through a reserves-oriented targeting
procedure, had come to be seen by some as an anachronism.
Actually, reserve requirements continue to be important in the
conduct of monetary policy, partly because they provide a stable,
predictable demand for aggregate reserves. Without reserve
requirements, banks would still hold some balances at the Federal
Reserve to meet their clearing needs. The exact amount of bal
ances that banks wish to hold for clearing purposes may vary
considerably from day to day, however, and the Federal Reserve
cannot precisely forecast it. By making reserve requirements the
binding constraint on banks' demand for reserves—that is, by
keeping required balances above the shifting and unpredictable
level needed for clearing purposes—the Federal Reserve can
more accurately determine the banking system's demand for
reserves. Thus, it can more readily achieve a desired degree of
pressure on bank reserve positions by manipulating the supply
of reserves.
Moreover, the level of required reserves and the averaging
method used to meet it afford banks flexibility that helps smooth
fluctuations in reserve markets. Banks use this flexibility by sub

stituting reserves on one day of the period, when reserves are ex
pected to be less costly, for those on another day, when reserves
are expected to be more costly. This flexibility would be reduced
if most reserve balances were needed for purposes of clearing.
Depositories that have insufficient required reserve balances to
meet their clearing needs can, under the provisions of the MCA,
open clearing accounts. Banks can contract with the Federal Re
serve to hold an average amount of their clearing balances in
their reserve accounts over the two-week reserve maintenance
period. If they fail to hold the amount required under the con
tract, they are penalized, much as they would be if they failed to
hold sufficient balances to meet their reserve requirements. Un
like required reserve balances, however, which do not earn inter
est, banks receive earnings credits on clearing balances held un
der their contractual agreement. They may use these earnings
credits to defray the costs of Federal Reserve priced services.
Thus, for a bank, opening a clearing balance account is a virtually
costless means of boosting the average balance it must hold in its
reserve account over the maintenance period, of providing extra
insurance against overdrafts, and of adding flexibility to reserve
management.

Changes in reserve requirement ratios—the percentage of depos
its of certain types that depositories must hold in reserve—can be
a useful supplementary tool of monetary policy. Increasing the
ratios reduces the volume of deposits that can be supported by a
given level of reserves and, in the absence of other actions, re
duces the money stock and raises the cost of credit. Decreasing
the ratios leaves depositories initially with excess reserves, which
can induce an expansion of bank credit and deposit levels and a
decline in interest rates; it also lowers the costs of bank funding
by reducing the amount of non-interest-bearing assets that must
be held in reserve.
However, because even small changes in reserve ratios can sub
stantially affect required reserves, adjustments to reserve require
ments are not well suited to the day-to-day implementation of
monetary policy. Indeed, to avoid large, sudden effects on depos
its and credit, changes in reserve ratios have, when implemented,

typically been at least partially offset by open market operations.
Also, as reserve requirements are an important variable in banks'
business calculations, frequent changes in them would unneces
sarily complicate financial planning by these institutions. As a re
sult, the Federal Reserve changes reserve requirements only infre
quently and usually merely to reinforce or to supplement the
effects of open market operations and discount policy on overall
monetary and credit conditions. Changes in reserve ratios have
also been used at times for their announcement effect—that is, to
emphasize a particular direction of policy and to influence the
public's perception of the thrust of monetary policy.
The use of reserve requirements to supplement
monetary policy was somewhat more prevalent in
the 1960s and 1970s, when the Federal Reserve
\ ^ h e Federal
sought to influence the expansion of money and
Reserve changes
credit
partly by manipulating bank funding costs.
reserve requirements
As financial innovation spawned new sources of
only infrequently.
bank funding, the Federal Reserve adapted re
serve requirements to these new financial prod
ucts. It also often changed requirements on spe
cific bank liabilities that were most frequently used to fund new
lending. As banks relied more heavily on the issuance of largedenomination time deposits, such as certificates of deposit, to
fund their acquisitions of assets, the Federal Reserve periodically
altered reserve requirements on these instruments and thereby
affected the cost of their issuance and, hence, the supply of credit
through banks. It sometimes supplemented its actions by placing
a marginal reserve requirement on large time deposits—that is, an
additional requirement applied only to each new increment of
these deposits. Reserve requirements were also imposed on other,
newly emerging liabilities that were the functional equivalents of
deposits, such as Eurodollar borrowings. The imposition of re
quirements on these and other managed liabilities was especially
useful in the late 1970s as the Federal Reserve sought to curb the
expansion of money and credit and thereby reduce inflation.

rr*

More recently, the Federal Reserve has taken steps to reduce re
serve requirements. In December 1990, the required reserve ratio
on nonpersonal time deposits was pared from 3 percent to zero,
and in April 1992 the 12 percent requirement on transaction de
posits was trimmed to 10 percent. These actions were partly moti
vated by evidence suggesting that some lenders had adopted a

..J¥ J ... T .. A ... R ... Y ........P '

... Y

•• / ..M

R L S h = M = S = = H = ^ = X = ^ r= Q = ^

more cautious approach to extending credit, which was increas
ing the cost and restricting the availability of credit to some types
of borrowers. By reducing funding costs and thus providing de
positories with easier access to capital markets, the cuts in reserve
requirements put banks in a better position to extend credit. The
reduction for nonpersonal time deposits was aimed directly at
spurring bank lending because these accounts are often used as a
marginal source for funding. ■

The Federal Reserve in the
International Sphere
he

••••••

U.S.economy and the world economy are linked in many ways.
Economic developments in this country have a major influ
ence on production, employment, and prices beyond our bor
ders; at the same time, developments abroad significantly af
fect our economy. The U.S. dollar, which is the currency most
used in international transactions, constitutes more than half
of other countries' official foreign exchange reserves. U.S.
banks abroad and foreign banks in the United States are im
portant actors in international financial markets.

THE ACTIVITIES OF THE FEDERAL RESERVE and the international economy influence each other. Thus, in deciding on the ap
propriate monetary policy for achieving basic economic goals, the
Board of Governors and the Federal Open Market Committee
consider the record of U.S. international transactions, movements
in foreign exchange rates, and other international economic de
velopments. And in the area of bank supervision and regulation,
innovations in international banking require continual assess
ments of and modifications in the Federal Reserve's orientation,
procedures, and regulations.
Not only do Federal Reserve policies shape and get shaped by in
ternational developments; the U.S. central bank also participates
directly in international affairs. For example, the Federal Reserve
undertakes foreign exchange transactions in cooperation with the
U.S. Treasury. These transactions, and similar ones by foreign
central banks involving dollars, may be facilitated by reciprocal
currency (swap) arrangements that have been established be
tween the Federal Reserve and the central banks of other coun
tries. The Federal Reserve also works with other agencies of the
U.S. government to conduct international financial policy, partici
pates in various international organizations and forums, and is in
almost continuous contact with other central banks on subjects of
mutual concern.

INTERNATIONAL LINKAGES
The primary instruments of monetary policy—open market op
erations, the discount window, and reserve requirements—are
employed essentially to attain basic economic objectives for the
U.S. economy. But their use also influences, and is influenced by,
international developments.
For example, U.S. monetary policy actions influence exchange
rates. Thus, the dollar's foreign exchange value in terms of other
currencies is one of the channels through which U.S. monetary
policy affects the U.S. economy. If Federal Reserve actions
raised U.S. interest rates, for instance, the foreign exchange
value of the dollar generally would rise. An increase in
the foreign exchange value of the dollar, in turn, would
raise the foreign price of U.S. goods traded on world mar
kets and lower the price of goods imported into the United
States. These developments could lower output and price
levels in the U.S. economy. An increase in interest rates in a for
eign country, in contrast, could raise worldwide demand for as
sets denominated in that country's currency and thereby reduce
the dollar's value in terms of that currency. U.S. output and price
levels would tend to increase—directions just opposite of when
U.S. interest rates rise.
Therefore, in formulating monetary policy, the Board of Gover
nors and the FOMC draw upon information about and analysis of
international as well as U.S. domestic influences. Changes in pub
lic policies or in economic conditions abroad and movements in
international variables that affect the U.S. economy, such as ex
change rates, must be evaluated in assessing the stance of U.S.
monetary policy.
In the 1980s, recognizing their growing economic interdepen
dence, the United States and the other major industrial countries
intensified their efforts to consult and cooperate on macroeco
nomic policies. At the 1986 Tokyo Economic Summit, they agreed
upon formal procedures to improve the coordination of policies
and the multilateral surveillance of their economic performance.
The Federal Reserve works with the U.S. Treasury in coordinating
international policy, particularly when, as has been the norm
since the late 1970s, they intervene together in currency markets
to influence the external value of the dollar.

I N T E R N A T I O N A L

S P H E R E

Using the forum provided by the Bank for International Settle
ments (BIS), in Basle, Switzerland, the Federal Reserve works
with representatives of the central banks of other countries on
mutual concerns regarding monetary policy, international finan
cial markets, banking supervision and regulation, and payments
systems. (The Chairman of the Board of Governors also repre
sents the U.S. central bank on the Board of Directors of the BIS.)
Representatives of the Federal Reserve participate in the activities
of the International Monetary Fund (IMF), discuss macroeco
nomic, financial market, and structural issues with representa
tives of other industrial countries at the Organisation for Eco
nomic Co-operation and Development, in Paris, and work with
central bank officials of Western Hemisphere countries at meet
ings such as that of the Governors of Central Banks of the Ameri
can Continent.
,>v.

, ; ^

■■■■■■■■■■■■■■■
FOREIGN CURRENCY OPERATIONS

The Federal Reserve has conducted foreign currency operations—
the buying and selling of dollars in exchange for foreign currency
—for customers since the 1950s and for its own account since
1962. These operations are directed by the FOMC, acting in close
cooperation with the U.S. Treasury, which has overall responsibil
ity for U.S. international financial policy. The Manager of the Sys
tem Open Market Account at the Federal Reserve Bank of New
York acts as the agent for both the FOMC and the Treasury in car
rying out foreign currency operations.
The purpose of Federal Reserve foreign currency operations has
evolved in response to changes in the international monetary sys
tem. The most important of these changes was the transition in
the 1970s from the Bretton Woods system of fixed exchange rates
to a system of flexible exchange rates for the dollar in terms of
other countries' currencies.1Under the latter system, the main aim
of Federal Reserve foreign currency operations has been to
counter disorderly conditions in exchange markets through the

1. The IMF and the International Bank for Reconstruction and Development
(known informally as the World Bank) were created at an international
monetary conference held in Bretton Woods, New Hampshire, in 1944. As
part of the Bretton Woods arrangements, a system of fixed exchange rates was
established.

purchase or sale of foreign currencies (called intervention opera
tions), primarily in the New York market. During some episodes
of downward pressure on the foreign exchange value of the dol
lar, the Federal Reserve has purchased dollars (sold foreign cur
rency) and has thereby absorbed some of the selling pressure on
the dollar. Similarly, the Federal Reserve may sell dollars (pur
chase foreign currency) to counter upward pressure on the
dollar's foreign exchange value. The Federal Reserve Bank of
New York also carries out transactions in the U.S. foreign ex
change market as an agent for foreign monetary authorities.
Intervention operations involving dollars could affect the supply
of reserves in the U.S. depository system. A purchase of foreign
currency by the Federal Reserve with newly created dollars, for
instance, would increase the supply of reserves. In practice, how
ever, such operations are not allowed to alter the supply of mon
etary reserves available to U.S. depository institutions. That is, in
terventions are "sterilized" through open market operations so
that they do not lead to a change in the market for domestic mon
etary reserves different from that which would have occurred in
the absence of intervention.
For example, the Federal Reserve, perhaps in connection with Ger
man authorities, may want to counter downward pressure on the
dollar's foreign exchange value in relation to the German mark.
The Federal Reserve reduces its balances denominated in German
marks (an asset on the Federal Reserve balance sheet) and sells
the marks for dollars on
the open market, reduc
ing the supply of dollar
bank reserves. Unless
an explicit decision has
been made to lower the
supply of bank reserves,
the Federal Reserve
uses the dollars it has
acquired in the transac
tion to purchase a Trea
sury security and thus

he Foreign Exchange Desk at the
Federal Reserve Bank of New York.

I N T E R N A

T I O

N A

S P H E R E

restores the supply of dollar bank reserves to the former ]evel.
The net effect of such an intervention operation on the pr vate
sector is a reduction in the supply of dollar-denominated
securities and an increase in the supply of mark-denomi
nated assets. The German central bank, in turn, will ster
ilize the unwanted effects of the transaction, if any, on
the level of mark-denominated bank reserves.
A dollar intervention initiated by a foreign central bank
also leaves the supply of bank reserves in the United
States unaffected, unless it changes the deposits that the central
bank holds with the Federal Reserve. If, for example, the foreign
central bank were to purchase dollars and place them in its ac
count with the Federal Reserve, it would take these dollars from
the U.S. banking system. However, the Domestic Trading Desk at
the Federal Reserve Bank of New York would offset this with
drawal by buying a Treasury security to supply reserves. Most
dollar sales by foreign central banks are implemented by drawing
down holdings of dollar securities or by borrowing dollars in the
market, and thus they do not need to be countered by open mar
ket operations to leave the supply of reserves unchanged.

SwapNeiwork
An important feature of the foreign currency operations of the
Federal Reserve and of foreign central banks over the past thirty
years has been the reciprocal currency (swap) network, which
consists of reciprocal short-term arrangements (comparable to re
purchase and matched sale-purchase agreements in the domestic
government securities market) among the Federal Reserve, other
central banks, and the BIS. These arrangements, which have been
used infrequently in recent years, give the Federal Reserve tem
porary access to the foreign currencies it needs for intervention
operations to support the dollar and give the partner foreign cen
tral banks temporary access to the dollars they need to support
their own currencies. Swap transactions involving dollars are
implemented through the Federal Reserve Bank of New York,
acting as an agent for the Federal Reserve System.
A swap transaction involves both a spot (immediate delivery)
transaction, in which the Federal Reserve transfers dollars to an
other central bank in exchange for foreign currency, and a simul

taneous forward (future delivery) transaction, in which the two
central banks agree to reverse the transaction, typically three
months in the future. The Federal Reserve may initiate a swap
transaction (make a swap drawing) when it needs the foreign cur
rency obtained in the spot half of the transaction to finance inter
vention sales of foreign currency in support of the dollar. To repay
the drawings at maturity, the Federal Reserve re-acquires the for
eign currency. Such acquisitions have usually been accomplished
by purchasing foreign currency in the market, thereby reversing
the original intervention in support of the dollar. When a foreign
central bank initiates the swap drawing, it uses the dollars ob
tained in the spot half of the transaction to finance sales of dollars
to support its own currency. Subsequently, it meets its obligation
to deliver dollars to the Federal Reserve by re-acquiring dollars in
the market. In these swap transactions, the foreign central bank
pays interest on the dollar drawings, at the U.S. Treasury bill rate,

Table 4.1
Federal Reserve reciprocal currency arrangements, June 30, 1994
Millions of dollars

Institution
Austrian National Bank

Amount o f
facility

National Bank of Belgium

250
1,000

Bank of Canada

2,000

National Bank of Denmark

250

Bank of England

3,000

Bank of France

2,000

German Bundesbank

6,000

Bank of Italy

3,000

Bank of Japan

5,000

Bank of Mexico

3,000

Netherlands Bank

500

Bank of Norway

250

Bank of Sweden

300

Swiss National Bank

4,000

B a n k f o r In te r n a tio n a l S ettlem en ts

Dollars against Swiss francs
Dollars against other authorized European currencies
Total

600
1,250
32,400

.Q .U A .&.S

-P —H - E R E

and the Federal Reserve pays a comparable rate on the foreign
currency counterpart.
The Federal Reserve established its first swap arrangement with
the Bank of France in March 1962. It subsequently made similar
arrangements with other central banks, and the sizes of the facili
ties have increased from time to time. At the end of June 1994, the
Federal Reserve had swap arrangements with fourteen foreign
central banks and the BIS totaling $32.4 billion (table 4.1). Since
the establishment of the network, eleven foreign central banks
and the BIS have made swap drawings. Foreign drawings were
more frequent and on a larger scale in the 1960s than they have
been since. The Federal Reserve has, at various times, made swap
drawings on nine foreign central banks and the BIS.

Market Intervention
The nature and scope of exchange market operations by the Fed
eral Reserve and the use of the swap network have changed in re
sponse to changes in the character of the international monetary
system. Under the Bretton Woods system of fixed exchange rates,
foreign authorities were responsible for intervening in exchange
markets to maintain their countries' exchange rates within 1 per
cent of their currencies' parities with the U.S. dollar; direct ex
change market intervention by U.S. authorities was extremely
limited because the United States stood ready to buy and sell dol
lars against gold at $35 per ounce. After the United States sus
pended the gold convertibility of the dollar in 1971, a regime of
managed flexible exchange rates emerged; in 1973, under that re
gime, the United States began to intervene in exchange markets
on a more significant scale. Federal Reserve swap drawings fi
nanced much of this intervention. In 1978, the regime of flexible
exchange rates was codified in an amendment to the IMF's Ar
ticles of Agreement.
In the early 1980s, the United States curtailed its official exchange
market operations, although it remained ready to enter the market
when needed to counter disorderly conditions. In 1985, particu
larly after September, when representatives of the five major in
dustrial countries reached the so-called Plaza Accord on exchange
rates, the United States began to use exchange market interven
tion more frequently as a policy instrument. During the second

..=gy

half of the 1980s, U.S. intervention to restrain the rise in the
dollar's value on foreign exchange markets (that is, official U.S.
purchases of assets denominated in foreign currencies) was suffi
ciently heavy that the stock of foreign exchange reserves acquired
enabled the Federal Reserve to finance purchases of dollars, when
it needed to support the dollar's external value, without drawing
on its swap lines with other central banks.

Other U.S. For

rces

Since the late 1970s, the U.S. Treasury has financed about half of
total U.S. support for the dollar, and the Federal Reserve has fi
nanced the rest. The Treasury acquired foreign currency resources
partly through its own swap arrangement with the German cen
tral bank but mainly through drawings on the International Mon
etary Fund (IMF), sales of special drawing rights, and issuance of
securities denominated in foreign currencies (these securities have
since been retired).2Moreover, over the post-Bretton Woods era,
Federal Reserve and Treasury interventions have on balance been
net purchases of foreign currencies against dollars; these net pur
chases, along with cumulated earnings on the assets, have tended
to build up the stock of U.S. official foreign exchange reserves.
At the end of June 1994, the United States held foreign currency
reserves valued at $42.8 billion. Of this amount, the Federal Re
serve held foreign currency assets of $22.5 billion, and the Ex
change Stabilization Fund of the Treasury held the rest.

INTERNATIONAL BANKING
The Federal Reserve is interested in the international activities of
banks not only because of its role as a bank supervisor but also be
cause such activities are often close substitutes for domestic bank
ing activities and need to be monitored carefully to help interpret
U.S. monetary and credit conditions. Moreover, international
banking institutions are important vehicles for capital flows into
and out of the United States.

2. Special drawing rights (SDRs) are unconditional credit lines created by the
IMF and allocated on occasion to the members of the IMF to supplement their
international reserve assets.

The location of international banking depends on such factors
as the business needs of customers, the scope of operations
permitted by a country's legal and regulatory framework, and
tax considerations. The international activities of U.S.-chartered
banks include lending to and accepting deposits from foreign cus
tomers at the banks' U.S. offices and engaging in other financial
transactions with foreign counterparts. However, the bulk of the
international business of U.S.-chartered banks takes place at their
branch offices located abroad and at their foreign-incorporated
subsidiaries, usually wholly owned. Much of the activity of for
eign branches and subsidiaries of U.S. banks has been Euro
currency business—that is, taking deposits and lending in curren
cies other than that of the country in which the banking office is
located. U.S. banks are also increasingly offering a range of so
phisticated financial products to residents of other countries and
to U.S. firms abroad.
The international role of U.S. banks has a counterpart in foreign
bank operations in the United States. U.S. offices of foreign banks
actively participate as both borrowers and investors in U.S. do
mestic money markets and are active in the market for loans to
U.S. businesses. (See chapter 5 for a discussion of the Federal
Reserve's supervision and regulation of the international activities
of U.S. banks and the U.S. activities of foreign banks.)
International banking by both U.S.-based and foreign banks facili
tates the holding of Eurodollar deposits—dollar deposits in bank
ing offices outside the United States—by nonbank U.S. entities.
Similarly, Eurodollar loans—dollar loans from banking offices
outside the United States—can be an important source of credit
for U.S. companies (banks and nonbanks). Because they are close
substitutes for deposits at domestic banks, Eurodollar deposits of
nonbank U.S. entities at foreign branches of U.S. banks are in
cluded in the U.S. monetary aggregate M3; Eurodollar term de
posits of nonbank U.S. entities at all other banking offices in the
United Kingdom and Canada are also included in M3. Overnight
Eurodollar deposits of nonbank U.S. entities at foreign branches of
U.S. banks are included in M2. (See box in chapter 2 for the U.S.
monetary aggregates.) ■

Supervision and
Regulation
he Federal Reserve has supervisory and regulatory authority
over a wide range of financial institutions and activities.
It works with other federal and state financial authorities to en
sure safety and soundness in the operation of financial institu
tions, stability in the financial markets, and fair and equitable
treatment of consumers in their financial transactions.

THE FEDERAL RESERVE HAS PRIMARY RESPONSIBILITY
for supervising and regulating several types of banking organizations:
• All bank holding companies, their nonbank subsidiaries, and
their foreign subsidiaries
• State-chartered banks that are members of the Federal Reserve
System (state member banks) and their foreign branches and
subsidiaries
• Edge Act and agreement corporations, through which U.S.
banking organizations conduct operations abroad.
It also shares important responsibilities with state supervisors
and with other federal supervisors, including overseeing both the
operations of foreign banking organizations in the United States
and the establishment, examination, and termination of branches,
agencies, commercial lending subsidiaries, and representative of
fices of foreign banks in the United States.
Other supervisory and regulatory responsibilities of the Federal
Reserve include
• Regulating margin requirements on securities transactions
• Implementing certain statutes that protect consumers in credit
and deposit transactions
• Monitoring compliance with the money-laundering provisions
contained in the Bank Secrecy Act
• Regulating transactions between banking affiliates.

7 2

The hands-on experience of supervision and regulation provides
the Federal Reserve with a base of essential knowledge for mon
etary policy deliberations. Further, its supervisory and regulatory
roles enable the Federal Reserve to forestall financial crises or to
manage crises once they occur. In the past decade, the experience
and knowledge of examiners and supervisory staff proved instru
mental in the Federal Reserve's responsiveness to the Mexican
debt crisis of 1982, the collapse in 1985 of privately insured thrift
institutions in Ohio and Maryland, the stock market crash of
1987, and the 1990 failure of the Drexel-Burnham investment firm.

SUPERVISORY FUNCTIONS
Although the terms bank supervision and bank regulation are often
used interchangeably, they actually refer to distinct, but comple
mentary, activities. Bank supervision involves the monitoring, in
specting, and examining of banking organizations to assess their
condition and their compliance with relevant laws and regula
tions. When an institution is found to be in noncompliance or to
have other problems, the Federal Reserve may use its supervi
sory authority to take formal or informal action to have the insti
tution correct the problems. Bank regulation entails making and
issuing specific regulations and guidelines governing the struc
ture and conduct of banking, under the authority of legislation.
The Federal Reserve shares supervisory and regulatory responsi
bilities with the Office of the Comptroller of the Currency (OCC),
the Federal Deposit Insurance Corporation (FDIC), and the Office
of Thrift Supervision (OTS) at the federal level, with the banking
agencies of the various states, and with foreign banking authori
ties for the international operations of U.S. banks and the opera
tions of foreign banks in the United States (see table 5.1). This
structure has evolved partly out of the complexity of the U.S. fi
nancial system, with its many kinds of depository institutions
and numerous chartering authorities. It has also resulted from a
wide variety of federal and state laws and regulations designed
to remedy problems that the U.S. commercial banking system has
faced over its history.
In recent years, several factors—including rapidly changing con
ditions in the banking industry, problems within the savings and
loan and banking industries, and legislative requirements—have

Table 5.1
Federal supervisor and regulator of corporate components
of banking organizations in the United States

Component

Supervisor and Regulator

Bank holding companies

National banks

OCC

State banks
Members
Nonmembers

FR
FDIC

Cooperative banks

FDIC/FR

Industrial banks (if insured)1

FDIC

Section 20 affiliates

SEC/FR

Thrift holding companies

OTS

Savings banks

OTS/FDIC/FR

Savings and loan associations

OTS

Edge Act and agreement corporations

Foreign banks2
Branches and agencies3
State licensed
Federally licensed
Representative offices

FR/FDIC
OCC/FR/FDIC
FR

N ote. FR = Federal Reserve; OCC = Office of the Comptroller of the Cur
rency; FDIC = Federal Deposit Insurance Corporation; SEC = Securities and
Exchange Commission; OTS = Office of Thrift Supervision
1. Uninsured industrial banks are supervised by the states.
2. Applies to direct operations in the United States. Foreign banks may also
have indirect operations in the United States through their ownership of U.S.
banking organizations.
3. The FDIC has responsibility for branches that are insured.

necessitated the increased coordination of regulatory efforts. An
important element in such coordination is the Federal Financial
Institutions Examination Council (FFIEC), established by statute
in 1978, consisting of the Chairpersons of the FDIC and the Na
tional Credit Union Administration, the Comptroller of the Cur
rency, the Director of the OTS, and a Governor of the Federal
Reserve Board appointed by the Board Chairman. The FFIEC's
purposes are to prescribe uniform federal principles and stan

dards for the examination of depository institutions, to promote
coordination of bank supervision among the federal agencies that
regulate financial institutions, and to encourage better coordina
tion of federal and state regulatory activities. Through the FFIEC,
state and federal regulatory agencies may exchange views on im
portant regulatory issues. Among other things, the FFIEC has de
veloped uniform financial reporting forms for use by all federal
and state banking regulators.

Domestic Upexations of U.S. Banking Organizations
The Federal Reserve's off-site supervision of banking institutions
involves the periodic review of financial and other information
about banks and bank holding companies. Information that the
Federal Reserve reviews includes reports of recent
examinations and inspections, information pub
lished in the financial press and elsewhere, and,
(
upervision
most important, the standard financial regulatory
includes
reports that are filed by institutions. The reports
off-site monitoring
for banks are referred to as the Consolidated Re
o f financial reports
ports of Condition and Income (Call Reports) and
and on-site
examination visits.
those for bank holding companies, as the Consoli
dated Financial Statements for Bank Holding
Companies (FR Y-9 Series). The number and the
type of report forms that must be filed depend on the size of an
institution, the scope of its operations, and the types of financial
entities that it includes. Therefore, the report forms filed by larger
institutions that engage in a wider range of activities are gener
ally more numerous and more detailed than those filed by
smaller organizations.
In its ongoing, off-site supervision of banks and bank holding
companies, the Federal Reserve uses automated screening sys
tems to identify organizations that have poor or deteriorating fi
nancial profiles and to help detect adverse trends developing in
the banking industry. The System to Estimate Examinations Rat
ings (SEER) statistically estimates an institution's supervisory rat
ing based on information that institutions provide in their quar
terly Call Report filings. When SEER and other supervisory tools
identify an organization that has problems, a plan for correcting
the problems—which may include sending examiners to the insti
tution—is developed.

In on-site examinations of state member banks and inspections of
bank holding companies and their nonbank subsidiaries, the su
pervisory staffs of the Federal Reserve Banks generally
• Evaluate the soundness of the institution's assets and the ef
fectiveness of its internal operations, policies, and management
• Analyze key financial factors such as the institution's capital,
earnings, liquidity, and sensitivity to interest rate risk
• Assess the institution's exposure to off-balance-sheet risks
• Check for compliance with banking laws and regulations
• Determine the institution's overall soundness and solvency.
The Federal Reserve also evaluates transactions between a bank
and its affiliates to determine the effect of the transactions on the
institution's condition and to ascertain whether the transactions
are consistent with sections 23A and 23B of the Federal Reserve
Act. Section 23A prohibits, among other things, a bank from pur
chasing the low-quality assets of an affiliate and limits asset pur
chases, extensions of credit, and other enumerated transactions
by a single bank from a single affiliate to 10 percent of the bank's
capital, or from all affiliates combined to 20 percent of its surplus.
Moreover, section 23B requires that all transactions with affiliates
be on terms substantially the same as, or at least as favorable as,
those prevailing at the time with comparable non-affiliated com
panies. The Federal Reserve is the only banking agency that has
the authority to exempt any bank from these requirements.
The Federal Reserve Board has consistently em
phasized the importance of its on-site examina
tions and inspections in the supervisory process.
y - \ ll insured
Policies regarding the frequency of examinations
^ depository
institutions
must be
and inspections are reviewed regularly to address
examined
annually.
concerns of safety and soundness as well as of
regulatory burden on institutions under Federal
Reserve supervision. In response to banking and
other financial problems that developed in the 1980s, the Board in
1985 adopted a policy requiring the Reserve Banks to examine ev
ery state member bank and inspect all large bank holding compa
nies at least once every year. Subsequently, in 1991, Congress
passed the Federal Deposit Insurance Corporation Improvement
Act of 1991 (FDICIA), which imposed the legal requirement that
all insured depository institutions be examined once every twelve
months. (Certain small banks may be examined once every eigh
teen months.) The Board's policy is that large banks are to be ex

amined by a Reserve Bank or jointly by a Reserve Bank and the
responsible state banking agency; for smaller institutions, the Re
serve Banks may alternate years with the responsible state bank
ing agency. Board policy also requires that problem banks be exam
ined more frequently by Reserve Banks.
The Board's policy regarding on-site inspections of bank holding
companies also requires that companies that are large, have sig
nificant credit-extending nonbank subsidiaries or debt outstand
ing to the general public, or have severe problems be inspected
annually. The remaining companies must be inspected at least
once every three years, except for the smallest, least-complex
bank holding companies, which may be inspected on a sample basis.
The Federal Reserve also conducts special on-site examinations of
banking organizations' securities trading activities. Generally, se
curities trading activities of banking organizations are conducted
in separately incorporated, nonbank entities directly or indirectly
owned by bank holding companies. Such activities are governed
by section 20 of the Banking Act of 1933 (the
Glass-Steagall Act), which prohibits banks that are
members of the Federal Reserve System from affili
ating with entities that are "engaged principally" in
underwriting (that is, purchasing for resale) or oth
erwise dealing in securities. In 1987, the Board ruled
that a company would not be engaged principally
in these activities if no more than 5 percent of its
revenues were derived from underwriting or dealing in certain
types of securities that banks are not eligible to trade (referred to
as bank-ineligible securities). The subsidiaries in which such ac
tivities are conducted are commonly referred to as section 20 sub
sidiaries. As a result of the 1987 ruling, the Board approved pro
posals by banking organizations to underwrite and deal in
specific types of securities (commercial paper, municipal revenue
bonds, conventional residential mortgage-related securities, and
securitized consumer loans) on a limited basis and in a manner
consistent with existing banking statutes. Before the ruling, bank
ing organizations were restricted to underwriting and dealing in
bank-eligible securities, such as government securities, general
municipal obligations, and money market instruments. In 1989,
the Board raised the percentage of permissible trading in bankineligible securities to 10 percent of revenues. It also expanded
the range of permitted activities and approved applications by

S U P E R V I S I O N

R E G U L A T I O N

five banking organizations to underwrite and deal in any debt or
equity security (except mutual funds), subject to several condi
tions, including reviews of the organization's management and
operations. By year-end 1993, thirty-one foreign and domestic
banking organizations had established section 20 subsidiaries.
The Federal Reserve conducts on-site examinations of other bank
and nonbank activities: consumer affairs (see chapter 6 for a dis
cussion of this area); trust activities; securities transfer agency ac
tivities; activities by government and municipal securities deal
ers; and electronic data processing.
If the Federal Reserve determines that a bank or bank holding
company has problems that affect the institution's safety and
soundness or is out of compliance with laws and regulations, it
may take a supervisory action to ensure that the organization un
dertakes corrective measures. Typically, such findings are com
municated to the management and directors of a banking organi
zation in a written report. The management and directors are then
requested to address all identified problems voluntarily and to
take measures to ensure that the problems are corrected and will
not recur. Most problems are resolved promptly after they are
brought to the attention of an institution's management and di
rectors. In some situations, however, the Federal Reserve may
need to take an informal supervisory action, by requesting that an
institution adopt a broad resolution or agree to the provisions of a
memorandum of understanding to address the problem.
If necessary, the Federal Reserve may take formal enforcement
actions to compel the management and directors of a troubled
banking organization or persons associated with it to address the
organization's problems. For example, if an institution has signifi
cant deficiencies or fails to comply with an informal action, the
Federal Reserve may enter into a written agreement with the
troubled institution, or may issue a cease and desist order against
the institution or against an individual associated with the insti
tution, such as an officer or director. The Federal Reserve may
also assess a fine, or remove an officer or director from office and
permanently bar him or her from the banking industry, or both.
All written agreements issued after November 1990 and all cease
and desist orders, civil money penalty orders, and removal and
prohibition orders issued after August 1989 are available to the public.

7 7

The Federal Reserve's supervision and regulation of the interna
tional operations of banking organizations that are members of
the Federal Reserve System entail four principal statutory respon
sibilities:
• Authorizing the establishment of foreign branches of member
banks and regulating the scope of their activities
• Chartering and regulating the activities of Edge Act and
agreement corporations
• Authorizing overseas investments by member banks, Edge
Act and agreement corporations, and bank holding compa
nies, and regulating the activities of foreign firms acquired by
such investments
• Establishing supervisory policy and practices with respect to
the foreign lending of member banks.
Under federal law, U.S. banks may conduct a wider range of ac
tivities abroad than they may pursue in this country. The Federal
Reserve Board has broad discretionary powers to regulate the
overseas activities of member banks and bank
holding companies so that, in financing U.S. trade
and investments overseas, U.S. banks can be fully
competitive with institutions of the host country.
he foreign
In addition, through Edge Act and agreement cor
activities o f
porations, banks may conduct deposit and loan
US. banking
business in U.S. markets outside their home states,
organizations are
provided that the operations of these corporations
also supervised by
the Federal Reserve.
are related to international transactions.
The International Lending Supervision Act of 1983
directed the Federal Reserve and other U.S. banking agencies to
consult with the supervisory authorities of other countries to
adopt effective and consistent supervisory policies and practices
with respect to international lending. It also directed the banking
agencies to strengthen the international lending procedures of
U.S. banks by, among other things, requiring an institution either
to write off assets or to maintain special reserves when potential
or actual impediments to the international transfer of funds make
it likely that foreign borrowers will be unable to make timely pay
ments on their debts.

U P*

g" y

&—

fl £• G (/ I— A

U.S. Activities of Foreign Banking Organizations
Although foreign banks have been operating in the United States
for more than a century, before 1978 the U.S. branches and agen
cies of these banks were not subject to supervision or regulation
by any federal banking agency. When Congress enacted the Inter
national Banking Act of 1978 (IBA), it created a federal regulatory
structure for the U.S. branches and agencies of foreign banks. The
IBA established a policy of "national treatment" for foreign banks
operating in the United States to promote competitive equality
between them and domestic institutions. This
policy gives foreign banking organizations operat
ing in the United States the same powers, and
( ~^\Toreign banks
subjects them to the same restrictions and obliga
'—
operating in
tions, that apply to the domestic operations of U.S.
the United States
banking organizations.
must adhere to
US. laws.
Under the IBA, primary responsibility for the su
pervision and regulation of branches and agencies
remained with the state or federal licensing authorities. The Fed
eral Reserve was assigned residual authority to ensure national
oversight of the operations of foreign banks. Congress gave the
Federal Reserve examination authority over state-licensed U.S.
branches and agencies and state-chartered banking subsidiaries
of foreign banks but instructed it to rely, to the extent possible, on
the examinations conducted by the licensing authorities.
The Federal Reserve may not approve an application by a foreign
bank to establish a branch, agency, or commercial lending com
pany unless it determines that (1) the foreign bank and any par
ent foreign bank engage directly in the business of banking out
side the United States and are subject to comprehensive
supervision or regulation on a consolidated basis by their home
country supervisors and (2) the foreign bank has furnished to the
Federal Reserve the information that the Federal Reserve requires
in order to assess the application adequately. The Federal Reserve
may take into account other factors such as (1) whether the home
country supervisor of the foreign bank has consented to the pro
posed establishment of the U.S. office, (2) the financial and mana
gerial resources of the foreign bank and the condition of any U.S.
office of the foreign bank, (3) whether the foreign bank's home
country supervisor shares material information regarding the op

erations of the foreign bank with other supervisory authorities,
(4) whether the foreign bank and its U.S. affiliates are in compli
ance with applicable U.S. law, and (5) whether the foreign bank
has provided the Federal Reserve with adequate assurances that
information will be made available on the operations or activities
of the foreign bank and any of its affiliates that the Federal Re
serve deems necessary to determine and enforce compliance with
applicable federal banking statutes. In approving the establish
ment of a representative office by a foreign bank, the Federal Re
serve is required to take these standards into account to the extent
deemed appropriate.
The Foreign Bank Supervision Enhancement Act of 1991 (FBSEA)
increased the responsibility and the authority of the Federal Re
serve to examine regularly the U.S. operations of foreign banks.
Under the FBSEA, all branches and agencies of foreign banks
must be examined on-site at least once every twelve months.
These examinations are coordinated with state and other federal
banking agencies, as appropriate. Supervisory actions resulting
from such examinations may be taken by the Federal Reserve act
ing alone or with other agencies.
Under the authority of the Bank Holding Company Act and the
IBA, the Federal Reserve is also responsible for approving, re
viewing, and monitoring the U.S. nonbanking activities of foreign
banking organizations. In addition, under an FBSEA amendment
to the Bank Holding Company Act, a foreign bank must obtain
Federal Reserve approval to acquire more than 5 percent of the
shares of a U.S. bank or bank holding company.

REGULATORY FUNCTIONS
As a bank regulator, the Federal Reserve establishes standards de
signed to ensure the safe and sound operation of financial institu
tions. These standards may take the form of regulations, rules,
policy guidelines, or supervisory interpretations and may be es
tablished under specific provisions of a law or under more gen
eral legal authority. Regulatory standards may be either restric
tive (limiting the scope of a banking organization's activities) or
permissive (authorizing banking organizations to engage in cer
tain activities). (A complete list of Federal Reserve regulations is
given in appendix B.)

S U P E R V I S I O N

R E G U L A T I O N

In response to the financial difficulties that the banking industry
faced in the late 1980s, Congress enacted several laws to improve
the condition of individual institutions and of the overall banking
industry, including the Competitive Equality Banking Act of 1987;
the Financial Institutions Reform, Recovery, and Enforcement Act
of 1989; and the Federal Deposit Insurance Corporation Improve
ment Act of 1991. Because of the savings and loan crisis and a
general decline in the level of bank capital during the same pe
riod, efforts to regulate the banking industry focused heavily on
defining the level of capital that is sufficient to enable an institu
tion to absorb reasonably likely losses. In 1989, the federal bank
ing regulators adopted a common standard for measuring capital
adequacy that is based on the riskiness of an institution's invest
ments. This common standard, in turn, was based on the 1988
agreement International Convergence of Capital Measurement
and Capital Standards (commonly known as the Basle Accord)
developed by the international Basle Committee on Banking
Regulations and Supervisory Practices.
The risk-based capital standards require institutions that assume
greater risk to hold higher levels of capital. Moreover, the riskbased capital framework takes into account risks associated with
activities that are not included on a bank's balance sheet, such as
the risks arising from commitments to make loans. Because they
have been accepted by the bank supervisory authorities of most
of the countries with major international banking centers, the
risk-based capital standards promote safety and soundness and
reduce competitive inequities among banking organizations oper
ating within an increasingly global market.

Acquisitions and Mergers
Under the authority assigned to the Federal Reserve by the Bank
Holding Company Act of 1956, as amended, the Bank Merger Act
of 1960, and the Change in Bank Control Act of 1978, the Federal
Reserve Board maintains broad supervisory authority over the
structure of the banking system in the United States.
The Bank Holding Company Act of 1956 assigned primary re
sponsibility for supervising and regulating the activities of bank
holding companies to the Federal Reserve. This act was designed
to achieve two basic objectives. First, by controlling the expansion

of bank holding companies, the act sought to avoid the creation of
a monopoly or the restraint of trade in the banking industry. Sec
ond, it sought to keep banking and commerce separate by re
stricting the activities of bank holding companies to banking and
closely related endeavors.
Bank Acquisitions
Under the Bank Holding Company Act, a firm that seeks to be
come a bank holding company must first obtain approval from
the Federal Reserve. The act defines a bank holding company as
any institution that directly or indirectly owns, controls, or has
the power to vote 25 percent or more of any class of the voting
shares of a bank; controls in any manner the election of a majority
of the directors or trustees of a bank; or exercises a controlling in
fluence over the management or policies of a bank. An existing
bank holding company must obtain the approval of the Federal
Reserve Board before acquiring more than 5 per
cent of the shares of an additional bank. All bank
holding companies must file certain reports with
the Federal Reserve System.
requisitions
by bank holding
companies must be
The Bank Holding Company Act limits the inter
approved by the
state operations of bank holding companies by
Federal Reserve.
preventing them from acquiring a bank in a sec
ond state unless the second state specifically au
thorizes the acquisition by statute. In recent years, most states
have authorized such acquisitions, generally on a reciprocal basis
with other states.
In considering applications to acquire a bank or a bank holding
company, the Federal Reserve, carrying out legislative mandates,
takes into account the likely effects of the acquisition on competi
tion, the convenience and needs of the community to be served,
and the financial and managerial resources and future prospects
of the bank holding company and its banking subsidiaries.
Nonbanking Activities and Acquisitions
Through the Bank Holding Company Act, Congress prevented
bank holding companies from engaging in nonbanking activities
or from acquiring nonbanking companies, with certain excep
tions. The exceptions allow holding companies to undertake cer
tain activities that the Federal Reserve determines to be so closely
related to banking or to managing or controlling banks as to be a

f ON

"proper incident" to banking. In making this determination, the
Federal Reserve considers whether the exception to the prohibi
tion can reasonably be expected to produce public
benefits, such as greater convenience or gains in
efficiency, that outweigh possible adverse effects,
(^~ommunity
such as conflicts of interest or decreased competition.
consequences are
evaluated when
By late 1993, the Federal Reserve had approved
applications for
acquisitions and
more than two dozen activities for bank holding
mergers are
companies that are closely related to banking, in
considered.
cluding making, acquiring, or servicing loans or
other extensions of credit; supplying data process
ing and transmission services; providing investment advice; and
engaging in securities brokerage activities.
Bank Mergers
Another responsibility of the Federal Reserve is to act on pro
posed bank mergers when the resulting institution is a state
member bank. During the 1950s, the number of bank mergers,
several of which involved large banks in the same metropolitan
area, rose sharply. Fearing that a continuation of this trend could
seriously impair competition in the banking industry and lead to
an excessive concentration of financial power, Congress in 1960
passed the Bank Merger Act.
This act requires that all proposed bank mergers be
tween insured banks receive prior approval from the
agency under whose jurisdiction the surviving bank will
fall. It also requires that the responsible agency request reports
from the other banking agencies addressing applicable competi
tive factors and from the Department of Justice to ensure that all
merger applications are evaluated in a uniform manner.
The Bank Merger Act sets forth the factors to be considered in
evaluating merger applications. These factors include the finan
cial and managerial resources and the prospects of the existing
and proposed institutions, and the convenience and needs of the
community to be served. The Federal Reserve may not approve
any merger that could substantially lessen competition or tend to
create a monopoly unless it finds that the anticompetitive effects
of the transaction are outweighed by the transaction's probable
beneficial effects regarding the convenience and needs of the com
munity to be served.

Other Changes in Bank Control
The Change in Bank Control Act of 1978 authorizes the federal
bank regulatory agencies to deny proposals from a person acting
directly or indirectly, or in concert with other persons, to acquire
control of an insured bank or a bank holding company. The Fed
eral Reserve is responsible for changes in the control of bank
holding companies and state member banks, and the FDIC and
the OCC are responsible for such changes in the control of in
sured state nonmember and national banks respectively In con
sidering a proposal under the act, the Federal Reserve must
review factors such as the financial condition, competence, exper
ience, and integrity of the acquiring person or group of persons;
the effect of the transaction on competition; and the adequacy of
the information provided by the party proposing the change.

Other Regulatory Responsibilities
The Federal Reserve is also responsible for enforcing various laws
and regulations that are related to fair and equitable treatment in
financial transactions (see chapter 6), to margin requirements in
securities and futures markets, and to recordkeeping and report
ing by depository institutions.
Securities Regulation
The Securities Exchange Act of 1934 requires the Federal Reserve
to regulate the margin requirements in securities markets (that is,
requirements regarding purchase of securities on credit). Such
regulation was established in an effort to reduce price volatility
caused by speculation, to protect unsophisticated investors, and
to diminish the amount of credit used for speculation. However,
with the contemporary understanding of the dynamics of finan
cial markets, the focus of margin requirements has become
mainly prudential, that is, to protect the soundness of the mar
kets. In fulfilling its responsibility under the act, the Federal
Reserve limits the amount of credit that may be provided by secu
rities brokers and dealers (Regulation T), by banks (Regulation U),
and by other lenders (Regulation G). These regulations generally
apply to credit-financed purchases of securities traded on securi
ties exchanges and certain securities traded over the counter when
the credit is collateralized by such securities. In addition, Regula
tion X prohibits borrowers who are subject to U.S. laws from ob

taining such credit overseas on terms more favorable than could
be obtained from a domestic lender.
In general, compliance with the margin regulations is enforced by
several federal regulatory agencies. In the case of banks, the fed
eral agencies regulating financial institutions check for Regulation
U compliance during examinations. Compliance with Regulation
T is verified during examinations of broker-dealers by the securi
ties industry's self-regulatory organizations under the general
oversight of the Securities and Exchange Commission. Compli
ance with Regulation G is checked by the National Credit Union
Administration, the Farm Credit Administration, the OTS, or the
Federal Reserve.
Futures Trading Practices Act
In 1992, section 501 of the Futures Trading Practices Act amended
the Commodity Exchange Act to require that any rule establish
ing or changing the margin for a stock index futures contract or
for an option on such a futures contract be filed with the Federal
Reserve. The purpose of this requirement is to foster the integrity
of the contract markets and to limit systemic risk that might re
sult from a disturbance in the stock index futures market spilling
over to other markets. Consistent with the provisions of the act,
the Federal Reserve has delegated its authority with regard to
such activities to the Commodity Futures Trading Commission.
Bank Secrecy Act
The Bank Secrecy Act, enacted in 1970, requires financial institu
tions doing business in the United States to report large currency
transactions and to retain certain records. It also prohibits the use
of foreign bank accounts to launder illicit funds or to avoid U.S.
taxes and statutory restrictions. The Department of the Treasury
maintains primary responsibility for issuance of regulations
implementing this statute and for enforcement. However, the
Treasury Department has delegated responsibility for monitoring
the compliance of banks to the federal financial regulatory agen
cies. Therefore, during examinations of state member banks and
of Edge Act and agreement corporations, Federal Reserve exam
iners verify an institution's compliance with the recordkeeping
and reporting requirements of the act and with related regulations. ■

C onsumer and
Community Affairs
ince the late 1960s, the number of federal laws intended to protect
consumers in credit and other financial transactions has been
growing. Congress has assigned the Federal Resen/e the
duty of implementing these laws to ensure that consumers
receive comprehensive information and fair treatment.

AMONG THE FEDERAL RESERVE'S RESPONSIBILITIES
in this area are
• Writing and interpreting regulations to carry out many of the
major consumer-protection laws
• Reviewing bank compliance with the regulations
• Investigating complaints about compliance from the public
• Addressing issues of state and federal jurisdiction
• Testifying before Congress on consumer protection issues
• Directing a community affairs program.
In its efforts, the Federal Reserve is advised by a Consumer Advi
sory Council, whose members represent the interests of consum
ers, community groups, and creditors nationwide. Meetings of
the council, which take place three times a year at the Federal
Reserve Board in Washington, D.C., are open to the public.

CONSUMER PROTECTION
Virtually all financial transactions involving consumers are cov
ered by the consumer-protection laws. These include transactions
involving charge and credit cards from financial institutions and
retail establishments, automated teller machines, deposit accounts,
automobile leases, and mortgages.

The Federal Reserve writes regulations to implement these laws,
which cover not only banks but also certain businesses, including
finance companies, mortgage brokers, retailers, and automobile
dealers. Most aspects of financial transactions are governed by
regulations written by staff members at the Federal Reserve
Board. For example, Congress passed the Truth in Lending Act to
ensure that consumers had adequate information about credit.
The Board implemented that law by writing Regulation Z, which
requires that banks and other creditors provide detailed informa
tion about mortgages, car loans, credit and charge cards, and
other lending products. The Board also revises and updates its
regulations to address new products, such as home equity lines of
credit, adjustable-rate mortgages, and so forth; to implement leg
islative changes to existing laws; or to address problems encoun
tered by consumers.

The Federal Reserve has a comprehensive program to examine
banks to ensure that they comply with the consumer-protection
laws. Its enforcement responsibilities generally extend only to
state-chartered banks that are members of the Federal Reserve
System. Other federal regulators are responsible for examining
bank and thrift institutions under their jurisdictions and for tak
ing enforcement action.
Each Reserve Bank has on its staff specially trained
examiners who regularly evaluate the performance
of banks in its District. Most banks are evaluated
every eighteen months. Poorly rated banks are ex
amined more frequently, and highly rated banks are
examined every twenty-four months.
The examiners review the bank's policies and procedures and
consumer files and other financial documents, and they verify
that disclosures are given in a timely and accurate fashion and
that the bank has dedicated enough resources to ensure compliance
At the end of this dl|$ESEA R < m ttW R A fl* ir protection laws
for which the Feder;
l )n and enforce

of S t. L o u l«

C O N S U M E R

C O M M

U N I T Y

A F F A I R S

merit responsibility, the dates that the laws were enacted, and the
highlights of the laws' provisions.

CONSUMER COMPLAINT PROGRAM
The Federal Reserve operates a Systemwide program to respond
to inquiries and complaints from the public about consumer pro
tection issues involving the policies and practices of financial in
stitutions. It investigates complaints involving state member
banks and refers complaints involving other institutions to the
appropriate regulatory agencies.
The Federal Reserve Board maintains information on consumer
inquiries and complaints in a database. It regularly reviews the
data to identify potential problems at individual financial institu
tions and, as required by the Federal Trade Commission Improve
ment Act, to uncover potentially unfair or deceptive practices
within the banking industry.

COMMUNITY AFFAIRS
In accordance with the Community Reinvestment Act of 1977
(CRA), the Federal Reserve encourages banks to work with com
munity organizations to promote local economic development.
In the examination process, the Federal Reserve reviews a bank's
efforts to meet the credit needs of its entire community, including
low- and moderate-income neighborhoods; for example, it looks
at the extent to which a bank has programs that contribute to the
building of affordable housing and to other aspects of community
development. Banks are rated separately for compliance with the
CRA, and the Federal Reserve takes an institution's performance
under the CRA into account when deciding whether to approve
an application for aquisition or merger or for formation of a bank
holding company. The public may protest the approval of an ap
plication on the basis of the institution's record in community re
investment.
Each Reserve Bank has on its staff a community affairs officer
who is familiar witfi the credit*needs in the communities served
by the institutions
D i^ & 3 $ lf£ ^ fice r's responsi
bilities include fost'ejjj§g ; c n j ^ o d g banking institu

tions, government agencies, and community groups.
Through newsletters and other publications, seminars,
workshops, and conferences, the Federal Reserve
provides information to banks and bank holding
companies about economic initiatives in the private
sector, community development finance, publicprivate partnerships, and federal and state develop
ment programs. Staff members also work directly with individual
bankers and community development representatives to promote
community lending.

Consumer-Protection Laws
•

•

Community Reinvestment Act of 1977

■

Encourages financial institutions to help meet the credit needs of
their communities, particularly low- and moderate-income neighborhoods.

■

Consumer Leasing Act of 1976

Requires that institutions disclose the cost and terms of consumer
leases (such as those on automobiles).

■

Electronic Fund Transfer Act (1978)

■
■

Establishes rules concerning a consumer's liability for unauthorized
use of a debit card and the unsolicited issuance of debit cards by
financial institutions. Covers transactions conducted at automated
teller machines, at point-of-sale terminals in stores, and through
telephone bill-payment plans and preauthorized transfers to and
from a customer's account, such as direct deposit of salary or social
security payments.•
•

Equal Credit Opportunity Act (1974)

Prohibits discrimination in credit transactions on several bases, ineluding sex, marital status, age, race, religion, color, national origin,
the receipt of public assistance funds, or the exercise of any right
under the Consumer Credit Protection Act. Requires creditors to
grant credit to qualified individuals without requiring cosignature
by spouses, to inform unsuccessful applicants in writing of the rea
sons credit was denied, and to allow married individuals to have
credit histories on jointly held accounts maintained in the names of
both spouses.

■

■
m

■■■■■■■■■■■■■■■■■■■■■■■■■■■■■■■■■■■■■•■■■■■•■■■a

Expedited Funds Availability Act (1987)

Specifies when depository institutions must make consumers' de
posited funds available to them; requires institutions to disclose to
customers their policies on funds availability.
Fair Credit and Charge Card Disclosure Act of 1988

Requires that applications for credit cards that are sent through the
mail, solicited by telephone, or made available to the public (such
as at counters in retail stores or through catalogs) contain informa
tion about key terms of the account.
Fair Credit Billing Act (1974)

Specifies how creditors must respond to billing complaints from
consumers; imposes requirements to ensure that creditors handle
accounts fairly and promptly. Applies primarily to
revolving and credit card accounts (for example,
store card and bank card accounts).
Fair Credit Reporting Act (1970)

Protects consumers against inaccurate or mislead
ing information in credit files maintained by credit
reporting agencies; requires credit-reporting agen
cies to allow credit applicants to correct erroneous
reports.
Fair Debt Collection Practices Act (1977)

Prohibits abusive debt collection practices; applies to banks that
function as debt collectors for other entities.
Fair Housing Act of 1968

Prohibits discrimination in the extension of housing credit on
the basis of race, color, religion, national origin, sex, handicap,
or family status.
Federal Trade Commission Improvement Act of 1980

Authorizes the Federal Reserve to identify unfair or deceptive acts
or practices by banks and to issue regulations to prohibit them.
(Using this authority, the Federal Reserve has adopted rules that
restrict certain practices in the collection of delinquent consumer
debt, for example, practices related to late charges, responsibilities
of cosigners, and wage assignments.)
Flood Disaster Protection Act of 1973

Requires flood insurance on property in a flood hazard area that
comes under the National Flood Insurance Program.

•

Home Equity Loan Consumer Protection Act of 1988

Requires creditors to provide consumers with detailed information
about open-ended credit plans secured by the consumer's dwelling
and with a brochure describing home equity loans in general. Also
regulates advertising of home equity loans and restricts the terms of
home equity loan plans.
•

Home Mortgage Disclosure Act of 1975

Requires mortgage lenders to publicly disclose the geographic dis
tribution of their mortgage and home improvement loans and their
loan approval rates by sex, race, and other applicant characteristics.
Also directs the Federal Financial Institutions Examination Council
(of which the Federal Reserve is a member) to make sum
maries of these data available to the public.
•

Real Estate Settlement Procedures Act of 1974

Requires that the nature and costs of real estate settle
ments be disclosed to borrowers. Also protects borrowers
against abusive practices, such as kickbacks, and limits
the use of escrow accounts.
•

Right to Financial Privacy Act of 1978

Protects bank customers from the unlawful scrutiny of
their financial records by federal agencies and specifies procedures
that government authorities must follow when they seek informa
tion about a customer's financial records from a financial institution.
•

Truth in Lending Act (1968)

Requires uniform methods for computing the cost of credit and for
disclosing credit terms. Gives borrowers the right to cancel within
three days certain loans secured by their residences. Also prohibits
the unsolicited issuance of credit cards and limits cardholder liabil
ity for unauthorized use.
•

Truth in Savings Act (1991)

Requires that depository institutions disclose to depositors certain
information about their accounts, including the annual percentage
yield calculated in a uniform manner; regulates advertising of sav
ings accounts; and prohibits certain methods of calculating interest.
•

Women's Business Ownership Act of 1988

Extends to applicants for business credit certain protections
afforded consumer credit applicants, such as the right to an
explanation for credit denial.

Reserve Bank Services

he twelve Federal Reserve Banks provide banking services to
depository institutions and to the federal government. For de
pository institutions, they maintain reserve and clearing ac
counts and provide various payment services including
collecting checks, electronically transferring funds, and distrib
uting and receiving currency and coin. For the federal govern
ment, they act as fiscal agents. As such, the Reserve Banks
maintain the Treasury Department’s transaction account; pay
Treasury checks; process electronic payments; and issue,
transfer, and redeem U.S. government securities.

.....

THE RESERVE BANKS ALSO PERFORM numerous specialized
services for the federal government and its agencies, such as
redeeming food coupons and monitoring special accounts—
Treasury tax and loan accounts—in which tax receipts are held
until the Treasury needs funds to make payments.
In creating the Federal Reserve System, Congress intended to
eliminate the severe financial crises that had periodically swept
the nation. The System was to provide not only an elastic cur
rency—that is, a currency that would expand or shrink in amount
as economic conditions warranted—but also an efficient and equi
table check-collection system.
Congress's concerns about the nation's financial system centered
on the financial panic of 1907. During that episode, cash pay
ments were largely suspended throughout the country because
many banks and clearinghouses refused to clear checks drawn on
certain other banks. These practices led to the failure of otherwise
solvent banks. To address these problems, Congress gave the
Federal Reserve the authority to establish a nationwide check
clearing system.
Congress was also concerned that some banks refused to pay the
full amount of the check (nonpar collection) and that some
charged certain collecting banks fees to pay checks (presentment

IP *

fees). To avoid paying presentment fees, many collecting banks
routed checks through banks that were not charged presentment
fees by payor banks. This practice, called circuitous routing, re
sulted in extensive delays and inefficiencies in the check-collec
tion system. In 1917, Congress amended the Federal Reserve Act
to prohibit banks from charging the Federal Reserve Banks pre
sentment fees; the amended act also authorized nonmember
banks as well as member banks to collect checks through the
Federal Reserve System.
In passing the Monetary Control Act of 1980, Congress reaffirmed
its intention that the Federal Reserve should promote an efficient
nationwide payments system. To encourage competition between
the Federal Reserve and private-sector providers of payment ser
vices, the act requires the Federal Reserve to charge fees for its
payment services. The Monetary Control Act also requires all
depository institutions, not just member commercial banks, to
maintain reserves with the Federal Reserve System and grants
them equal access to Federal Reserve payment services.
Congress expanded the role of the Federal Reserve in the pay
ments system again in 1987 when it enacted the Expedited Funds
Availability Act. This act gives the Federal Reserve authority to
improve the check-collection system by using electronic means to
collect checks, by promoting truncation (under which a deposi
tory institution or Reserve Bank keeps the paper checks and
sends only electronic data to the payor bank to request payment),
and by handling all returned checks regardless of the way the
check was originally collected. The act also limits the time a de
pository institution may hold funds before making them available
to customers for withdrawal.

THE FEDERAL RESERVE AND THE PAYMENTS SYSTEM
The U.S. payments system is the largest in the world. Each year
billions of transactions, valued in the trillions of dollars, are con
ducted between payors (purchasers of goods, services, or finan
cial assets) and payees (sellers of goods, services, or financial as
sets). Based on the mandates of Congress, the Federal Reserve is
an active intermediary in clearing and settling interbank pay
ments. The Federal Reserve Banks play this role because they
maintain reserve or clearing accounts for the majority of deposi

R E S E R V E

V I

tory institutions. As a result, they can settle payment transactions
efficiently by debiting the accounts of the depository institutions
making payments and by crediting the accounts of depository in
stitutions receiving payments. Moreover, the Reserve Banks, as
part of the nation's central bank, are immune from liquidity prob
lems (not having sufficient funds to complete payment transac
tions) and credit problems. Payments received in accounts main
tained at the Federal Reserve, therefore, are free of liquidity and
default risk.
The Federal Reserve provides a variety of payment services to de
pository institutions. Its cash services include the distribution of
currency and coin and the removal of unfit notes and coins from
circulation. Its noncash services include the collection of checks,
the processing of electronic funds transfers, and the provision of
net settlement services to private clearing arrangements.

Cash Serviceis: Currency and Com
An important function of the Federal Reserve System
is ensuring that enough currency and coin are in cir
culation to meet the public's demand. When Congress
created the Federal Reserve System, it recognized that
the demand for cash by the public and the banking
system varies from time to time. This demand in
creases or decreases directly with the level of economic activity
and with the seasons of the year. For example, consumers' de
mand for currency typically increases during holiday seasons,
and farmers' demand increases during planting and harvesting
seasons. The additional currency and coin put into circulation to
meet seasonal demand is eventually returned to depository insti
tutions by merchants and other business owners. To reduce the
excess currency and coin held in their vaults, depository institu
tions return the excess to their regional Reserve Bank, where it is
credited to their accounts. The process is reversed when deposi
tory institutions need to replenish or increase their supply of cur
rency and coin.
Virtually all currency in circulation is in the form of Federal Re
serve notes. Each of the twelve Federal Reserve Banks is autho
rized by the Federal Reserve Act to issue currency. Before the Re
serve Banks issue currency to the banking system, the currency

must be secured by legally authorized collateral, most of which is
in the form of U.S. Treasury and federal agency securities held by
the Reserve Banks. The notes are a first lien on the assets of the
issuing Reserve Bank and are obligations of the U.S. government.
The notes are designed and printed by the Bureau of Engraving
and Printing of the Department of the Treasury and are delivered
to the Reserve Banks for circulation. The Federal Reserve System
pays the Bureau of Engraving and Printing only for the cost of
printing the notes.1
Coin is different from currency in that it is the direct obligation of
the Treasury. The Reserve Banks pay the Department of the
Treasury's Bureau of the Mint for the face value of the coin re
ceived rather than for the cost of the minting.
As currency and coin flow back to the Reserve Banks, each de
posit is counted and verified against the amount the depository
institution says it contains, and overages or shortages are credited
or debited to the institution's account. As currency de
posits are verified, notes that are suspected of being
counterfeit and those that are too worn for recirculation
are separated from the rest. The Reserve Banks hold
the fit notes in their vaults along with new notes until
they are needed to meet demand. The unfit notes are
destroyed, and their face value is deducted from the
total amount of Federal Reserve notes outstanding.
Currency and coin are used primarily for small-dollar trans
actions and thus account for only a small proportion of the total
dollar value of all monetary transactions. During 1993, the Fed
eral Reserve System delivered to depository institutions about
21.9 billion notes having a value of $324.2 billion and received
from depository institutions about 21.2 billion notes having a
value of $292.7 billion; 7.4 billion of the returned notes were de
stroyed. The difference between the amount of currency delivered
and the amount received equals the annual increase or decrease in

1. The first U.S. paper money under the Constitution— demand notes— was
issued in 1861. All currency issued by the U.S. government since then remains
valid. Currency in circulation, other than Federal Reserve notes, includes silver
certificates (which have a blue Department of the Treasury seal), United States
notes (red seal), and national bank notes (brown seal). Federal Reserve notes
(which have a green seal) were first issued in 1914.

N K

S E R V I C E S

depository institutions' demand for currency resulting from eco
nomic conditions.
Over the past several decades, the value of currency in circulation
has risen dramatically—from $31.2 billion in 1955 to $365.3 billion
in 1993 (table 7.1). The total number of notes in circulation (15.5
billion at the end of 1993) and the demand for larger denomina
tions ($20, $50, and $100 notes) have also increased (table 7.2). In
1960, these larger denominations constituted 64 percent of the to
tal value of currency in circulation; by the end of 1993, they ac
counted for 92 percent. Because the dollar is viewed throughout
the world as a highly stable and readily negotiable currency,
much of the increased demand for notes of larger denomination
has arisen outside the United States. Although the exact value of
U.S. notes held outside the United States is unknown, various es
timates suggest that at least one-half of all U.S. currency circulates
abroad and that flows abroad have been increasing in recent years.
The use of the dollar outside the United States does not affect the
supply of currency and coin needed to support domestic eco-

Table 7.1
Value of currency and coin in circulation, selected years, 1955-93
Millions of dollars

Year

Currency

Coin

Total

1955

29,242

1,916

31,158

1960

30,442

2,426

32,868

1965

38,029

4,027

42,056

1970

45,915

5,986

51,901

1975

68,059

8,285

76,344

1980

109,515

11,641

121,156

1985

182,003

15,456

197,459

1990

268,206

18,765

286,971

1991

288,453

19,263

307,716

1992

314,752

19,948

334,700

1993

344,465

20,804

365,269

Table 7.2
Estimated value of Federal Reserve notes in circulation by denomination,
selected years, 1960-93
Billions of dollars

Denomination, in dollars
Year

100 Other1 Total

1960

1.5

2.2

6.7

10.5

2.8

6.0

30.4

1970

2.1

2.9

8.4

16.6

4.4

10.9

45.9

1980

3.1

4.1 11.0

36.4

12.2

41.6

109.5

1990

5.1

6.3 12.6

69.0

33.9 140.2

268.2

1993

5.7

6.9 13.2

74.9

40.9 201.5

344.3

1. Other denominations include the $500, $1,000, $5,000, and $10,000 notes in
circulation. No denominations larger than $100 have been printed since 1946
nor issued since July 1969. A great majority of these larger notes outstanding
are held by private collectors, currency dealers, or financial institutions for pro
motion and display.

nomic activity. As noted earlier, the Federal Reserve supplies cur
rency and coin in amounts sufficient to meet the demand of the
U.S. public.

N oncash-Transaction

Although cash is convenient and is commonly used for small-dollar
transactions, noncash payment instruments—such as checks and
electronic funds transfers—are generally preferred for largervalue transactions. Figures for the noncash services provided by
the Federal Reserve give a general picture of the use of noncash
transactions in 1993 (chart 7.1). Notably, checks continue to ac
count for the largest share of noncash payments by number
(about 90 percent in 1993) but for a minor share in terms of value
(less than 4 percent). Fedwire funds transfers, in contrast, ac
counted for less than 1 percent of the number of noncash transac
tions processed by the Federal Reserve in 1993 but nearly 55 per
cent of the value. The use of the automated clearinghouse has
been growing rapidly since its inception in the 1970s, but transac
tion volume is still only a fraction of check volume.

Chart 7.1
Federal Reserve noncash-transaction services, 1993
Percent

Check Processing
In 1993, an estimated 59 billion checks were written in the United
States. About one-quarter of these checks were deposited in the
same institution on which they were drawn (called " on-us"
checks). Checks not drawn on the institution at which they were
deposited are called interbank checks. In 1993, more than 40 per
cent of interbank checks were collected through the Federal Re
serve, and the remainder were handled through private clearing
arrangements.
Handling interbank checks requires a mechanism for exchanging
them and providing for the related movement of funds (or settle
ment) among the banks and other depository institutions that are
involved. When a depository institution receives checks drawn on
other institutions, it may send the checks for collection to those
institutions directly, deliver them physically to the institutions at
a local clearinghouse, or purchase the collection services of a cor
respondent institution or a Federal Reserve office.
For checks collected through the Federal Reserve, the account of
the collecting institution is credited for the value of the deposited
checks in accordance with the availability schedules maintained
by the Reserve Banks. These schedules reflect the time normally

100

needed for the Federal Reserve to receive payments from the
institutions on which the checks are drawn. Credit is usually
given on the day of deposit or the next business day. In 1993,
the Federal Reserve collected 19 billion checks with a value of
$14.1 trillion (table 7.3).
Since it was established, the Federal Reserve has worked with the
private sector to improve the efficiency and cost-effectiveness of
the check-collection system. In the 1940s, the Federal Reserve and
the banking industry developed routing numbers. These num
bers are still printed on checks to identify the institution on which
a check is drawn and to which the check must be sent for pay
ment. In the 1950s, they developed and implemented the magnetic
ink character recognition (MICR) system for encoding pertinent
data on checks so that the data could be read electronically. This
development contributed significantly to the automation of check
processing.

Table 7.3
Number and value of commercial checks collected
by the Federal Reserve, selected years, 1920-931
Number in millions; value in millions of dollars

Year

Number

Value

1920

424

149,784

1930

905

324,883

1940

1,184

280,436

1950

1,955

856,953

1960

3,419

1,154,121

1970

7,158

3,331,733

1980

15,716

8,038,026

1990

18,598

12,519,171

1993

19,009

14,066,518

1. In 1993, the Federal Reserve System, acting as fiscal
agent for the U.S. Treasury, also paid 480 million checks
and 192 million postal money orders.

■
R..E-..S 1^ i :z R z = V ^ -^ =

B = A z=N = K = S = = ^ = J* = = ¥ ^ ^

In the 1970s, the Federal Reserve introduced a regional check
processing program to further improve the efficiency of check
clearing. The program expanded the number of check-processing
facilities, which enabled the Federal Reserve to collect signifi
cantly more checks faster. At the end of 1994, the Federal Reserve
maintained forty-six check-clearing centers. These centers are lo
cated at each of the Reserve Banks (except the Federal Reserve
Bank of New York), the twenty-five Reserve Bank Branches, and
the ten regional check
processing centers (see
chapter 1). Each center
serves a specific geo
graphical area.
In the mid-1980s, the
Federal Reserve began
to encourage the conver
sion of paper checks to
electronic records in
order to improve the
efficiency of the checkcollection process. Con
sequently, the Federal
Reserve has actively
equipment facilitates the rapid
promoted check trunca
processing of payments.
tion, which could signifi
cantly streamline the system. The Federal Reserve has also ac
tively supported research to develop check image processing,
which permits the image of a paper check to be captured, pro
cessed, and stored on electronic media for retrieval when needed.
Until the late 1980s, depository institutions were allowed to hold
deposited funds for an unlimited time before making them avail
able for withdrawal. Some banks continued to use circuitous
routes to clear checks to avoid presentment fees, and depositors
could not be sure when their funds would be available. In 1987,
Congress enacted the Expedited Funds Availability Act (EFAA),
which limits the time that banks can hold funds from checks de
posited into customer accounts before the funds are made avail
able for withdrawal. The law was implemented in September
1988 through the Board of Governors' Regulation CC, Availability
of Funds and Collection of Checks, which also establishes rules
designed to speed the return of unpaid checks.

102

The EFAA requires that funds be made available for deposits of
cash, Treasury checks, and cashier's checks no later than the busi
ness day after the banking day of deposit. Regulation CC extends
this next-day availability to U.S. Postal Service money orders and
to checks drawn on a Federal Reserve Bank or a Federal Home
Loan Bank. For the majority of other check deposits, the location of
the paying bank in relation to the bank in which the check was de
posited determines the availability of funds.
According to Regulation CC, the bank into which a local check is
deposited must make the funds available for withdrawal by the
second business day after the day of deposit. (A local check is a
check deposited in a bank in the same Federal Re
serve check-processing region as the paying bank.)
Proceeds of a nonlocal check—that is, one deposited
in a bank in a different check-processing region from
the paying bank—must be available for withdrawal
by the fifth business day after deposit. In certain cir
cumstances, such as when the bank has reasonable
cause to believe the check is uncollectible or when an
account is new, the bank may delay the availability of the funds.
In such a case, the bank must notify the customer, explain the de
lay, and indicate when the funds will be available.
In late 1992, the Federal Reserve modified Regulation CC to per
mit all depository institutions to demand payment in same-day
funds from payor institutions without paying presentment fees,
provided certain conditions are met by collecting banks. This
modification, called same-day settlement, grants depository insti
tutions the right to obtain payment for checks that is similar to the
right of the Federal Reserve. As depository institutions take ad
vantage of that right, an increasing number of checks will be pre
sented directly to the banks on which they are drawn.
Electronic Funds Transfer

Electronic funds transfer (EFT) is a faster and more secure method
of payment than either cash or check. The Federal Reserve Banks
provide two types of services for electronically transferring funds:
Fed wire and the Automated Clearinghouse (ACH). Through the
Fedwire service, depository institutions typically transfer largedollar payments (the average value of a Fedwire transfer in 1993
was approximately $3 million). Depository institutions generally
use the ACH for small-dollar payments.

R E & E # V

B A N K

S E R V I C E S

Fedwire allows depository institutions to transfer funds on their
own behalf or on behalf of their customers. Such transfers result
from trades of federal funds and other interbank transactions,
purchases and sales of securities, and time-sensitive payments.
The Department of the Treasury and other federal agencies also
use the Fedwire to disburse and collect funds. In 1993, the
Reserve Banks processed 70 million Fedwire payments having
a total value of $208 trillion (table 7.4).
Fedwire funds transfers are processed individually. Sophisticated
data-communications and data-processing systems ensure that
each transfer is authorized by the sender and that it is not altered
while it is under the control of the Federal Reserve. Although a
few banks continue to initiate Fedwire payments by telephone,
more than 99 percent of all Fedwire funds transfers are initiated
on-line through personal or mainframe computers. Fedwire funds
transfers are processed in seconds. When the Federal Reserve
processes a funds transfer, it electronically debits the account of
the sending institution and credits the account of the receiving
institution. The Federal Reserve guarantees the payment to the
bank receiving the transfer and assumes any risk if the bank
sending the payment has insufficient funds in its Federal Reserve
account to complete the transfer.
Table 7.4
Number and value of Fedwire funds transactions processed
by the Federal Reserve, selected years, 1920-93
Number in millions; value in millions of dollars

Year

Number

Value

1920

30,857

1930

2.0

198,881

1940

92,106

1950

1.0

509,168

1960

3.0

2,428,083

1970

7.0

12,332,001

1980

43.0

78,594,862

1990

63.0

199,067,200

1993

70.0

207,629,814

t03

104

Fedwire also allows depository institutions to transfer the owner
ship of U.S. Treasury securities and the securities of various fed
eral agencies, such as the Federal National Mortgage Association
and the Federal Home Loan Mortgage Corporation, for them
selves and for their customers. Most of these securities are held in
safekeeping by the Reserve Banks as book entries (as electronic
records of securities holdings rather than as paper
certificates). The Federal Reserve Banks safekeep
and transfer U.S. government securities in their ca
pacity as fiscal agents for the U.S. Treasury. They
carry out these functions for government agencies
as a service to depository institutions. In 1993,12.7
million book-entry securities transfers with a value
of $154 trillion were transferred using Fedwire
(table 7.5).
Fedwire book-entry securities transfers are processed individu
ally, in much the same way that Fedwire funds transfers are pro
cessed. When the Federal Reserve receives a request to transfer a
security, it determines that the security is held in safekeeping for
the institution requesting the transfer and withdraws the security
from the institution's safekeeping account. It then electronically
credits the proceeds of the sale to the account of the depository
institution, deposits the book-entry security into the safekeeping
account of the receiving institution, and electronically debits that
institution's account for the purchase price. The Federal Reserve
guarantees payments to institutions sending book-entry securi
ties transfers.

Table 7.5
Number and value of book-entry securities transfers processed
by the Federal Reserve, selected years, 1970-93
Number in millions; value in millions of dollars

Year

Number

Value

1970

258,200

1980

4.1

13,354,100

1990

11.5

101,262,260

1993

12.7

154,433,803

=RZZE==S .....g..n r = V ^ € ^ =9 = A - U - K -.....•~s:•'

Because of the difficulty in synchronizing the flow of payments
over Fedwire, depository institutions sometimes do not have suf
ficient funds in their accounts to cover all payments at the time
they are processed. To protect itself against the risk of nonpay
ment, the Federal Reserve sets limits on the amount of credit it
will extend to a depository institution during the business day,
may require institutions to post collateral, and assesses fees to
depository institutions for intraday loans.
The Automated Clearinghouse (ACH) is another electronic
funds transfer system, developed jointly by the private sector and
the Federal Reserve in the early 1970s as a more efficient alterna
tive to checks. Since then, the ACFI has evolved into a nationwide
mechanism that processes electronically originated credit and
debit transfers. For example, ACFI credit transfers are used to
make direct deposit payroll payments and corporate payments to
contractors and vendors. ACH debit transfers are used by con
sumers to make payments on insurance premiums, mortgages,
loans, and other bills and by businesses to concentrate funds at a
primary bank and to make payments to other businesses. In 1993,
the Federal Reserve processed 2.1 billion ACH payments with a
value of $8.7 trillion (table 7.6).
Unlike Fedwire funds transfers, which are processed individually
and settled immediately at the time of processing, ACH payments
are transmitted in batches to a Federal Reserve processing center
by a depository institution. Transfers are generally processed one
or two days before the settlement date and are delivered to receiv
ing depository institutions several times a day as they are pro-

Table 7.6
Number and value of ACH transactions processed by the Federal Reserve,
selected years, 1975-93
Number in millions; value in millions of dollars

Year

Number

Value

1975

92,868

1980

227

286,600

1990

1,435

4,660,476

1993

2,100

8,747,318

106

cessed. The Federal Reserve provides ACH services to all deposi
tory institutions. Some private-sector processors also provide
ACH services to their participants. Private-sector processors de
liver ACH payments to depository institutions other than their
participants through the Federal Reserve.
Both the government and the commercial sectors use ACH pay
ments. Compared with checks, ACH transfers are less costly and
provide greater certainty of payment to the receiver; they also
eliminate float because payors' and payees' accounts are debited
and credited simultaneously. Initially, the federal government
was the dominant user and promoted its use for social security
and payroll payments. Since the early 1980s, commercial ACH
volume has grown rapidly and, in 1993, accounted for more than
70 percent of total ACH volume (table 7.7).

A large number of payments are cleared privately by groups of
depository institutions that agree to a common set of rules. Check
clearinghouses, which exist in most major cities in the United
States, permit collecting institutions to present checks directly to
payor institutions without using intermediaries. The New York

Table 7.7
ACH volume by type, selected years 1975-93
Number in millions

Year

Number o f
commercial payments

Number o f
government payments

Ratio o f
government
to total (percent)

19751

5.8

19801

64.5

162.5

1990

915.3

519.5

1993

1,544.8

554.6

1. Estimate.

V I C

Clearing House Association operates a large-dollar funds transfer
system, called the Clearing House Interbank Payments System,
which is used principally to exchange large-dollar, international
payments. Some private networks also exchange securities trans
actions, automated clearinghouse transactions, automated teller
machine (ATM) transactions, and credit card transactions.
Private clearing arrangements track the value of payments ex
changed among their members and, at a cutoff time, calculate the
net position of each member. Those members that have made
more payments than they have received owe funds to the clearing
arrangement, and those that have received more payments than
they have made are due funds from the clearing arrangement.
The sum of the participants' net debit and credit positions equals
zero because the arrangements are closed systems.
In support of such arrangements, the Federal Reserve provides
net settlement services to depository institution participants.
Two types of settlement services are available. In one case, the
agent for the participant gives the Federal Reserve a statement
indicating the net debit and credit positions of each participant,
and the Federal Reserve posts the appropriate entries to the par
ticipating institutions' Federal Reserve accounts. In the other
case, the agent for the participants informs each participant of its
net position. Institutions in net debit positions send Fedwire
funds transfers to the clearing arrangement's net settlement ac
count at the Reserve Bank. When the account is fully funded, the
agent sends Fedwire funds transfers to the accounts of the partici
pants in net credit positions.
Depository institutions participating in large-dollar private-sector
clearing arrangements that make more payments to other partici
pants than they receive may have very large settlement obliga
tions each day. If one of these institutions were unable to settle its
obligation, other institutions participating in the arrangement
also might be unable to settle. The risk that one participant in a
privately operated clearing arrangement will not be able to settle
its obligation is called systemic risk. To protect the payments sys
tem, the Federal Reserve sets standards to ensure the integrity of
large-dollar clearing arrangements and to limit the systemic risk
that they create.

107

108

OTHER FEDERAL RESERVE BANK SERVICES
The Federal Reserve Banks provide definitive securities services
to depository institutions. These services include safekeeping of
physical (as opposed to book-entry) securities, through storage of
the securities in a Reserve Bank vault, and collection of matured
coupons and bonds by presenting them to the place at which they
are payable. The demand for definitive securities services has
been declining since the early 1980s, when federal tax legislation
effectively reduced the supply of definitive securities. As a result
of this decreased demand, the Federal Reserve Banks now keep
only those definitive securities that are pledged by depository in
stitutions as collateral to secure their borrowings from the Federal
Reserve or to comply with federal regulations.

FISCAL AGENCY FUNCTIONS
As fiscal agents of the United States, the Federal Reserve Banks
function as the federal government's bank and perform several
services for the Treasury. These services include the following:
•
•
•
•

Maintaining the Treasury's funds account
Clearing Treasury checks drawn on that account
Conducting nationwide auctions of Treasury securities
Issuing, servicing, and redeeming Treasury securities.

Federal Reserve Banks also perform fiscal agency services for
various federal and federally sponsored agencies. The Treasury
and other government agencies reimburse the Federal Reserve
Banks for the expenses incurred in providing these services.
One service performed by the Reserve Banks on behalf of the Trea
sury is the daily monitoring of federal tax receipts. Taxes paid by
businesses and individuals flow into special, interest-earning ac
counts, called Treasury tax and loan (TT&L) accounts, at more
than 12,000 depository institutions (TT&L depositaries) nation
wide. The TT&L depositaries accept tax payments directly from
employers and individuals and report the amount received to a
Federal Reserve office. The TT&L balances that are not protected
by deposit insurance are fully collateralized at all times, and the
Reserve Banks monitor them for compliance with collateral re

quirements. Each day the Federal Reserve Banks report the total
amount in TT&L accounts to the Treasury's cash managers, who
in turn decide what portion of the tax receipts is needed to cover
the government's daily operating expenses. The managers notify
the Reserve Banks of that amount, and the Reserve Banks transfer
the needed funds from the TT&L accounts to the Treasury's ac
count at the Federal Reserve.

The Reserve Banks also handle the weekly,
monthly, and quarterly auctions of Treasury secu
rities, through which the Treasury raises money to
finance government spending and to refinance the
debt. The Reserve Banks announce the sales, ac
cept the bids (called tenders), communicate the
bids to the Treasury, issue the securities in book-entry form once
the Treasury has chosen the successful bids, collect payment from
the successful bidders, and deposit the money in the Treasury's
funds account at the Federal Reserve. The Reserve Banks, on be
half of the Treasury and some other government agencies, also de
liver new book-entry securities, service securities that are out
standing, and redeem securities that have matured.

The Federal Reserve Banks provide another unique securities
service for the Treasury: They maintain a separate safekeeping
system, called Treasury Direct, which holds book-entry Treasury
securities purchased by individuals who wish to hold their securi
ties directly with the Treasury instead of with a depository institu
tion. Individuals purchase Treasury securities directly but instruct
that the securities be delivered to their Treasury Direct account.
Once the securities are deposited there, any interest or principal
payments owed to the account holder are directly deposited to the
account holder's account at a depository institution by the ACH.
At year-end 1993,1.2 million investor accounts were maintained
on the Treasury Direct system, and the securities holdings had a
par value of more than $60 billion.

The Federal Reserve Banks also issue, service, and redeem tens of
millions of U.S. savings bonds each year on behalf of the Treasury.
As authorized by the Treasury, they also qualify depository insti
tutions and corporations as issuing agents and paying agents for
savings bonds.

110

The federal government disburses funds to the public from the
account it maintains with the Federal Reserve. These disburse
ments can be made as Fedwire funds transfers, ACH
payments, or checks. Fedwire disbursements are typi
cally associated with, but not limited to, the redemp
tion of Treasury securities. Certain recurring payments,
such as social security benefits and government em
ployee salaries, are increasingly processed by the ACH
and electronically deposited directly to the recipients' accounts at
their depository institutions. Other government payments, such
as income tax refunds, are usually made using Treasury checks
drawn on the Treasury's funds account at the Federal Reserve.

INTERNATIONAL SERVICES
As the central bank of the United States, the Federal Reserve
performs services for foreign central banks and for international
organizations, such as the International Monetary Fund, the Inter
national Bank for Reconstruction and Development (informally
called the World Bank), and the Bank for International Settle
ments. These services are generally provided by the Federal
Reserve Bank of New York.
At the Federal Reserve Bank of New York, a foreign official insti
tution can establish a non-interest-bearing funds account (in U.S.
dollars), safekeeping accounts for book-entry and definitive secu
rities, and an account for safekeeping gold. Some foreign official
institutions channel a portion of their daily receipts and pay
ments in U.S. dollars through their funds acounts at the Federal
Reserve Bank of New York. If the account contains excess funds,
the foreign official institution may request the Bank to invest
these funds until they are needed. Conversely, if the account
needs additional funds, the foreign institution may instruct the
Bank to sell some securities it holds in safekeeping there.
The securities services available to foreign official institutions are
identical to those offered to U.S. depository institutions by the
Federal Reserve, except that the Federal Reserve does not limit
the safekeeping of definitive securities for foreign official institu
tions to those pledged as collateral. The Federal Reserve Bank of
New York also holds in its vaults billions of dollars in gold owned
by foreign official institutions.

R E S E R V E

B A N K

S E R V I C E S

At the request of a foreign official insti
tution, the Federal Reserve Bank of
New York will buy or sell foreign cur
rencies in exchange for U.S. dollars and
will debit or credit the institution's
funds account accordingly. Also upon
request, the Bank will purchase or sell
a U.S. government security on behalf
of the foreign institution and will
make the corresponding entries to the
securities and funds accounts that the
institution maintains with the Federal
Reserve. The Bank charges for the ser
vices it provides to foreign official in
stitutions.
As fiscal agent for international orga
nizations, the Federal Reserve Banks
old owned by foreign
make principal and interest payments
official institutions
for securities issued by many of these
held in the vault of the
organizations. The Federal Reserve
Federal Reserve Bank
Bank of New York maintains accounts
of New York.
for some international organizations
and receives and makes payments in
U.S. dollars on their behalf; it also in
vests funds for international organizations according to either spe
cific directions or standing instructions. ■

111

Appendix

Federal Reserve Balance Sheet
and
Reserve
Equa

THIS APPENDIX examines the individual factors that affect reserves.
Most of these factors, such as changes in the amount of Treasury
deposits at Federal Reserve Banks or in the volume of currency in circu
lation, respond to decisions made outside the Federal Reserve. The Fed
eral Reserve can offset the predictable effects of factors affecting the
overall availability of reserves, however, by adjusting another factor—
its holdings of securities on its balance sheet. The first section of the ap
pendix explains the consolidated balance sheet of the Federal Reserve
Banks. The second section explains a useful accounting relationship
called the reserve equation, which takes into account the Federal
Reserve's consolidated balance sheet and the Treasury's monetary ac
counts and specifies all of the factors that affect reserves.

CONSOLIDATED BALANCE SHEET

The consolidated balance sheet of the Federal Reserve Banks is an ac
counting summary of all phases of Federal Reserve Bank operations.
Also known as the statement of condition of the Federal Reserve Banks,
the consolidated balance sheet is published by the Federal Reserve
Board every Thursday to show the condition of the Reserve Banks as of
the previous day. The statement appears the next day (Friday) in many
daily newspapers around the country. The example in table A.l is a con
densed form of the statement published on June 30,1994, for June 29,1994.

Major Asset Accounts
The GOLD CERTIFICATE A CC O U N T (item 1 in the table) comprises certifi
cates that are issued to the Federal Reserve by the Treasury and backed
by gold held by the Treasury. In return, the Reserve Banks issue an
equal value of credits to the Treasury deposit account (item 9b), com
puted at the statutory price of $42.22 per fine troy ounce. Through such
transactions, the Treasury "monetizes" gold. Because all gold held by
the Treasury as of the date of the table has been monetized, the Federal
Reserve Banks' gold certificate account of $11.1 billion represents the
nation's entire official gold stock. New gold certificate credits may be
issued only if the Treasury acquires additional gold or if the statutory
price of gold is increased. If the gold stock is reduced, the Treasury must
redeem an equal value of gold certificates from the Federal Reserve in
exchange for a reduced Treasury deposit at the Federal Reserve.

114

Closely related to the gold certificate account is the SPECIAL DRAW ING
(item 2). Special drawing rights (SDRs)
are a type of asset created by the International Monetary Fund (IMF),
after agreement by a large majority of its members, to supplement the
members' international reserve assets; SDRs are allocated to the mem
bers according to the size of the members' quotas, but without any pay
ment. SDRs received by the U.S. government are, by law, held by the
RIGHTS CERTIFICATE A CC O U N T

Table A.l
Consolidated statement of condition of all Federal Reserve Banks, June 29, 1994
Millions of dollars

Account

Amount1

Assets
1.
2.
3.
4.
5.

Gold certificate account
Special drawing rights certificate account
Coin
Loans
Securities
a. Bought outright
b. Field under repurchase agreement
6. Cash items in process of collection
7. Other assets

11,052
8,018
302
381
355,841
351,563
4,279
4,998
32,013

Total a ssets

4 1 2 ,6 0 6

Liabilities
8. Federal Reserve notes
9. Deposits
a. Depository institutions
b. U.S. Treasury, general account
c. Foreign official accounts
d. Other
10. Deferred availability cash items
11. Other liabilities and accrued dividends

359,698
37,732
30,864
6,435
163
270
4,541
3,230

T otal lia b ilities

4 0 5 ,2 0 2

Capital accounts
12. Capital paid in
13. Surplus
14. Other capital accounts
T otal lia b ilities a n d c a p ita l a c co u n ts

3,523
3,401
481
4 1 2 ,6 0 6

1. In tables A .l and A.2, details may not sum to totals because of rounding.

B A L A N C E

S H E E T

R E S E

n = B = S = = B = C f-1/ A T £ = Q = ff

Secretary of the Treasury for the account of the Exchange Stabilization
Fund (ESF). From time to time, the ESF monetizes SDRs by issuing SDR
certificate credits to the Reserve Banks. These credits are added to the
SDR certificate account, and the dollar value of the new SDR certificate
credits is added to a special Treasury deposit account (part of item 9d).!
(item 3) represents the value of coins issued by the Treasury that
the Reserve Banks hold. When the Treasury issues coin, the Federal Re
serve credits the Treasury deposit account (item 9b) and increases its
own holding of coin (item 3). The public obtains coin, as needed, from
depository institutions, which in turn generally acquire it from the Re
serve Banks. When depository institutions obtain coin from the Reserve
Banks, their reserve deposits with the Reserve Banks (item 9a) are debited.
COIN

(item 4) represent the amount of discount window credit ex
tended by Federal Reserve Banks to depository institutions. The
proceeds of such loans are credited to the accounts of depository insti
tutions at the Federal Reserve (item 9a), and the accounts are debited
when the loan is repaid.
LOANS

The Federal Reserve System's portfolio of SECURITIES (item 5) contains
mainly U.S. government securities, including Treasury bills, notes, and
bonds and obligations of federal agencies, acquired originally through
open market operations.
(item 6) are checks and
other cash items (such as interest coupons from municipal securities)
that have been deposited with the Reserve Banks for collection on be
half of an institution having an account. This item has a counterpart on
the liability side of the statement, DEFERRED AVAILABILITY CASH ITEM S
(item 10). Items 6 and 10 are both "suspense items"—accounts that re
flect a transaction in process. When a Federal Reserve Bank receives a
check for collection, CIPC increases. Unless the depository institution
receives reserves the same day, the volume of deferred availability cash
items also rises.1
2 When the institution that brought the check for collec
tion receives credit, its reserve account, in item 9a, is increased, and
item 10 is reduced. When the check is actually collected, item 6 and the
CASH ITEM S IN PROCESS OF CO LLECTIO N (CIPC)

1. Since 1974, the IMF has calculated the daily value of the SDR using a weighted aver
age of exchange rates of the currencies of certain member countries. The Exchange Stabili
zation Fund values its SDR holdings on this basis and, when monetizing SDRs, deter
mines accordingly the dollar value of the SDR certificate credits issued. As of June 29,
1994—the date of table A .1—the ESF held $1.7 billion of unmonetized SDRs and $8 billion
of SDRs that had been monetized with the Federal Reserve.
2. Intraterritory checks (that is, checks involving a payor depository and a payee deposi
tory served by the same Federal Reserve office) generally are credited the same day that
the Federal Reserve receives the checks. Such payment is affected by directly debiting and
crediting the depositories' accounts at the Federal Reserve Bank, and no entry in the two
suspense accounts is necessary.

t i3

116

reserve account of the institution on which the check is drawn, in item
9a, are both reduced.
OTHER A SSETS (item 7) consist of the value of Federal Reserve Bank
premises, interest accrued, Federal Reserve holdings of foreign cur
rency, and various other items generally of minor importance.

(item 8) are the principal type of U.S. cur
rency in circulation. These notes represented almost 89 percent of total
Reserve Bank liabilities at the end of June 1994.3
FEDERAE RESERVE NOTES

DEPOSITS

of all kinds at Reserve Banks are reported in item 9:

(item 9a) take the form of
reserve balances and service-related balances. Service-related bal
ances are balances some depository institutions elect to maintain at
Federal Reserve Banks for clearing purposes; these balances earn
interest credits that can be used to defray the costs of various Fed
eral Reserve services used by an institution. Reserve balances are
considerably larger in volume than service-related balances and,
with certain holdings of vault cash, constitute the reserves available
to the depository system for satisfying reserve requirements.
• The second largest category of Reserve Bank deposit liabilities is
DEPOSITS OF THE US. TREASURY (item 9b). The Treasury draws on
these accounts to make payments by check or direct deposit for all
major types of federal spending. When these payments clear, de
pository reserve balances rise and Treasury deposits fall. The
Treasury's accounts at Reserve Banks are replenished primarily by
transfers of funds from accounts held at depository institutions, in
which the Treasury initially deposits its receipts from taxes and
from the sale of securities. When such transfers are made, reserve
balances are debited and Treasury deposits are credited.
• DEPOSITS OF FO REIG N CENTRAL BANKS A N D GO VERN M EN TS (item
9c) are the third category of deposit liabilities at the Reserve Banks.
Such deposits are maintained with the Federal Reserve Bank of
New York, but all the Reserve Banks share in the deposit liability.
These deposits represent working balances held by foreign authori
ties for purposes of international settlement.
• The fourth category, OTHER D EPO SIT LIABILITIES (item 9d), includes
deposits of some U.S. government agencies and of international or
ganizations of which the United States is a member, as well as mis
cellaneous deposits.

•

DEPOSITS OF DEPOSITORY IN STITU TIO N S

3. Although each Reserve Bank may hold as assets Federal Reserve notes issued by other
Reserve Banks, such notes cancel out in a consolidated statement of condition for the Sys
tem as a whole and thus do not appear in the table.

fi £~"/\ /if C g

S HE E T — t

" ff T ? E f Y f

EQU

f t 0 N—

As mentioned above, DEFERRED AVAILABILITY CASH ITEM S (item 10)
arise because Reserve Banks do not give immediate credit to the ac
count of a depositing institution for all checks presented to the Reserve
Banks for collection. In many cases, credit is deferred according to
schedules that allow some time for checks to be delivered to the institu
tions on which they are drawn. After this interval, the institution's re
serve balance is automatically credited, and the total of deferred avail
ability cash items is reduced. Because the time actually taken to collect a
check may be longer than that allowed in the schedule, the depositing
institution's reserve balance may be credited before the reserve balance
of the institution on which the check is drawn is debited.
The difference between the asset account (cash items in process of col
lection) and the liability account (deferred availability cash items) is
called Federal Reserve "float" and represents checks and other items
that, although not yet collected by the Reserve Banks, have already been
credited to the reserve balances of the institutions that deposited them.
Float measures the amount of Federal Reserve credit granted to deposi
tory institutions (item 9a) that is generated by the Federal Reserve's
involvement in the national process of check collection.
(item 11) consist of un
earned discounts, discounts on securities, and miscellaneous accounts
payable.
OTHER LIABILITIES AND ACCRU ED DIVIDENDS

A bank that is a member of the Federal Reserve System must, under the
Federal Reserve Act, subscribe to the capital stock of the Reserve Bank
of its District. The total amount of a member bank's subscription is
equal to 6 percent of its current capital stock and surplus. Of this
amount, one-half is CAPITAL PAID IN (item 12) and one-half is subject to
call by the Board of Governors. These shares, unlike ordinary stock in
private banks or corporations, do not carry voting power to control the
policies of the Reserve Banks. Member institutions are entitled by stat
ute to a cumulative dividend of 6 percent per year on the value of their
paid-in stock. Holdings of Reserve Bank stock may not be transferred,
nor may the shares be used as collateral for loans.
The SURPLUS A CC O U N T (item 13) represents retained net earnings of
the Reserve Banks, and the OTHER CAPITAL A CCOUNTS (item 14) reflect
the unallocated net earnings for the current year to the date of the state
ment. The Reserve Banks may draw on their surplus to meet deficits
and to pay dividends in years when operations result in loss, but they
may not otherwise distribute it to the stockholding member banks. The
Federal Reserve for some years has retained sufficient earnings to
equate its surplus to capital paid in; the balance of net Federal Reserve
earnings is turned over to the Treasury.

14?

118

THE RESERVE EQUATION

Shown in table A.2, the “reserve equation" specifies all the factors that
can influence the supply of reserves. Thus, it provides a useful frame
work for analyzing how the quantity of reserves is determined. Factors
1 through 7 in the equation determine reserve balances of depository
institutions that are held at Reserve Banks during the current reserve
maintenance period. Factors 1 through 3 are the sources of funds that
could end up as reserve balances with the Federal Reserve Banks. Fac
tors 4 through 7 are the uses other than reserve balances that could ab
sorb reserve funds. Factor 8, reserve balances, is the remaining use for
such reserve funds. Indeed, the amount of reserve balances is deter
mined here as the difference between total supply of such reserve funds
and total uses, other than reserve balances, absorbing such reserve funds.
Most of the factors in the equation appear on the consolidated balance
sheet of the Federal Reserve Banks. In the reserve equation, reserve bal
ances are separated from service-related balances and adjustments
(factor 6c), rather than combined in deposits of depository institutions
(item 9a on the balance sheet). Similarly, Federal Reserve float (factor lc
in the reserve equation) is defined as cash items in process of collection
(item 6 in the balance sheet) less deferred availability cash items (item
10) plus minor technical adjustments. A convenient rule of thumb is
that items from the asset side of the Reserve Bank balance sheet enter
the equation as sources (which supply potential reserve funds) and that
liabilities enter as uses (which absorb potential reserve funds).
The equation for determining reserve balances also incorporates the
Treasury's monetary accounts, which reflect the Treasury's holdings of
gold, currency, and coin as well as its issuance of currency and coin.
The first steps in incorporating these accounts into the reserve equation
are to (1) add unmonetized gold and Treasury currency holdings (in
cluding coin) to both sides of the balance sheet and (2) subtract coin
held by the Federal Reserve from both sides of the balance sheet. Cer
tain items on the resulting balance sheet are then combined to give the
remaining sources and uses of reserve balances.
Gold stock (a source, factor 2a) consists of the gold certificate account
plus unmonetized gold. Currency in circulation (a use, factor 4) consists
of Federal Reserve notes and Treasury currency outstanding less coin
and currency held by the Treasury and coin held by Federal Reserve
Banks. (Federal Reserve notes held by Reserve Banks are already netted
out in the consolidated balance sheet of the Reserve Banks.) Another
use, Treasury cash holdings (factor 5), consists of unmonetized gold
plus coin and currency held by the Treasury. (Because coin and cur
rency held by the Treasury are netted out of currency in circulation,
they must be included in this use of reserve funds.)

t tS

Ei E ‘T*

15 ^£|

Tab/e A.2
Reserve equation, June 29,1994
Weekly averages, millions of dollars

Week ending
June 29, 1994

Change from
week ending
June 30, 1993

Sources (factors supplying reserve funds)

428,927

27,070

1. Reserve Bank credit
a. Security holdings
b. Loans
c. Float
d. Other assets

387,351
353,993
385
535
32,439

26,280
26,570
-2
-105
-184

2. Monetary reserves
a. Gold stock
b. Special drawing rights certificate account

11,052
8,018

-5
0

3. Treasury currency outstanding

22,507

796

404,126

28,485

4. Currency in circulation

379,126

36,280

5. Treasury cash holdings

355

-93

6. Deposits, other than reserve balances,
with Federal Reserve Banks
a. Treasury deposits
b. Foreign deposits
c. Service-related balances and adjustments
d. Other deposits

13,887
7,561
182
5,870
274

-9,159
-8,695
-36
-410
-18

7. Miscellaneous accounts, liabilities, and capital

10,758

1,457

EQUALS:
8. Reserve balances with Federal Reserve Banks

24,801

-1,415

PLUS:
9. Vault cash used to satisfy reserve requirements

33,571

2,539

EQUALS:
10. Total reserves
a. Nonborrowed reserves
b. Borrowed reserves

58,372
57,804
568

1,124
867
257

Factor

LESS:
Uses other than reserve balances

(factors absorbing reserve funds)

120

When the source factors increase, they provide reserve funds. For ex
ample, an increase in factor 1, Reserve Bank credit—composed of
the System's holdings of securities, discount window loans, Federal
Reserve float, and other assets—would augment reserve balances if all
other items in the reserve equation stayed the same. A decrease in Re
serve Bank credit (or any other source factor) would reduce reserve bal
ances, other things being unchanged.
Reserve Bank credit is the largest factor on the sources side of the re
serve equation, as table A.2 shows; By far the most important compo
nent of Reserve Bank credit is the System's portfolio of securities (factor
la), which accounted for around 90 percent of Reserve Bank credit as of
June 29,1994. Securities holdings are the principal factor in the reserve
equation over which the Federal Reserve has direct control. Requests to
borrow reserves at the discount window—another component of Re
serve Bank credit—take place at the initiative of depository institutions.
The significance of the float component (factor lc) hinges not so much
on the total amount of reserve funds it might provide, which is usually
small compared with other components of Reserve Bank credit, as on
the size and frequency of changes in its level. Float sometimes varies
erratically from day to day, especially in winter, when bad weather may
hinder the shipment of checks. Because of this volatility, it can be diffi
cult to predict.
Reserve

An increase in any of the use factors other than reserve balances (factors
4, 5, 6, or 7) absorbs funds that otherwise could be held as reserve bal
ances. For example, if other items were unchanged, a rise in currency in
circulation (factor 4) would be accompanied by a decline in reserve bal
ances, as depository institutions drew down such accounts to pay the
Federal Reserve for currency received from the System.
Currency in circulation is the largest single factor absorbing potential
reserve funds. The public's demands for currency depend principally
on the volume of spending, which varies with both long-run growth
and cyclical movements of the U.S. economy. However, some evidence
suggests that a substantial share of total currency outstanding is held
outside the United States. Foreign demands for U.S. currency appear to
increase in times of political and economic uncertainty abroad. Seasonal
swings in demands for currency are also sizable, especially around ma
jor holidays (see chart A.l). In the last two months of a year, the increase
in currency in circulation absorbs several billion dollars of reserves. In
the following two months, much of this bulge returns from circulation.
One of the original reasons for creating the Federal Reserve System was

■ b

z ^ x = t t = c = s =^ s .i r g 'g = r = & .r

r v

cr v

a t t

& n

Chart A.l
Seasonal variation in currency in circulation
and Federal Reserve float
Currency in circulation

Billions of dollars

Federal Reserve float

Note. Weekly averages of daily data.

to provide a means of accommodating such seasonal increases in the
public's currency holdings (by supplying reserve funds) and to avoid
the often undesirable contraction of bank reserves and deposits that
would otherwise occur.
Both Treasury deposits (factor 6a) and service-related balances and ad
justments of depository institutions (factor 6c) also absorb potential re
serve funds. Week-to-week changes in these items can be sizable even
though their levels are relatively low.

Reserve balances with Federal Reserve Banks (factor 8) constitute only
one component of the total reserves available to depository institutions;

121

vault cash (factor 9) must be added to reserve balances to derive total
reserves (line 10 in table A.2). Vault cash held during the previous com
putation period is eligible to satisfy reserve requirements in the current
reserve maintenance period. However, not all such vault cash is actually
counted as reserves. Many institutions hold vault cash in excess of their
reserve requirements; such surplus holdings in the lagged computation
period are not included in the vault cash component of total reserves
(factor 9), which consists only of that portion of vault cash held during
the previous computation period that is used to satisfy reserve require
ments in the current maintenance period.4 Total reserves increased
$1,124 million from June 29,1993, to June 29,1994; nonborrowed re
serves increased $867 million, while borrowing from the Federal Re
serve by depository institutions increased $257 million. ■

4. Before November 12,1992, vault cash that was held two computation periods before
the current maintenance period was used to satisfy current period reserve requirements.
The lag has been shortened to smooth fluctuations in required reserve balances.

Appendix u jM

Federal Reserve Regulations

Regulation

Subject

Purpose

Extensions of Credit
by Federal Reserve Banks

Governs borrowing by
depository institutions at the
Federal Reserve discount
window

Equal Credit Opportunity

Prohibits lenders from
discriminating against credit
applicants, establishes guide
lines for gathering and
evaluating credit informa
tion, and requires written
notification when credit is
denied

Home Mortgage
Disclosure

Requires certain mortgage
lenders to disclose data
regarding their lending
patterns

Reserve Requirements
of Depository Institutions

Sets uniform requirements
for all depository institutions
to maintain reserve balances
either with their Federal
Reserve Bank or as cash in
their vaults

Electronic Funds Transfers

Establishes the rights, liabil
ities, and responsibilities
of parties in electronic funds
transfers and protects con
sumers when they use such
systems

Limitations on Interbank
Liabilities

Prescribes standards to limit
the risks posed by obliga
tions of insured deposi
tory institutions to other
depository institutions

124

Subject

Purpose

Securities Credit by
Persons other than
Banks, Brokers, or
Dealers

Governs extension of credit
by parties other than
banks, brokers, or dealers
to finance the purchase or the
carrying of margin securities;
see also regulations T, U,
and X

Membership of
State Banking
Institutions in the
Federal Reserve System

Defines the requirements
for membership by statechartered banks in the
Federal Reserve System
and establishes minimum
levels for the ratio of
capital to assets to be
maintained by state
member banks

Issue and Cancellation of
Capital Stock of Federal
Reserve Banks

Sets forth stocksubscription requirements
for all banks joining the
Federal Reserve System

Collection of Checks and
Other Items by Federal
Reserve Banks and Funds
Transfers through Fedwire

Establishes procedures,
duties, and responsibili
ties among (1) Federal
Reserve Banks, (2) the
senders and payors of
checks and other items,
and (3) the senders and
recipients of wire trans
fers of funds

International Banking
Operations

Governs the international
banking operations of
U.S. banking organiza
tions and the operations
of foreign banks in the
United States

Management Official
Interlocks

Restricts the management
relationships that an
official in one depository
institution may have with
other depository institu
tions

Consumer Leasing

Implements the consumer
leasing provisions of the
Truth in Lending Act by
requiring meaningful
disclosure of leasing terms

Regulation

Subject

Purpose

Relations with Foreign
Banks and Bankers

Governs relationships and
transactions between
Federal Reserve Banks
and foreign banks, bank
ers, or governments

Loans to Executive
Officers, Directors, and
Principal Shareholders of
Member Banks

Restricts credit that a
member bank may extend
to its executive officers,
directors, and principal
shareholders and their
related interests

Minimum Security Devices
and Procedures for
Federal Reserve Banks
and State Member Banks

Sets requirements for a
security program that
state-chartered member
banks must establish to
discourage robberies,
burglaries, and larcenies

Prohibition against
Payment of Interest on
Demand Deposits

Prohibits member banks
from paying interest on
demand deposits (for
example, checking
accounts)

Relationships with
Dealers in Securities
under Section 32 of the
Banking Act of 1933

Restricts employment
relations between securi
ties dealers and member
banks to avoid conflict of
interest, collusion, or un
due influence on member
bank investment policies or
advice to customers

Reimbursement to
Financial Institutions for
Assembling or Providing
Financial Records

Establishes rates and
conditions for reimburse
ment to financial institu
tions for providing customer
records to a government
authority

Credit by Brokers
and Dealers

Governs extension of
credit by securities brokers
and dealers, including all
members of national
securities exchanges; see also
regulations G, U, and X

R egulation

126

Subject

Purpose

Credit by Banks for
Purchasing or Carrying
Margin Stocks

Governs extension of credit
by banks to finance the pur
chase or the carrying of
margin securities; see also
regulations G, T, and X

Loan Guarantees for
Defense Production
(Dormant)

Facilitates the financing of
contracts deemed necessary
to national defense
production

Vacant

Borrowers of Securities
Credit

Extends to borrowers who
are subject to U.S. laws the
provisions of regulations G, T,
and U for obtaining credit
within or outside the United
States for the purpose of
purchasing securities

Bank Holding Companies
and Change in Bank
Control

Governs the bank and
nonbank expansion of bank
holding companies, the
divestiture of impermissible
nonbank interests, and the
acquisition of a bank by
individuals

Truth in Lending

Prescribes uniform methods
for computing the cost of
credit, for disclosing credit
terms, and for resolving
errors on certain types of
credit accounts

Unfair or Deceptive Acts
or Practices

Establishes consumer
complaint procedures and
defines unfair or deceptive
practices in extending credit
to consumers

Community Reinvestment

Implements the Community
Reinvestment Act and
encourages banks to help
meet the credit needs of their
communities

Regulation

R egulation

Subject

Purpose

Availability of Funds and
Collection of Checks

Governs the availability of
funds deposited in checking
accounts and the collection
and return of checks

Truth in Savings

Requires depository institu
tions to provide disclosures to
enable consumers to make
meaningful comparisons of
deposit accounts

Netting Eligibility
for Financial
Institutions

Defines financial institu
tions to be covered by
statutory provisions regard
ing netting contracts—that is,
contracts in which the parties
agree to pay or receive the
net, rather than the gross,
payment due

Appendix

Glossary of Terms

THIS GLOSSARY gives basic definitions of terms used in the text.
Readers seeking more comprehensive explanations may want to consult
sources listed in "Selected Readings" in this volume and textbooks in
economics, banking, and finance.

Corporation chartered by a state to engage in
international banking; so named because the corporation enters into
an "agreement" with the Board of Governors to limit its activities to
those permitted an Edge Act corporation.

■ agreement corporation

Electronic clearing and settlement
system for exchanging electronic transactions among participating
depository institutions; such electronic transactions are substitutes
for paper checks and are typically used to make recurring payments
such as payroll or loan payments. The Federal Reserve Banks
operate an automated clearinghouse, as do some private-sector
firms.

automated clearinghouse (ACH)

International organization
established in 1930 and based in Basle, Switzerland, that serves as
a forum for central banks for collecting information, developing
analyses, and cooperating on a wide range of policy-related
matters.

■ Bank for International Settlements (BIS)

Company that owns, or has controlling
interest in, one or more banks. A company that owns more than
one bank is known as a multibank holding company. (A bank
holding company may also own another bank holding company,
which in turn owns or controls a bank; the company at the top of
the ownership chain is called the top holder.) The Board of Gover
nors is responsible for regulating and supervising bank holding
companies, even if the bank owned by the holding company is
under the primary supervision of a different federal agency (the
Comptroller of the Currency or the Federal Deposit Insurance
Corporation).

bank holding company

A top holder bank holding company (consoli
dated to include all of its subsidiary banks and nonbank subsidiar
ies) or an independent bank (a bank that is not owned or controlled
by a bank holding company).

banking organization

130

Actions to make, issue, and enforce specific rules
and regulations governing the structure and conduct of banking,
under the authority of legislation.

bank regulation

Oversight of individual banks to ensure that they
are operated prudently and in accordance with applicable statutes
and regulations.

bank supervision

Central, governmental agency of the Federal
Reserve System, located in Washington, D.C., and composed of
seven members, who are appointed by the President and confirmed
by the Senate. The Board of Governors is responsible for domestic
and international economic analysis; with other components of the
System, for the conduct of monetary policy; for supervision and
regulation of certain banking organizations; for operation of much
of the nation's payments system; and for administration of most of
the nation's laws that protect consumers in credit transactions.

Board of Governors

Securities that are recorded in electronic
records, called book entries, rather than as paper certificates.
Ownership of U.S. government book-entry securities is transferred
over Fedwire. (Compare definitive securities.)

book-entry securities

Reserves that eligible depository institutions
obtain by borrowing from the Federal Reserve through the discount
window.

borrowed reserves

■

Call Report

Informal name for Report of Condition and Income.

In banking, the funds invested in (as opposed to deposited in)
a bank.

capital

The market in which corporate equity and longer-term
debt securities (those maturing in more than one year) are issued
and traded. (Compare money market.)

capital market

cash

Currency plus coin.

Principal monetary authority of a nation, which per
forms several key functions, including issuing currency and regu
lating the supply of credit in the economy. The Federal Reserve is
the central bank of the United States.

central bank

The movement of a check from the depository institu
tion at which it was deposited back to the institution on which it
was written, the movement of funds in the opposite direction, and
the corresponding credit and debit to the involved accounts. The
Federal Reserve operates a nationwide check-clearing system.

check clearing

* F= E = -O ^B -6 -

Practice of holding a paper check at the bank at
which it was deposited (or at an intermediary bank) and electroni
cally forwarding the essential information on the check to the bank
on which it was written. A truncated check is not returned to the
writer.

check truncation

General term that may refer to check clearing or to the
process of matching trades between the sellers and buyers of
securities and other financial instruments and contracts.

clearing

Bank that offers a broad range of deposit accounts,
including checking, savings, and time deposits, and extends loans
to individuals and businesses. Commercial banks can be contrasted
with investment banking firms, such as brokerage firms, which
generally are involved in arranging for the sale of corporate or
municipal securities. (Also compare savings bank.)

commercial bank

Short-term, unsecured promissory note issued by a
commercial firm, a financial company, or a foreign government.

commercial paper

Statutory group composed of thirty
members who represent the interests of a broad range of consumers
and creditors. The council meets with the Board of Governors three
times a year on matters concerning consumers and the consumer
protection laws administered by the Board.

Consumer Advisory Council

Interest-bearing or discounted debt obligation issued
by a private corporation rather than by a government or a govern
ment agency.

corporate bond

Bank that accepts the deposits of, and performs
services for, another bank (called a respondent bank); in most cases,
the two banks are in different cities.

correspondent bank

credit aggregate

A term sometimes used instead of debt aggregate.

Financial cooperative organization of individuals who
have a common bond, such as place of employment or residence or
membership in a labor union. Credit unions accept deposits from
members, pay interest (in the form of dividends) on the deposits out
of earnings, and use their funds mainly to provide consumer
installment loans to members.

credit union

currency

Paper money.

Term used informally for domestic nonfinancial sector
debt, which is an aggregate measure through which the Federal
Reserve monitors debt in the economy; includes outstanding credit
market debt of federal, state, and local governments and of private
nonfinancial sectors (including mortgages and other kinds of
consumer credit and bank loans, corporate bonds, commercial
paper, bankers acceptances, and other debt instruments).

■ debt aggregate

t31

132

Securities that are recorded on engraved paper
certificates payable to the bearers or to specific, registered owners.

definitive securities

(C o m p a re book-entry securities.)

A deposit that may be withdrawn at any time
without prior written notice to the depository institution. A
checking account is the most common form of demand deposit.

demand deposit

Financial institution that obtains its funds
mainly through deposits from the public; includes commercial
banks, savings and loan associations, savings banks, and credit
unions. (Sometimes called a depository intermediary.)

depository institution

Practice of deducting the interest on a loan from the
principal amount before giving the borrowed funds to the bor
rower; the borrower receives the principal amount less the interest
due over the term of the loan but repays the principal amount.

discounting

Interest rate at which an eligible depository institution
may borrow funds, typically for a short period, directly from a
Federal Reserve Bank. The law requires that the board of directors
of each Reserve Bank establish the discount rate every fourteen
days subject to the approval of the Board of Governors.

discount rate

Figurative expression for Federal
Reserve facility for extending credit directly to eligible depository
institutions (those that hold transaction deposits or nonpersonal
time deposits); so named because in the early days of the Federal
Reserve System, bankers would come to a Reserve Bank teller
window to obtain credit.

discount window (the window)

Credit extended by a Federal Reserve Bank
to an eligible depository institution. All discount window borrow
ing must be secured by colla teral.

discount window credit

Discount window credit extended to help
depository institutions handle temporary liquidity problems
arising from short-term fluctuations in assets and liabilities.

• adjustment credit

Discount window credit, typically extended
to small depository institutions that have difficulty raising funds
in national money markets, to help meet temporary needs for
funds resulting from regular, seasonal fluctuations in loans and
deposits.

• seasonal credit

Discount window credit extended to help
depository institutions resolve longer-term liquidity problems
resulting from exceptional circumstances.

• extended credit

Trading desk at the Federal
Reserve Bank of New York through which open market purchases
and sales of government securities and certain other securities are
made.

Domestic Trading Desk (the Desk)

Federal Reserve action to increase the amount of credit avail
able to the public through the banking system; undertaken when the
economy needs to be stimulated. (Compare tightening.)

easing

Corporation chartered by the Federal Reserve
to engage in international banking. The Board of Governors acts on
applications to establish Edge Act corporations and also examines
the corporations and their subsidiaries. Named after Senator
Walter Edge of New Jersey who sponsored the original legislation
to permit formation of such organizations. (Compare agreement

Edge Act corporation

corporation.)

Currency that can, by the actions of the central
monetary authority, expand or shrink in amount as economic
conditions warrant.

elastic currency

Transfer of funds electronically rather
than by check or cash. The Federal Reserve's Fedwire and auto
mated clearinghouse services are EFT systems.

electronic funds transfer (EFT)

A generic term referring to deposits in a bank
located in a country other than the one of issue of the currency in
which the deposit is denominated. Despite its name, not all
Eurocurrency is money deposited in European banking offices or
denominated in European currencies.

Eurocurrency deposits

Dollar-denominated deposits in banks and other
financial institutions outside the United States; includes deposits at
banks not only in Europe, but in all parts of the world.

Eurodollar deposits

Purchase or sale of the currencies of
other nations by a central bank for the purpose of influencing
foreign exchange rates or maintaining orderly foreign exchange
markets.

exchange market intervention

Advisory group made up of one represen
tative (in most cases a banker) from each of the twelve Federal
Reserve Districts. Established by the Federal Reserve Act, the
council meets periodically with the Board of Governors to discuss
business and financial conditions and to make recommendations.

Federal Advisory Council

Interest-bearing obligations issued by
certain federal and federally sponsored agencies, including the
Federal Home Loan Banks, the Federal Farm Credit Banks, the
Federal National Mortgage Association, and the Tennessee Valley
Authority. Some federal agency securities are backed by the U.S.
government, while others are backed only by the issuing agency.

federal agency securities

Group
of representatives of the federal banking regulatory agencies—the
Board of Governors, the Office of Thrift Supervision, the Federal
Deposit Insurance Corporation, the Office of the Comptroller of
the Currency, and the National Credit Union Administration—
established to maintain uniform standards for examining and
supervising federally insured depository institutions, bank holding
companies, and savings and loan holding companies.

Federal Financial Institutions Examination Council (FFIEC)

Short-term transactions in immediately available funds
between depository institutions and certain other institutions that
maintain accounts with the Federal Reserve; usually not
collateralized.

federal funds

Rate charged by a depository institution on an
overnight sale of federal funds to another depository institution;
rate may vary from day to day and from bank to bank.

federal funds rate

Federal Open Market Committee (FOMC, or the Committee)

Twelve-member committee made up of the seven members of the
Board of Governors; the president of the Federal Reserve Bank of
New York; and, on a rotating basis, the presidents of four other
Reserve Banks. The FOMC meets eight times a year to set Federal
Reserve guidelines regarding the purchase and sale of government
securities in the open market as a means of influencing the volume
of bank credit and money in the economy. It also establishes policy
relating to System operations in the foreign exchange markets.
Federal Reserve Act of 1913

Federal legislation that established the

Federal Reserve System.
One of the twelve operating arms of the
Federal Reserve System, located throughout the nation, that
together with their twenty-five Branches carry out various System
functions, including operating a nationwide payments system,
distributing the nation's currency and coin, supervising and regu
lating member banks and bank holding companies, and serving as
banker for the U.S. Treasury.

Federal Reserve Bank

Federal Reserve District (Reserve District, or District)

One of the
twelve geographic regions served by a Federal Reserve Bank.

-G — jr~-Q-- -G~~~-S-

Float is checkbook money that appears on the
books of both the check writer (the payor) and the check receiver
(the payee) while a check is being processed. Federal Reserve float
is float present during the Federal Reserve's check-collection
process. To promote efficiency in the payments system and provide
certainty about the date that deposited funds will become available
to the receiving depository institution (and the payee), the Federal
Reserve credits the reserve accounts of banks that deposit checks
according to a fixed schedule. However, processing certain checks
and collecting funds from the banks on which these checks are
written may take more time than the schedule allows. Therefore,
the accounts of some banks may be credited before the Federal
Reserve is able to collect payment from other banks, resulting in
Federal Reserve float.

Federal Reserve float

Currency issued by the Federal Reserve. Nearly
all the nation's circulating currency is in the form of Federal Re
serve notes, which are printed by the Bureau of Engraving and
Printing, a part of the U.S. Department of the Treasury. Federal
Reserve notes are, by law, obligations of the U.S. government.

Federal Reserve note

Monthly subscription service
that details all statutes and regulations for which the Federal
Reserve has responsibility and that keeps subscribers informed of
all interpretations, Board of Governors rulings, staff opinions and
commentaries, and procedural rules under which the Board operates.

Federal Reserve Regulatory Service

The central bank of the United States,
created by Congress and made up of a seven-member Board of
Governors in Washington, D.C., twelve regional Federal Reserve
Banks, and their twenty-five Branches.

Federal Reserve System

Electronic funds transfer network operated by the Federal
Reserve. Fedwire is usually used to transfer large amounts of funds
and U.S. government securities from one institution's account at the
Federal Reserve to another institution's account. It is also used by
the U.S. Department of the Treasury and other federal agencies to
collect and disburse funds.

Fedwire

Institution that uses its funds chiefly to purchase
financial assets, such as loans or securities (as opposed to tangible
assets, such as real estate). Financial institutions can be separated
into two major groups according to the nature of the principal
claims they issue: nondepositories (sometimes called nondepository
intermediaries), such as life insurance and property-casualty
insurance companies and pension funds, whose claims are the
policies they sell or their promise to provide income after retire
ment; and depository institutions (also called depository intermedi
aries), such as commercial banks, savings and loan associations,
savings banks, and credit unions, which obtain funds mainly by
accepting deposits from the public.

financial institution

136

Services performed by the Federal Reserve
Banks for the U.S. government, including maintaining accounts for
the U.S. Department of the Treasury, paying checks drawn on the
Treasury, and selling and redeeming savings bonds and other
government securities.

fiscal agency services

Federal government policy regarding taxation and
spending, set by Congress and the Administration.

fiscal policy

Arrangements in which the rate of exchange
between countries' currencies (the foreign exchange rate) is
allowed to fluctuate in response to market forces of supply and
demand.

flexible exchange rates

Transactions in the foreign exchange
markets involving the purchase of the currency of one nation with
that of another. Also called foreign exchange transactions.

foreign currency operations

Trading desk at the Federal Reserve Bank of
New York through which transactions in the foreign exchange
markets are conducted. The desk undertakes operations for the
account of the Federal Open Market Committee and, as agent, for
the U.S. Department of the Treasury and for the central banks of
other nations.

Foreign Exchange Desk

foreign exchange markets

Markets in which foreign currencies are

purchased and sold.
Price of the currency of one nation in terms of
the currency of another nation.

foreign exchange rate

Full Employment and Balanced Growth Act of 1978 (HumphreyHawkins Act) Federal legislation that, among other things,

specifies the primary objectives of U.S. economic policy—maximum
employment, stable prices, and moderate long-term interst rates.
Movement of funds between an originating financial
institution and a receiving financial institution.

funds transfer

■

government securities

Securities issued by the U.S. Treasury or

federal agencies.
Total value of goods and services
produced by labor and property located in the United States during
a specific period. In 1991, GDP became the U.S. government's
primary measure of economic activity in the nation, replacing gross
national product (GNP), which is the total value of goods and
services produced by labor and property supplied by U.S. residents
(but not necessarily located within the country).

gross domestic product (GDP)

L O S S

International group made up of seven leading
industrial nations—Canada, France, Germany, Italy, Japan, the
United Kingdom, and the United States—whose finance ministers
and central bank governors meet occasionally to discuss economic
policy.

Group of Seven (G-7)

Informal name for the Full Employment
and Balanced Growth Act of 1978, from the names of the act's
original sponsors.

■ Humphrey-Hawkins Act

Risk of gain or loss in the value of a portfolio as a
result of changes in market interest rates.

■ interest rate risk

International organization
established for lending funds to member nations to promote
international monetary cooperation among nations, to facilitate the
expansion and balanced growth of international trade, and to
finance temporary balance of payments deficits, usually in conjunc
tion with macroeconomic adjustment programs.

International Monetary Fund (IMF)

Quality that makes an asset easily convertible into cash with
relatively little loss of value in the conversion process. Sometimes
used more broadly to encompass credit in hand and promises of
credit to meet needs for cash.

■ liquidity

In banking, risk that a depository institution will not
have sufficient cash or liquid assets to meet borrower and depositor
demand.

liquidity risk

■ Ml

Measure of the U.S. money stock that consists of currency held by
the public, travelers checks, demand deposits, and other checkable
deposits, including NOW (negotiable order of withdrawal) and ATS
(automatic transfer service) account balances and share draft
account balances at credit unions.

Measure of the U.S. money stock that consists of Ml, certain
overnight repurchase agreements and certain overnight Eurodol
lars, savings deposits (including money market deposit accounts),
time deposits in amounts of less than $100,000, and balances in
money market mutual funds (other than those restricted to institu
tional investors).

Measure of the U.S. money stock that consists of M2, time deposits
of $100,000 or more at all depository institutions, term repurchase
agreements in amounts of $100,000 or more, certain term Eurodol
lars, and balances in money market mutual funds restricted to
institutional investors.

137

"Buying on margin" refers to buying stocks or
securities with borrowed money (usually borrowed from a broker
age firm or bank). The margin requirement is the minimum amount
(expressed as a percentage) the buyer must put up (rather than
borrow). The Federal Reserve sets margin requirements.

margin requirement

Rates of interest paid on deposits and other
investments, determined by the interaction of the supply of and
demand for funds in the money market.

market interest rates

Transaction in which the Federal
Reserve sells a government security to a dealer or a foreign central
bank and agrees to buy back the security on a specified date (usu
ally within seven days) at the same price (the reverse of a repur
chase agreement). Such transactions allow the Federal Reserve to
temporarily absorb excess reserves from the banking system,
limiting the ability of banks to make new loans and investments.

matched sale-purchase transaction

Depository institution that is a member of the Federal
Reserve System. All federally chartered banks are automatically
members of the System; state-chartered banks may elect to join the
System.

member bank

Aggregate measures through which the Federal
Reserve monitors the nation's monetary assets: Ml, M2, and M3.

monetary aggregates

A central bank's actions to influence the availability
and cost of money and credit, as a means of helping to promote
national economic goals. Tools of monetary policy include open
market operations, discount policy, and reserve requirements.

monetary policy

Action by a central bank to purchase an object that is not
money (for example, gold) that has the net effect of increasing bank
reserves and permitting an increase in the money stock.

monetize

Anything that serves as a generally accepted medium of
exchange, a standard of value, and a means of saving or storing
purchasing power. In the United States, currency (the bulk of which
is Federal Reserve notes) and funds in checking and similar ac
counts at depository institutions are examples of money.

money

Figurative expression for the informal network of
dealers and investors over which short-term debt securities are
purchased and sold. Money market securities generally are highly
liquid securities that mature in less than one year, typically less than
ninety days. (Compare capital market.)

money market

Total quantity of money available for transactions and
investment; measures of the U.S. money stock include Ml, M2, and
M3. (Also referred to as the money supply, or simply money.)

money stock

G L O S S A R Y

Savings bank owned by its depositors (con
trasted with a stock savings bank, which issues common stock to
the public).

mutual savings bank

A commercial bank that is chartered by the Comptrol
ler of the Currency; by law, national banks are members of the
Federal Reserve System.

■ national bank

nominal interest rates Current stated rates of interest paid or earned.
(C o m p a re real interest rates.)

Portion of total reserves in the banking system
that have not been borrowed by depository institutions through the
Federal Reserve's discount window. The Federal Reserve influences
the supply of nonborrowed reserves by buying and selling securi
ties through the Domestic Trading Desk.

nonborrowed reserves

Depository institution that is not a member of the
Federal Reserve System; specifically a state-chartered commercial
bank that has elected not to join the System.

nonmember bank

Time deposit held by a depositor other
than an individual (for example, a corporation).

nonpersonal time deposit

Assets denominated in foreign
currencies held by the Federal Reserve and the U.S. Treasury.

■ official foreign exchange reserves

open market

Freely competitive market.

Purchases and sales of government securities
and certain other securities in the open market, through the Domes
tic Trading Desk at the Federal Reserve Bank of New York as
directed by the Federal Open Market Committee, to influence the
volume of money and credit in the economy. Purchases inject
reserves into the banking system and stimulate growth of money
and credit; sales do the opposite.

open market operations

"Permanent" sale, purchase, or redemption of
securities by the Federal Reserve in the open market, to adjust the
supply of reserves in the economy over the longer run. (Contrasts
with transactions intended to adjust the supply of reserves only
temporarily, including repurchase agreements and matched sale-

outright transaction

purchase transactions.)

Figurative term for the means of trading securities
that are not listed on an organized stock exchange such as the New
York Stock Exchange. Over-the-counter trading is done by brokerdealers who communicate by telephone and computer networks.

over the counter

139

■

General term for short-term debt instruments such as commer
cial paper.

paper

Collective term for mechanisms (both paper-backed
and electronic) for moving funds, payments, and money among
financial institutions throughout the nation. The Federal Reserve
plays a major role in the nation's payments system through distri
bution of currency and coin, processing of checks, electronic trans
fer of funds, and the operation of automated clearinghouses that
transfer funds electronically among depository institutions; various
private organizations also perform payments system functions.

payments system

Collection of loans or assets, classified by type of borrower
or asset. For example, a bank's portfolio might include loans,
investment securities, and assets managed in trust; the loan portfo
lio might include commercial, mortgage, and consumer installment
loans.

portfolio

Fee that a bank receiving a check imposes on the
bank collecting payment.

presentment fee

■

Interest rates adjusted for the expected erosion of
purchasing power resulting from inflation. Technically defined as
nominal interest rates minus the expected rate of inflation.

real interest rates

Short-term reciprocal arrange
ments among the Federal Reserve, the central banks of certain other
nations, and the Bank for International Settlements. By drawing on
a swap the Federal Reserve, in effect, can obtain foreign currency to
purchase dollars in the foreign exchange markets, thereby increas
ing the demand for dollars and the foreign exchange value of the
dollar. Likewise, the Federal Reserve can temporarily provide
dollars to other central banks by means of swap arrangements.

reciprocal currency (swap) networks

Financial report that all banks, bank
holding companies, savings and loan associations, Edge Act and
agreement corporations, and certain other types of organizations
must file with a federal regulatory agency. Informally termed a
Call Report.

Report of Condition and Income

repurchase agreement (RP, or repo)

Transaction in which one party
purchases, from another party, a government security for immedi
ate delivery and simultaneously agrees to deliver back the security
at a predetermined price on a specified future date; may be an
overnight RP or a term RP. RPs allow the Federal Reserve to inject
reserves temporarily into the banking system, by adding to the level
of nonborrowed reserves, and to withdraw these reserves as soon
as the need has passed.

Amount kept by a depository
institution in an account at a Federal Reserve Bank, in addition
to its required reserve balance, to ensure that it can meet its
daily transaction obligations without overdrawing its required
reserve account and thereby incurring a penalty. Required clearing
balances earn credits that can be used to pay for services provided
by the Federal Reserve.

required clearing balance

Percentage of reservable liabilities that deposi
tory institutions must set aside in the form of reserves.

required reserve ratio

Bank deposits subject to reserve requirements.
Transaction deposits, nonpersonal time deposits, and Eurocurrency
liabilities are all reservable deposits; the required reserve ratios for
nonpersonal time deposits and Eurocurrency liabilities were set at
zero in December 1990.

reservable liabilities

Requirements set by the Board of Governors for
the amounts that certain financial institutions must set aside in the
form of reserves. Reserve requirements act as a control on the
expansion of money and credit and may be raised or lowered
within limits specified by law (lowering reserve requirements
allows more bank lending and money growth; raising requirements,
less lending and money growth).

reserve requirements

A depository institution's vault cash (up to the level of its
required reserves) plus balances in its reserve account (not includ
ing funds applied to its required clearing balance).

reserves

Funds that a depository institution is
required to maintain as vault cash or on deposit with a Federal
Reserve Bank; required amount varies according to required
reserve ratios set by the Board of Governors and the volume of
reservable liabilities held by the institution.

• required reserves

Portion of its required reserves that
a depository institution must hold in an account at a Federal
Reserve Bank

• required reserve balance

Amount of reserves held by an institution in
excess of its reserve requirement and required clearing balance.

• excess reserves

Depository institution historically engaged primarily in
accepting consumer savings deposits and in originating and invest
ing in securities and residential mortgage loans; now may offer
checking-type deposits and make a wider range of loans.

savings bank

A nonmarketable debt obligation of the U.S. govern
ment, issued in denominations of $50 to $10,000, that is sold to the
public through depository institutions and Federal Reserve Banks.

savings bond

t4 2

Historically, depository institution
that accepted deposits mainly from individuals and invested
heavily in residential mortgage loans; although still primarily
residential lenders, s&ls may now offer checking-type deposits and
make a wider range of loans.

savings and loan association (s&l)

Paper certificates (definitive securities) or electronic records
(book-entry securities) evidencing ownership of equity (stocks) or
debt obligations (bonds).

securities

In banking, the process of recording the debit and credit
positions of two parties in a transfer of funds. Also, the delivery of
securities by a seller and the payment by the buyer.

settlement

Unanticipated or unusual event that has a noticeable impact on
the economy or a financial system.

shock

Type of international reserve asset
created by the International Monetary Fund and allocated, on
occasion, to the nations that are members of the IMF.

special drawing rights (SDRs)

Bank that is chartered by a state; may or may not be a
member of the Federal Reserve System.

state bank

Company in which another corporation (called the parent
corporation) owns controlling stock interest or voting control.

subsidiary

The Federal Reserve's portfolio of
government (and certain other) securities from which it conducts
open market operations under the overall supervision of the
Manager of the System Open Market Account, subject to the
policies and rules of the Federal Open Market Committee.

System Open Market Account

Risk that a disruption (at a firm, in a market segment, to
a settlement system, or in a similar setting) will cause widespread
difficulties at other firms, in other market segments, or in the
financial system as a whole.

systemic risk

A general term encompassing savings banks,
savings and loan associations, and credit unions.

■ thrift institution

Group established by the Board
of Governors after passage of the Depository Institutions Deregula
tion and Monetary Control Act of 1980 to obtain information and
opinions on the needs and problems of thrift institutions. Made up
of representatives of savings and loan associations, savings banks,
and credit unions.

Thrift Institutions Advisory Council

Federal Reserve action to reduce the amount of credit
available to the public through the banking system; undertaken
when inflation is a concern. (Compare easing.)

tightening

Funds deposited in an account that has a fixed term to
maturity and technically cannot be withdrawn before maturity
without advance notice (for example, a certificate of deposit). Most
time deposits earn interest.

time deposit

A checking account or similar deposit account
from which transfers of funds can be made. Demand deposit
accounts, NOW (negotiable order of withdrawal) accounts, ATS
(automatic transfer service) accounts, and credit union share draft
accounts are examples of transaction accounts.

transaction deposit

Service provided to the U.S. Department of the
Treasury whereby Federal Reserve Banks hold book-entry
Treasury securities purchased by individuals.

Treasury Direct

Interest-bearing checking
accounts that the U.S. Department of the Treasury maintains at
depository institutions, primarily commercial banks, to hold
deposits of federal taxes paid by businesses and individuals. The
Federal Reserve Banks monitor the accounts and, on daily instruc
tions from cash managers at the Treasury Department, transfer
funds to the department's account at the Federal Reserve to cover
the government's daily operating expenses.

Treasury tax and loan (TT&L) accounts

Interest-bearing obligations of the U.S.
government issued by the U.S. Department of the Treasury as a
means of borrowing money to meet government expenditures not
covered by tax revenues. There are three types of marketable
Treasury securities—bills, notes, and bonds.

U.S. Treasury securities

Short-term U.S. Treasury security
having a maturity of up to one year and issued in denomina
tions of $10,000 to $1 million. T-bills are sold at a discount:
Investors purchase a bill at a price lower than the face value (for
example, the investor might buy a $10,000 bill for $9,700); the
return is the difference between the price paid and the amount
received when the bill is sold or it matures (if held to maturity,
the return on the T-bill in the example would be $300). T-bills are
the type of security most frequently used in Federal Reserve
open market operations.
• Treasury note Intermediate-term security having a maturity of
one to ten years and issued in denominations of $1,000 or more.
Notes pay interest semiannually, and the principal is payable at
maturity.
• Treasury bond Long-term security having a maturity of ten
years or longer and issued in denominations of $1,000 or more.
A thirty-year bond is sometimes referred to as a long bond.
Bonds pay interest semiannually, and the principal is payable at
maturity.
• Treasury bill (T-bill)

The Treasury Department also issues several types of nonmarketable securities, including savings bonds.

144

Cash kept on hand in a depository institution's vault
to meet day-to-day business needs, such as cashing checks for
customers; can be counted as a portion of the institution's required
reserves.

■ vault cash

■ wire transfer

payments.

Electronic transfer of funds; usually involves large dollar

Appendix WJM
• • • • • • • • • • • • • • • • • •

Selected Readings

T he FOLLOWING LIST has been compiled from publications
of the Federal Reserve System.

Broaddus, Alfred. A Primer on the Fed. Federal Reserve Bank of
Richmond, 1988.
Dunne, Gerald T. A Christmas Present for the President: A Short History of
the Creation of the Federal Reserve System. Federal Reserve Bank of
St. Louis, 1985.
Dykes, Sayre Ellen, and Michael A. Whitehouse. "The Establishment
and Evolution of the Federal Reserve Board: 1913-23," Federal Reserve
Bulletin, vol. 75 (April 1989), pp. 227-43.
Federal Reserve Bank of Atlanta. Federal Reserve System Structure and
Functions. 1992.
Federal Reserve Bank of St. Louis. "The Role of Regional Reserve
Banks." 1992 Annual Report, 1993.
Gamble, Richard FI. A History of the Federal Reserve Bank of Atlanta.
Federal Reserve Bank of Atlanta, 1989.
Johnson, Roger T. Historical Beginnings . . . The Federal Reserve. Federal
Reserve Bank of Boston, 1990.
Primm, James Neal. A Foregone Conclusion: The Founding of the Federal
Reserve Bank of St. Louis. Federal Reserve Bank of St. Louis, 1989.
Rolnick, Arthur J., and Warren E. Weber. "Free Banking, Wildcat Bank
ing, and Shinplasters," Federal Reserve Bank of Minneapolis Quarterly
Review, vol. 6 (Fall 1982), pp. 10-19.
Domestic Monetary Policy
Aiyagari, S. Rao. "Deflating the Case for Zero Inflation," Federal Reserve
Bank of Minneapolis Quarterly Review, vol. 14 (Summer 1990), pp. 2-11.

146

___________. "Response to a Defense of Zero Inflation," Federal Reserve
Bank of Minneapolis Quarterly Review, vol. 15 (Spring 1991), pp. 21-24.
Cox, W. Michael. "Two Types of Paper: The Case for Federal Reserve
Independence," in Federal Reserve Bank of Dallas, Annual Report,
1990, pp. 6-18.
Duca, John V. "Monitoring Money: Should Bond Funds Be Added to
M2?" in Federal Reserve Bank of Dallas, The Southwest Economy,
special ed. (June 1993), pp. 1-8.
Federal Reserve Bank of Chicago. Modern Money Mechanics: A Workbook
on Bank Reserves and Deposit Expansion. 1992.
___________. Points of Interest: What Determines Interest Rates? 1992.
Federal Reserve Bank of Cleveland. "Central Bank Independence,"
in Annual Report, 1990, pp. 4-19.
___________."Central Banking in the United States: A Fragile Commit
ment to Price Stability and Independence," in Annual Report, 1991,
pp. 4-17.
Federal Reserve Bank of Kansas City. Changing Capital Markets:
Implications for Monetary Policy: A Symposium Sponsored by the Federal
Reserve Bank of Kansas City. 1993.
___________. Monetary Policy Issues in the 1990s: A Symposium
Sponsored by the Federal Reserve Bank of Kansas City. 1989.
___________. Policies for Long-Run Economic Growth: A Symposium
Sponsored by the Federal Reserve Bank of Kansas City. 1992.
Federal Reserve Bank of San Francisco. Monetary Policy in the United
States. 1987.
Feinman, Joshua N. "Reserve Requirements: History, Current Practice,
and Potential Reform," Federal Reserve Bidletin, vol. 79 (June 1993),
pp. 569-89.
Hoskins, W. Lee. "Defending Zero Inflation: All for Naught," Federal
Reserve Bank of Minneapolis Quarterly Review, vol. 15 (Spring 1991),
pp. 16-20.
McNees, Stephen K. "The Discount Rate: The Other Tool of Monetary
Policy," in Federal Reserve Bank of Boston, New England Economic
Review (July/August 1993), pp. 3-22.

Mauskopf, Eileen. "The Transmission Channels of Monetary Policy:
How Have They Changed?" Federal Reserve Bulletin, vol. 76 (Decem
ber 1990), pp. 985-1007.
Meulendyke, Ann-Marie. "Reserve Requirements and the Discount
Window in Recent Decades," in Federal Reserve Bank of New York,
Quarterly Review, vol. 17 (Autumn 1992), pp. 25-43.
__________ . ILS. Monetary Policy and Financial Markets. Federal
Reserve Bank of New York, 1989.
Tootell, Geoffrey M.B. "Regional Economic Conditions and the FOMC
Votes of District Presidents," in Federal Reserve Bank of Boston, New
England Economic Review (March/April 1991), pp. 3-16.
Wallace, Neil. "Why the Fed Should Consider Holding M0 Constant,"
Federal Reserve Bank of Minneapolis Quarterly Review, vol. 1 (Summer
1977), pp. 2 -1 0 .

Monetary Policy

Pauls, B. Dianne. "U.S. Exchange Rate Policy: Bretton Woods to
Present," Federal Reserve Bulletin, vol. 76 (November 1990),
pp. 891-908.
Wallace, Neil. "Why Markets in Foreign Exchange Are Different from
Other Markets," Federal Reserve Bank of Minneapolis Quarterly Review,
vol. 3 (Fall 1979), pp. 1-7. Reprinted in vol. 14 (Winter 1990),
pp. 12-18.
Welch, John H., and William C. Gruben. "Economic Liberalization in the
Americas," in Federal Reserve Bank of Dallas, Annual Report, 1991,
pp. 4-17.

Baer, Herbert, and Sue F. Gregorash, eds. Toward Nationwide Banking: A
Guide to the Issues. Federal Reserve Bank of Chicago, 1986.
Federal Reserve Bank of Kansas City. Restructuring the Financial System:
A Symposium Sponsored by the Federal Reserve Bank of Kansas City. 1987.
Houpt, James V., and James A. Embersit. "A Method for Evaluating
Interest Rate Risk in U.S. Commercial Banks," Federal Reserve Bulletin,
vol. 77 (August 1991), pp. 625-37.

148

Kareken, John H. "Deposit Insurance Reform; Or, Deregulation Is the
Cart, Not the Horse," Federal Reserve Bank of Minneapolis Quarterly
Review, vol. 7 (Spring 1983), pp. 1-9. Reprinted in vol. 14 (Winter
1990), pp. 3-11.
Spong, Kenneth. Banking Regulation: Its Purposes, Implementation, and
Effects, 3rd ed. Federal Reserve Bank of Kansas City, 1990.
Community and Consumer Affairs
Canner, Glenn B., and Dolores S. Smith. "Home Mortgage Disclosure
Act: Expanded Data on Residential Lending," Federal Reserve Bulletin,
vol. 77 (November 1991), pp. 859-81.
___________and___________ . "Expanded HMDA Data on Residen
tial Lending: One Year Later," Federal Reserve Bulletin, vol. 78
(November 1992), pp. 801-24.
Canner, Glenn B., Wayne Passmore, and Dolores S. Smith. "Residential
Lending to Low-Income and Minority Families: Evidence from the
1992 HMDA Data," Federal Reserve Bulletin, vol. 80 (February 1994),
pp. 79-108.
Fain, Kenneth R, and Sandra F. Braunstein. "Bank Holding Company
Investments for Community Development," Federal Reserve Bulletin,
vol. 77 (June 1991), pp. 388-96.
Garwood, Griffith L., and Dolores S. Smith. "Community Reinvestment
Act: Evolution and Current Issues," Federal Reserve Bulletin, vol. 79
(April 1993), pp. 251-67.
Munnell, Alicia H., Lynn E. Browne, James McEneaney, and Geoffrey
M. B. Tootell. Mortgage Lending in Boston: Interpreting HMDA Data.
Federal Reserve Bank of Boston Working Paper Series, No. 92-7,
October 1992.
Wood, John C., and Dolores S. Smith. "Electronic Transfer of Govern
ment Benefits," Federal Reserve Bulletin, vol. 77 (April 1991),
pp. 203-17.
Federal Reserve Bank Services amt thg Payments System
Bauer, Paul W. "Efficiency and Technical Progress in Check Processing,"
in Federal Reserve Bank of Cleveland, Economic Review, vol. 29 (Quar
ter 3,1993), pp. 24-38.

T E

R E A D I N G S

Belton, Terrence M., Matthew D. Gelfand, David B. Humphrey, and
Jeffrey C. Marquardt. "Daylight Overdrafts and Payments System
Risk," Federal Reserve Bulletin, vol. 73 (November 1983), pp. 839-52.
Board of Governors of the Federal Reserve System. "The Federal
Reserve in the Payments System," Federal Reserve Bulletin, vol. 76
(May 1990), pp. 293-98.
Booth, George. Currency and Coin Responsibilities of the Federal Reserve—
A Historical Perspective. Federal Reserve Bank of Cleveland, 1992.
Juncker, George R., Bruce J. Summers, and Florence M. Young. "A
Primer on the Settlement of Payments in the United States," Federal
Reserve Bulletin, vol. 77 (November 1991), pp. 847-58.
Knudson, Scott E., Jack K. Walton II, and Florence M. Young. "Businessto-Business Payments and the Role of Financial Electronic Data Inter
change," Federal Reserve Bulletin, vol. 80 (April 1994), pp. 269-78.
Manypenny, Gerald D., and Michael L. Bermudez. "The Federal
Reserve Banks as Fiscal Agents and Depositories of the United
States," Federal Reserve Bulletin, vol. 78 (October 1992), pp. 727-37.
Miller, Preston J. "The Right Way to Price Federal Reserve Services,"
Federal Reserve Bank of Minneapolis Quarterly Review, vol. 1 (Summer
1977), pp. 1 5-22.

Summers, Bruce J. "Clearing and Payment Systems: The Role of the
Central Bank," Federal Reserve Bulletin, vol. 77 (February 1991),
pp. 81-91.
TSeneral information
Board of Governors of the Federal Reserve System. 1st Annual Report,
1914, through 80th Annual Report, 1993. Annual.
___________ . Annual Report: Budget Review, 1986-87 through 1993-94.
Annual.
Federal Reserve Bank of New York. Public Information Materials,
1992-1993. 1992.
Federal Reserve Bank of Philadelphia. Fed in Print: Economics and
Banking Topics. Semiannual.

Index

■

Adjustment credit (See also Discount window lending),
44, 47-49
Advisory committees, 3,14
Agreement corporations, 71, 78
Annual Report, Board of Governors, publication, 7,12
Asset accounts, Federal Reserve Banks, 113-16
Automated Clearinghouse, 98, 102, 105

■

Balance sheet, Federal Reserve Banks, 113-17
Bank
Acquisitions and mergers, 81-83
Control, changes in, 84
Examination, 75
Supervision and regulation, definitions, 72
Bank for International Settlements, 6, 63,110
Bank holding companies, 71, 74-78, 81-84
Bank Holding Company Act, 2, 80, 81
Banking
Federal Reserve services, 93-111
International, 68, 78-80
Banking Act of 1933, 76
Banking Act of 1935, 2
Bank Merger Act of 1960, 81, 83
Bank Secrecy Act, 85
Basle Accord, 81
Basle Committee on Banking Regulations and Supervisory
Practices, 81
Beige Book, Federal Reserve publication, 11
Board of Governors (See also Federal Reserve System)
Audits of, 7
Consumer affairs, responsibilities, 87
Contacts with other officials and organizations, 5, 6
Examinations, on-site, 75-77
Membership and responsibilities, 4-7
Regulations, 123-27
Reports to Congress, 7,12
Book-entry securities, 104,109, 110
Borrowed reserves, 20
Bretton Woods system, 63, 67
Budget Review, Board of Governors, publication, 7
Bureau of Engraving and Printing, 96
Bureau of the Mint, 96

152

P U R

■

Call Reports, 74
Capital accounts, Federal Reserve Banks, 117
Central banks, foreign, 1, 63, 67, 68, 110,116
Change in Bank Control Act of 1978, 84
Checks
Clearing and collection, 94, 99-102,115
Processing centers, 101
Clearing House Interbank Payments System, 107
Commercial banks (See Depository institutions)
Commodity Futures Trading Commission, 85
Community affairs, 89
Comptroller of the Currency, Office of the, 72, 73
Condition statement of Federal Reserve Banks, 113-17
Consolidated Financial Statements for Bank Holding Companies, 74
Consolidated Reports of Condition and Income (Call Reports), 74
Consumer Advisory Council, 14, 87
Consumer and community affairs, 87-92
Consumer protection, 87
Complaint program, 89
Laws
Enforcement, 88
List, 90-92
Contemporaneous reserve requirement (CRR) scheme, 56
Credit
Adjustment, 44, 47-49
Consumer, 87-92
Discount window, 42-53
Emergency, 52
Extended, 47, 51
Seasonal, 47, 50
Securities, 84
Currency and coin
Circulation, tables, 97, 98
Demand for, 95-98, 115
Federal Reserve notes, 96-98, 116

■

Definitive securities, 108,110, 111
Depository institutions
Access to discount window, 45
Deposits at Federal Reserve Banks, 116
Regulations, Federal Reserve, 123-27
Reserve requirements, 18, 53-55
Supervision and regulation of, 72-74
Depository Institutions Deregulation and Monetary Control Act
of 1980 (See Monetary Control Act of 1980)
Directors, Federal Reserve Banks, 11
Discount window lending
Administration, 42-53
Borrowing procedures, 45-48

Discount window lending—continued
Discount rates, 5, 20, 43-45
Tool of monetary policy, 5, 33, 42
Domestic Trading Desk, 21, 42
Earnings and income, Federal Reserve System, 12
Edge Act corporations, 71, 78
Electronic funds transfers, 102-7,123
Emergency credit (See also Discount window lending), 53
Employment Act of 1946, 2
Eurodollars and Eurocurrency, 69
Examination of banks (See also Bank holding companies), 75
Exchange rates, 31
Expedited Funds Availability Act, 91, 94,101
Extended credit (See also Discount window lending), 47, 51
Federal Advisory Council, 14
Federal Deposit Insurance Corporation, 72, 73
Federal Deposit Insurance Corporation Improvement Act of 1991,
2, 52, 75, 81
Federal Financial Institutions Examination Council, 73, 92
Federal funds, 22, 33, 34
Federal Open Market Committee (See also Monetary policy
and Open market operations)
Membership and responsibilities, 3,12
Foreign currency operations, 61, 63
Federal Reserve Act, 2,17, 75, 95
Federal Reserve Banks
Asset accounts, 113-16
Audits of, 12
Balance sheet, 113-17
Banking services
Automated Clearinghouse, 98, 102, 105
Check clearing and collection, 99-102
Currency and coin, 95-98
Electronic funds transfer, 102
Fedwire, 98, 102, 103
Foreign central banks and international organizations, 110
Net settlement, 106
Noncash transactions, 98-106
Other, 108
Banks and Branches, list, 10
Capital accounts, 117
Directors of, 11
Earnings and expenses of, 12
Fiscal agency functions, 108-10
Liability accounts, 116-17
New York Bank, 21, 42, 64,110,116
Organization, 7
Representation on Federal Open Market Committee, 3,12

154

Federal Reserve Banks—continued
Reserve funds, 120-22
Supervision of, 4,12
Federal Reserve Bulletin, publication, 7
Federal Reserve notes, 95, 96, 98, 116
Federal Reserve System (See also Board of Governors and
Federal Reserve Banks)
Advisory councils and committees, 14
Earnings and income, 12
Establishment, 1
Functions and duties, 1
International sphere, operations and activities, 61-69
Map, 8, 9
Membership, 13
Monetary policy
Guides for, 26-31
Implementation of, 33-59
Overview, 1-15
Payments system, 94
Services
Banking organizations, 93-108
Federal government, 108-10
Foreign central banks and international organizations, 110-11
Structure, 3-14
Supervisory and regulatory functions, 5, 71-86, 87-92
Swap (reciprocal currency) arrangements, 61, 65-68
Fedwire, 98, 102, 103
Financial Institutions Reform, Recovery, and Enforcement Act
of 1989, 2,81
Fiscal agency functions of Federal Reserve Banks, 108-10
Float, 38,117,118,121
Foreign Bank Supervision Enhancement Act of 1991, 80
Foreign banks, U.S. activities, supervision of, 79
Foreign central banks, 1, 63, 67, 68
Deposits at Federal Reserve Banks, 116
Federal Reserve services to, 110
Foreign currency operations, 63-68
Foreign Exchange Desk, 64
Foreign exchange markets, 64, 67
Foreign exchange rates, 31
Foreign operations of U.S. banks, 78
Full Employment and Balanced Growth Act of 1978 (HumphreyHawkins Act), 2, 26
Futures Trading Practices Act, 85
■

General Accounting Office, 7,12
Glass-Steagall Act, 76
Gold
Certificate account, Federal Reserve Banks, 113

Gold—continued
Held for foreign central banks, 110
Stock, 118
Government funds transfer accounts, 110
Governors of Central Banks of the American Continent, 63
Group of Seven, 6
Humphrey-Hawkins Act (Full Employment and Balanced Growth
Act of 1978), 2, 26
Interest rates (See also Discount window lending and Federal funds)
Effects of monetary policy on, 23
Short and long term, 30, 34
International Bank for Reconstruction and Development, 63,110
International banking, 68, 78, 79
Developments, influence on monetary policy, 62
Operations and activities of foreign banks, 61, 78
Organizations, Federal Reserve services to, 110
International Banking Act of 1978, 2, 79
International Convergence of Capital Measurement and
Capital Standards, 81
International Lending Supervision Act of 1983, 78
International Monetary Fund, 6, 63, 67, 68,110,114
Liability accounts, Federal Reserve Banks, 116-17
M2 velocity and opportunity cost, chart, 29
Magnetic ink character recognition system (MICR), 100
Margin requirements, supervision and regulation of, 84
Matched sale-purchase transactions, 40
Member banks (See also Depository institutions and
State member banks)
Supervision and regulation of, 71-86
System membership and obligations, 13,124
Mergers and acquisitions, supervision and regulation of, 81-84
Monetary and credit aggregates, 26-29, 34, 35, 55-57
Definitions of Ml, M2, M3, and debt, 28
Monetary Control Act of 1980, 2, 54, 55, 94
Monetary policy
Effects on economy, 23-32
Foreign exchange rates, 31
Full Employment and Balanced Growth Act of 1978, 2, 26
Goals, 2,17
Guides for, 26-31
Implementation of, 33-59
Interest rates, 30
Limitations of, 25
Monetary and credit aggregates, 26-29
Reserves market, 18-23
Tools, 5, 33

156

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National Advisory Council on International Monetary and
Financial Policies, 6
National Credit Union Administration, 6, 73, 85
National Monetary Commission, 2
Net settlement services, 106
New York Clearing House Association, 107
Nonbanking activities and acquisitions, supervision and
regulation of, 82
Nonborrowed reserves, 21, 37
Noncash transaction services, Federal Reserve Banks, 98, 99
Notes, Federal Reserve, 95, 96, 98 116

■

Open market operations (See also Federal Open Market
Committee), 35-42
Techniques, 38-41
Tool of monetary policy, 3, 5, 33
Organisation for Economic Co-operation and Development, 6, 63
Outright purchases and sales of securities, 39

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Payments system, Federal Reserve's role in, 94-107
Plaza Accord, 67
Presentment fees, 102

■

Reciprocal currency arrangements, 61, 65-68
Regulations (Board of Governors)
CC, Availability of Funds and Collection of Checks, 102,127
Federal Reserve writing of, 88
G, T, U, X, margin requirements, 84,124,125,126
List of, 123-27
Z, Truth in Lending, 88, 92,126
Repurchase agreements, 39
Reserve equation, 113,118-22
Reserve Bank credit, 120
Reserve requirements (See also Reserves)
Change in required reserve ratios, 57
Depository institutions, 53,123
Open market operations, 55
Structure, 53
Tool of monetary policy, 5, 33
Reserves
Borrowed, 20
Demand for, 18
Excess, 19, 20
Nonborrowed, 21, 33, 37
Open market operations, 35-42
Required, 19
Supply of, 20
Trading of, 22

N D E X

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Savings bonds, U.S., 109
Seasonal credit (See also Discount window lending), 47, 50
Section 20 subsidiaries, 76
Securities and Exchange Commission, 85
Securities Exchange Act of 1934, 84
Securities, U.S. government, 12, 20, 36
Book-entry, 104, 109,110
Definitive, 108,110, 111
Federal Reserve holdings, tables, 37,114
Federal Reserve open market operations, 35-42
Federal Reserve services to U.S. Treasury, 108
Margin requirements, supervision and regulation of, 84,124,
125, 126
State member banks (See also Depository institutions and
Member banks)
Examination of, 75
Supervision and regulation of, 71-78
System membership and obligations, 13,124
Supervision and regulation
Acquisitions and mergers, 81-84
Bank control, changes in, 84
Board of Governors, 71-86
Consumer-protection laws, 87-92
Domestic operations of U.S. banking organizations, 74
International operations of U.S. banks, 78
Securities transactions, 84-85
U.S. activities of foreign banks, 79
Swap (reciprocal currency) arrangements, 61, 65-68
System Open Market Account, 35-37, 41,115
System to Estimate Examinations Ratings (SEER), 74

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Thrift Institutions Advisory Council, 14
Thrift Supervision, Office of, 72, 73, 85
Treasury Direct, 109
Treasury tax and loan accounts, 108,109
Treasury, U.S. Department of the, 62, 85, 96,103, 104
Truth in Lending Act, 88, 92,126
Truth in Savings Act, 92,127

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U.S. government securities (See Securities, U.S. government)

■

World Bank, 63,110

FRBl—100,000—1/95 C

157

Full text of The Federal Reserve System : Purposes & Functions, (1994)

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