FEDERAL RESERVE SYSTEM PUBLICATION
The Fed Explained
What the Central Bank Does
PUBLIC EDUCATION & OUTREACH
FEDERAL RESERVE SYSTEM PUBLICATION
The Fed Explained
What the Central Bank Does
PUBLIC EDUCATION & OUTREACH
First Edition, May 1939
Second Edition, November 1947
Third Edition, April 1954
Fourth Edition, February 1961
Fifth Edition, December 1963
Sixth Edition, September 1974
Seventh Edition, December 1984
Eighth Edition, December 1994
Ninth Edition, June 2005
Tenth Edition, October 2016
Eleventh Edition, August 2021
ISSN: 0199-9729
DOI: 10.17016/0199-9729.11
This and other Federal Reserve publications are available
online in the Publications section of the Federal Reserve
Board’s website, https://www.federalreserve.gov. To order
copies of publications available in print, access the Federal
Reserve System Publication Order Form or contact:
Publications Fulfillment
(email) [email protected]
(ph) 202-452-3245
(fax) 202-728-5886
(mail) Mail Stop N-127
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, DC 20551
Contents
1 Overview of the Federal Reserve System ............................. vi
The U.S. Approach to Central Banking ..................................... 2
The Decentralized System Structure and Its Philosophy ........................ 3
The Reserve Banks: A Blend of Private and Governmental Characteristics ........... 4
2 The Three Key System Entities ...................................... 6
The Federal Reserve Board: Selection and Function ........................... 7
The Federal Reserve Banks: Structure and Function ........................... 8
The Federal Open Market Committee: Selection and Function .................... 12
Other Signicant Entities Contributing to Federal Reserve Functions ............... 13
3 Conducting Monetary Policy ........................................ 16
The Federal Reserve’s Monetary Policy Mandate and Strategy and Why It Matters ..... 21
The Conduct of Monetary Policy ......................................... 24
Monetary Policy Tools ................................................ 34
How Monetary Policy Is Implemented ..................................... 39
4 Promoting Financial System Stability ................................ 46
What Is Financial Stability? ............................................ 47
Monitoring Risk across the Financial System ................................ 48
Macroprudential Supervision and Regulation of Large, Complex Financial Institutions ... 55
Domestic and International Cooperation and Coordination ...................... 57
5 Supervising and Regulating Financial Institutions and Activities ......... 62
Overview of the Federal Reserve’s Financial Institution Oversight ................. 63
How the Federal Reserve Supervises Financial Institutions ...................... 69
How the Federal Reserve Regulates Financial Institutions ...................... 75
6 Fostering Payment and Settlement System Safety and Efciency ........ 84
Overview of Key Federal Reserve Payment System Functions .................... 86
Providing Services to Banks and the Federal Government ....................... 86
The U.S. Payment System Today and Reserve Bank Services .................... 88
Regulating and Supervising the Payment System ............................. 104
Providing Banking System Liquidity ....................................... 108
Exploring and Implementing Payment System Improvements ..................... 109
7 Promoting Consumer Protection and Community Development .......... 112
Consumer Protection Supervision and Examination ........................... 114
Administering Consumer Laws and Drafting Regulations ........................ 123
Research and Analysis of Emerging Consumer Issues ......................... 123
Community Economic Development Activities ............................... 125
vi The Fed Explained: What the Central Bank Does
1
Overview of the Federal
Reserve System
The Federal Reserve performs five key functions
in the public interest to promote the health of the
U.S. economy and the stability of the U.S. financial
system.
The U.S. Approach to Central Banking ......................2
The Decentralized System Structure and Its Philosophy ..........3
The Reserve Banks: A Blend of Private and
Governmental Characteristics ...........................4
Overview of the Federal Reserve System 1
The Federal Reserve System is the central bank of the United States. It performs five general
functions to promote the effective operation of the U.S. economy and, more generally, the public
interest. The Federal Reserve
• conducts the nation’s monetary policy to promote maximum employment and stable prices in
the U.S. economy;
• promotes the stability of the financial system and seeks to minimize and contain systemic
risks through active monitoring and engagement in the U.S. and abroad;
• promotes the safety and soundness of individual financial institutions and monitors their
impact on the financial system as a whole;
• fosters payment and settlement system safety and efficiency through services to the banking
industry and the U.S. government that facilitate U.S.-dollar transactions and payments; and
• promotes consumer protection and community development through consumer-focused
supervision and examination, research and analysis of emerging consumer issues and trends,
community economic development activities, and the administration of consumer laws and
regulations.
Figure 1.1. The Federal Reserve System
The Federal Reserve is unique among central banks. By statute, Congress provided for a central banking
system with public and private characteristics. The System performs five functions in the public interest.
The Federal
Reserve System
Federal
Reserve Board
of Governors
12 Federal
Reserve
Banks
1
U.S.
Central Bank
3
Key
Entities
5
Key
Functions
Conducting
the nation’s
monetary
policy
Helping
maintain the
stability of
the financial
system
Supervising
and regulating
financial
institutions
Fostering
payment and
settlement
system safety
and efficiency
Promoting
consumer
protection and
community
development
Federal
Open Market
Committee
2 The Fed Explained: What the Central Bank Does
The U.S. Approach to Central Banking
The framers of the Federal Reserve Act purposely rejected the concept of a single central bank.
Instead, they provided for a central banking “system” with three salient features: (1) a central
governing Board, (2) a decentralized operating structure of 12 Reserve Banks, and
(3) a combination of public and private characteristics.
Although parts of the Federal Reserve System share some characteristics with private-sector enti-
ties, the Federal Reserve was established to serve the public interest.
There are three key entities in the Federal Reserve System: the Federal Reserve Board of Gov-
ernors (Board of Governors), the Federal Reserve Banks (Reserve Banks), and the Federal Open
Market Committee (FOMC). The Board of Governors, an agency of the federal government that
reports to and is directly accountable to Congress (figure 1.2), provides general guidance for the
System and oversees the 12 Reserve Banks.
Within the System, certain responsibilities are shared between the Board of Governors in Wash-
ington, D.C., whose members are appointed by the President with the advice and consent of the
Senate, and the Reserve Banks and Branches, which constitute the System’s operating presence
around the country. While the Federal Reserve has frequent communication with executive branch
and congressional officials, its decisions are made independently.
Figure 1.2. Three key entities, serving the public interest
The framers of the Federal Reserve Act developed a central banking system that would broadly represent the public
interest.
CONGRESS
oversees the Federal Reserve System
and its entities.
BOARD OF GOVERNORS
is an independent agency of the
federal government.
FEDERAL RESERVE BANKS
are the operating arms of the
Federal Reserve System and are
supervised by the Board of Governors.
FEDERAL OPEN MARKET
COMMITTEE
consists of the members of the Board of
Governors and Reserve Bank presidents.
The Chair of the Board is the
FOMC Chair.
Overview of the Federal Reserve System 3
The Decentralized System Structure and Its Philosophy
In establishing the Federal Reserve System, the United States was divided geographically into 12
Districts, each with a separately incorporated Reserve Bank. District boundaries were based on
prevailing trade regions that existed in 1913 and related economic considerations, so they do not
necessarily coincide with state lines (figure 1.3).
As originally envisioned, each of the 12 Reserve Banks was intended to operate independently
from the other Reserve Banks. Variation was expected in discount rates—the interest rate that
commercial banks were charged for borrowing funds from a Reserve Bank. The setting of a sepa-
rately determined discount rate appropriate to each District was considered the most important
tool of monetary policy at that time. The concept of national economic policymaking was not well
developed, and the impact of open market operations—purchases and sales of U.S. government
securities—on policymaking was less significant.
As the nation’s economy became more integrated and more complex, through advances in tech-
nology, communications, transportation, and financial services, the effective conduct of monetary
Figure 1.3. Twelve Federal Reserve Districts operate independently but with supervision
Federal Reserve District boundaries are based on economic considerations; the Reserve Banks in each District
operate independently but under the supervision of the Federal Reserve Board of Governors.
Washington, D.C.
(Board of Governors)
2
San Francisco
12
Kansas City
10
11
Dallas
Minneapolis
9
Chicago
7
St. Louis
8
Cleveland
4
Richmond
5
New York
Boston
1
Philadelphia
3
Atlanta
6
Alaska
Hawaii
Puerto Rico
Virgin Islands
Guam
4 The Fed Explained: What the Central Bank Does
policy began to require increased collaboration and coordination throughout the System. This was
accomplished in part through revisions to the Federal Reserve Act in 1933 and 1935 that together
created the modern-day FOMC.
The Depository Institutions Deregulation and Monetary Control Act of 1980 (Monetary Control
Act) introduced an even greater degree of coordination among Reserve Banks with respect to the
pricing of financial services offered to depository institutions. There has also been a trend among
Reserve Banks to centralize or consolidate many of their financial services and support functions
and to standardize others. Reserve Banks have become more efficient by entering into intra-
System service agreements that allocate responsibilities for services and functions that are na-
tional in scope among each of the 12 Reserve Banks.
The Reserve Banks: A Blend of Private and Governmental
Characteristics
Pursuant to the Federal Reserve Act, each of the 12 Reserve Banks is separately incorporated
and has a nine-member board of directors.
Commercial banks that are members of the Federal Reserve System hold stock in their District’s
Reserve Bank and elect six of the Reserve Bank’s directors; three remaining directors are appoint-
ed by the Board of Governors. Most Reserve Banks have at least one Branch, and each Branch
has its own board of directors. Branch directors are appointed by either the Reserve Bank or the
Board of Governors.
Directors serve as a link between the Federal Reserve and the private sector. As a group, directors
bring to their duties a wide variety of experiences in the private sector, which gives them invaluable
insight into the economic conditions of their respective Federal Reserve Districts. Reserve Bank
head-office and Branch directors contribute to the System’s overall understanding of the economy.
The Federal Reserve is not funded by congressional appropriations. Its operations are financed
primarily from the interest earned on the securities it owns—securities acquired in the course of
the Federal Reserve’s open market operations. The fees received for priced services provided to
depository institutions—such as check clearing, funds transfers, and automated clearinghouse op-
erations—are another source of income; this income is used to cover the cost of those services.
After payment of expenses and transfers to surplus (limited to an aggregate of $6.785 billion), all
the net earnings of the Reserve Banks are transferred to the U.S. Treasury (figure 1.4).
Overview of the Federal Reserve System 5
Despite the need for coordination and consistency throughout the Federal Reserve System,
geographic distinctions remain important. Effective monetary policymaking requires knowledge
and input about regional differences. For example, two directors from the same industry may have
different opinions regarding the strength or weakness of that sector, depending on their regional
perspectives. The decentralized structure of the System and its blend of private and public charac-
teristics, envisioned by the System’s creators, therefore, remain important features today.
Figure 1.4. Federal Reserve net earnings are paid to the U.S. Treasury
The Federal Reserve transfers its net earnings to the U.S. Treasury.
$75.4
$88.4
$79.6
$96.9
$91.5
$80.6
$54.9
$86.9
$62.1
$3.2**
$97.7
$19.3*
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
$120
$100
$80
$60
$40
$20
$–
Earnings remittances
Transfer of capital surplus
Billions of
dollars
Source: Federal Reserve Board news release, January 11, 2021 (available in the News & Events section of the Federal Reserve
Board’s website, https://www.federalreserve.gov/newsevents.htm).
* The Reserve Banks transferred to the Treasury $19.3 billion from their capital surplus on December 28, 2015, which was the
amount necessary to reduce aggregate Reserve Bank surplus to the $10 billion surplus limitation in the Fixing America’s Surface
Transportation Act.
** The Reserve Banks transferred to the Treasury $3.175 billion from their capital surplus in 2018, of which $2.5 billion was the
amount necessary to reduce aggregate Reserve Bank surplus to the $7.5 billion surplus limitation in the Bipartisan Budget Act of
2018 and $675 million was the amount necessary to further reduce aggregate Reserve Bank surplus to the $6.825 billion surplus
limitation in the Economic Growth, Regulatory Relief, and Consumer Protection Act.
6 The Fed Explained: What the Central Bank Does
2
The Three Key System
Entities
The Board of Governors, the Federal Reserve
Banks, and the Federal Open Market Committee
work together to promote the health of the U.S.
economy and the stability of the U.S. financial
system.
The Federal Reserve Board: Selection and Function ............7
The Federal Reserve Banks: Structure and Function ............8
The Federal Open Market Committee: Selection and Function ....12
Other Significant Entities Contributing to Federal
Reserve Functions ..................................13
The Three Key System Entities 7
Three key Federal Reserve entities—the Federal Reserve Board of Governors (Board of Governors),
the Federal Reserve Banks (Reserve Banks), and the Federal Open Market Committee (FOMC)—
make decisions that help promote the health of the U.S. economy and the stability of the U.S.
financial system.
The Federal Reserve Board: Selection and Function
The Board of Governors—located in Washington, D.C.—is the governing body of the Federal Re-
serve System. It is run by seven members, or “governors,” who are nominated by the President of
the United States and confirmed in their positions by the Senate. The Board of Governors guides
the operation of the Federal Reserve System to promote the goals and fulfill the responsibilities
given to the Federal Reserve by the Federal Reserve Act.
Figure 2.1. How the Federal Reserve operates within the U.S. government framework
A statutory framework established by Congress guides the operation of the Federal Reserve System.
THE FEDERAL RESERVE ACT
creates the Federal Reserve System and
specifies how Board members and Reserve
Bank presidents are chosen.
BOARD OF GOVERNORS
Seven Board members guide all
aspects of the operation of the Federal
Reserve System and its five key functions.
SENATE
confirms Board members appointed by the
President to staggered 14-year terms, and
confirms the nominations of Board members to
be either Chair or Vice Chair.
FEDERAL RESERVE BANKS
12 Reserve Banks examine and supervise
financial institutions, act as lenders of last
resort, and provide U.S. payment system
services, among other things.
PRESIDENT
nominates members of the Board of Governors,
the chief governing body of the Federal Reserve
System, and nominates one Board member to be
Chair and one to be Vice Chair.
FEDERAL OPEN MARKET
COMMITTEE
Seven Board members and five Reserve
Bank presidents direct open market
operations that sets U.S. monetary policy to
promote maximum employment, stable
prices, and moderate long-term interest
rates in the U.S. economy.
8 The Fed Explained: What the Central Bank Does
All of the members of the Board serve on the FOMC, which is the body within the Federal Reserve
that sets monetary policy (see “The Federal Open Market Committee: Selection and Function” on
page 12). Each member of the Board of Governors is appointed for a 14-year term; the terms are
staggered so that one term expires on January 31 of each even-numbered year. After serving a full
14-year term, a Board member may not be reappointed. If a Board member leaves the Board be-
fore his or her term expires, however, the person nominated and confirmed to serve the remainder
of the term may later be appointed to a full 14-year term (figure 2.2).
The Chair and Vice Chair of the Board are also appointed by the President and confirmed by the
Senate, but serve only four-year terms. They may be reappointed to additional four-year terms. The
nominees to these posts must already be members of the Board or must be simultaneously ap-
pointed to the Board.
The Board oversees the operations of the 12 Reserve Banks and shares with them the respon-
sibility for supervising and regulating certain financial institutions and activities (see section 5,
“Supervising and Regulating Financial Institutions and Activities,” on page 62). The Board also
provides general guidance, direction, and oversight when the Reserve Banks lend to depository
institutions and when the Reserve Banks provide financial services to depository institutions and
the federal government. The Board also has broad oversight responsibility for the operations and
activities of the Reserve Banks (see section 6, “Fostering Payment and Settlement System Safety
and Efficiency,” on page 84). This authority includes oversight of the Reserve Banks’ services
to depository institutions and to the U.S. Treasury, and of the Reserve Banks’ examination and
supervision of various financial institutions. As part of this oversight, the Board reviews and ap-
proves the budgets of each of the Reserve Banks.
The Board also helps to ensure that the voices and concerns of consumers and communities are
heard at the central bank by conducting consumer-focused supervision, research, and policy analy-
sis, and, more generally, by promoting a fair and transparent consumer financial services market
(see section 7, “Promoting Consumer Protection and Community Development,” on page 112).
The Federal Reserve Banks: Structure and Function
The 12 Reserve Banks and their 24 Branches are the operating arms of the Federal Reserve
System. Each Reserve Bank operates within its own particular geographic area, or district, of the
United States.
Each Reserve Bank gathers data and other information about the businesses and the needs of
local communities in its region. That information is then factored into monetary policy decisions by
the FOMC and other decisions made by the Board of Governors.
The Three Key System Entities 9
Reserve Bank Leadership
As set forth in the Federal Reserve Act, each Reserve Bank is subject to “the supervision and
control of a board of directors.” Much like the boards of directors of private corporations, Reserve
Bank boards are responsible for overseeing their Bank’s administration and governance, reviewing
the Bank’s budget and overall performance, overseeing the Bank’s audit process, and developing
broad strategic goals and directions. However, unlike private corporations, Reserve Banks are not
operated in the interest of shareholders, but rather in the public interest.
Each year, the Board of Governors designates one chair and one deputy chair for each Reserve
Bank board from among its Class C directors. The Federal Reserve Act requires that the chair of a
Reserve Bank’s board be a person of “tested banking experience,” a term which has been inter-
preted as requiring familiarity with banking or financial services.
Each Reserve Bank board delegates responsibility for day-to-day operations to the president of
that Reserve Bank and his or her staff. Reserve Bank presidents act as chief executive officers
of their respective Banks and also serve, in rotation, as voting members of the FOMC. Presidents
are nominated by a Bank’s Class B and C directors and approved by the Board of Governors for
five-year terms.
Figure 2.2. Serving on the Board of Governors
The Federal Reserve’s governors serve staggered 14-year terms and may not be reappointed; all governors—
including the Chair and Vice Chair—are appointed by the President and confirmed by the Senate.
The member is nominated to be Chair or Vice Chair
by the President and confirmed by the Senate.
He or she may be reappointed as Chair or Vice
Chair for one or more additional four-year terms.
The member
leaves before his
or her term has expired.
He or she
is replaced.
The newly appointed member serves the remainder
of his or her predecessor’s term and may be
appointed to a full 14-year term.
The member
serves a
14-year term.
The member’s term ends
on January 31, and he or she
cannot be reappointed.
A Board member
is appointed and
confirmed.
10 The Fed Explained: What the Central Bank Does
Reserve Bank Branches also have boards of directors. Pursuant to policy established by the Board
of Governors, Branch boards must have either five or seven members. All Branch directors are
appointed: the majority of directors on a Branch board are appointed by the Reserve Bank, and
the remaining directors on the board are appointed by the Board of Governors. Each Branch board
selects a chair from among those directors appointed by the Board of Governors. Unlike Reserve
Bank directors, Branch directors are not divided into different classes. However, Branch directors
must meet different eligibility requirements, depending on whether they are appointed by the Re-
serve Bank or the Board of Governors.
Reserve Bank and Branch directors are elected or appointed for staggered three-year terms. When
a director does not serve a full term, his or her successor is elected or appointed to serve the
unexpired portion of that term.
Reserve Bank Responsibilities
The Reserve Banks carry out Federal Reserve core functions by
1. supervising and examining state member banks (state-chartered banks that have chosen to
become members of the Federal Reserve System), bank and thrift holding companies, and non-
Figure 2.3. Composition of Federal Reserve Bank boards of directors and selection of
Reserve Bank presidents
The boards of directors of the Reserve Banks represent a cross-section of banking, commercial, agricultural, and
industrial interests. Six of the nine members of each board of directors are chosen to represent the public interest;
those six board directors nominate their Bank’s president.
Class C directors
represent the public.
Federal Reserve
Board of Governors appoints
three Class C directors.
Chair and deputy chair
are designated by the
Board of Governors
from among Class C
directors.
Reserve Bank presidents are nominated
by Class B and C directors and approved
by the Board of Governors.
Class B directors
represent the public.
Federal Reserve member banks
elect three Class A directors and
three Class B directors.
Class A directors
represent District
member banks.
The Three Key System Entities 11
bank financial institutions that have been designated as systemically important under authority
delegated to them by the Board;
2. lending to depository institutions to ensure liquidity in the financial system;
3. providing key financial services that undergird the nation’s payment system, including distribut-
ing the nation’s currency and coin to depository institutions, clearing checks, operating the Fed-
Wire and automated clearinghouse (ACH) systems, and serving as a bank for the U.S. Treasury;
and
4. examining certain financial institutions to ensure and enforce compliance with federal consum-
er protection and fair lending laws, while also promoting local community development.
In its role providing key financial services, the Reserve Bank acts, essentially, as a financial institu-
tion for the banks, thrifts, and credit unions in its District—that is, each Reserve Bank acts as a
“bank for banks.” In that capacity, it offers (and charges for) services to these depository institu-
tions similar to those that ordinary banks provide their individual and business customers: the
equivalent of checking accounts; loans; coin and currency; safekeeping services; and payment
services (such as the processing of checks and the making of recurring and nonrecurring small-
and large-dollar payments) that help banks, and ultimately their customers, buy and sell goods,
services, and securities.
In addition, through their leaders and their con-
nections to, and interactions with, members of
their local communities, Reserve Banks
provide the Federal Reserve System with a
wealth of information on conditions in virtually
every part of the nation—information that is
vital to formulating a national monetary policy
that will help to maintain the health of the economy and the stability of the nation’s financial sys-
tem.
Certain information gathered by the Reserve Banks from Reserve Bank directors and other sourc-
es is also shared with the public prior to each FOMC meeting in a report commonly known as the
Beige Book. In addition, every two weeks, the board of each Reserve Bank recommends discount
rates (interest rates to be charged for loans to depository institutions made through that Bank’s
discount window); these interest rate recommendations are subject to review and determination
by the Board of Governors.
Want to learn more about Reserve Bank directors?
Reserve Bank and Branch directors play a number
of roles at their Banks. To learn more about director
responsibilities and requirements, see Roles and Re-
sponsibilities of Federal Reserve Directors in the About
the Fed section of the Board’s website, https://www.
federalreserve.gov/aboutthefed/directors/about.htm.
12 The Fed Explained: What the Central Bank Does
The Federal Open Market Committee:
Selection and Function
The FOMC is the body of the Federal Reserve System that sets national monetary policy (figure
2.4). The FOMC makes all decisions regarding the appropriate position or “stance” of monetary
policy to help move the economy toward the congressionally mandated goals of maximum em-
ployment and price stability. The Committee
raises and lowers its target range for the policy
rate, which is the federal funds rate (the rate
at which depository institutions lend to each
other), to achieve these dual objectives. At
times, as an additional policy measure, the
FOMC has used forward guidance about its policy rate to influence expectations about the future
course of monetary policy. In addition, the Committee sometimes leans on balance sheet policy,
where it adjusts the size and composition of the Federal Reserve’s asset holdings, to assist with
market functioning and help foster accommodative financial conditions. Congress enacted legisla-
tion that created the FOMC as part of the Federal Reserve System in 1933 and 1935.
FOMC Membership
The FOMC consists of 12 voting members—the 7 members of the Board of Governors; the presi-
dent of the Federal Reserve Bank of New York; and 4 of the remaining 11 Reserve Bank presi-
dents, who serve one-year terms on a rotating basis.
Want to learn more about the FOMC?
For more information about the FOMC, visit the About
the Fed section of the Board’s website, https://www.
federalrserve.gov/aboutthefed/structure-federal-open-
market-committee.htm.
Figure 2.4. Composition of the Federal Open Market Committee
The Federal Open Market Committee’s (FOMC) structure promotes the consideration of broad U.S. economic
perspectives and the public interest in key monetary policy decisions made by the U.S. central bank.
Board of Governors
(permanent FOMC
participants)
Federal Reserve Bank
of New York president
(permanent FOMC
participant)
Reserve Bank presidents
(serve one-year terms
on a rotating basis)
The Three Key System Entities 13
All 12 of the Reserve Bank presidents attend FOMC meetings and participate in FOMC discus-
sions, but only the presidents who are Committee members at the time may vote on policy deci-
sions.
By law, the FOMC determines its own internal organization and, by tradition, the FOMC elects the
Chair of the Board of Governors as its chair and the president of the Federal Reserve Bank of New
York as its vice chair. FOMC meetings are typically held eight times each year in Washington, D.C.,
and at other times as needed.
FOMC Responsibilities
Once the FOMC determines the appropriate stance of policy, it must then make sure this stance
is effectively transmitted to financial markets. The Board and FOMC have many monetary policy
implementation tools at their disposal. Key tools include the Federal Reserve’s administered inter-
est rates and open market purchases and sales of securities (see section 3, “Conducting Mon-
etary Policy,” on page 16). The FOMC also directs operations undertaken by the Federal Reserve in
foreign exchange markets and authorizes currency swap programs with foreign central banks.
Other Significant Entities Contributing to Federal Reserve
Functions
Two other groups play important roles in the Federal Reserve System’s core functions:
(1) depository institutions—banks, thrifts, and credit unions; and (2) Federal Reserve System
advisory committees, which make recommendations to the Board of Governors and to the Reserve
Banks regarding the System’s responsibilities.
Depository Institutions
Depository institutions offer transaction, or checking, accounts to the public and may maintain
accounts of their own at their local Reserve Banks. Depository institutions receive interest on
the reserve balances they hold in their Reserve Bank accounts. Interest on reserves is a key tool
for monetary policy implementation (see section 3, “Conducting Monetary Policy,” on page 16 for
more information about the conduct of monetary policy).
Advisory Councils
Five advisory committees assist and advise the Board on matters of public policy.
1. Federal Advisory Council (FAC). This council, established by the Federal Reserve Act, comprises
12 representatives of the banking industry. The FAC ordinarily meets with the Board four times
14 The Fed Explained: What the Central Bank Does
a year, as required by law. Annually, each Reserve Bank chooses one person to represent its
District on the FAC. FAC members customarily serve three one-year terms and elect their own
officers.
2. Community Depository Institutions Advisory Council (CDIAC). The CDIAC was originally estab-
lished by the Board of Governors to obtain information and views from thrift institutions (savings
and loan institutions and mutual savings banks) and credit unions. More recently, its member-
ship has expanded to include community banks. Like the FAC, the CDIAC provides the Board of
Governors with firsthand insight and information about the economy, lending conditions, and
other issues.
3. Model Validation Council. This council was
established by the Board of Governors in
2012 to provide expert and independent ad-
vice on its process to rigorously assess the
models used in stress tests of banking insti-
tutions. Stress tests are required under the
Dodd-Frank Wall Street Reform and Consumer Protection Act. The council is intended to improve
the quality of stress tests and thereby strengthen confidence in the stress testing program. (For
more information about stress tests, see “Capital Planning and Stress Testing” on page 77.)
4. Community Advisory Council (CAC). This council was formed by the Federal Reserve Board in
2015 to offer diverse perspectives on the economic circumstances and financial services needs
of consumers and communities, with a particular focus on the concerns of low- and moderate-
income populations. The CAC complements the FAC and CDIAC, whose members represent
depository institutions. The CAC meets semiannually with members of the Board of Governors.
The 15 CAC members serve staggered three-year terms and are selected by the Board through a
public nomination process.
5. Insurance Policy Advisory Committee (IPAC). This council was established at the Board of
Governors in 2018 by section 211(b) of the Economic Growth, Regulatory Relief, and Consumer
Protection Act. The IPAC provides information, advice, and recommendations to the Board on
international insurance capital standards and other insurance issues.
Reserve Banks also have their own advisory committees. Perhaps the most important of these are
committees that advise the Banks on agricultural, small business, and labor matters. The Federal
Reserve Board solicits the views of each of these committees biannually.
More on Federal Reserve Advisory Councils
For a current roster of Federal Reserve advisory coun-
cil members, visit the About the Fed section of the
Board’s public website at https://www.federalreserve.
gov/aboutthefed/advisorydefault.htm.
16 The Fed Explained: What the Central Bank Does
3
Conducting Monetary Policy
The Federal Reserve sets U.S. monetary policy to
promote maximum employment and stable prices
in the U.S. economy.
The Federal Reserve’s Monetary Policy Mandate and Strategy and
Why It Matters ....................................21
The Conduct of Monetary Policy ..........................24
Monetary Policy Tools .................................34
How Monetary Policy Is Implemented ......................39
Conducting Monetary Policy 21
What is monetary policy? It is the Federal Reserve’s actions, as a central bank, to achieve the
“dual mandate” goals specified by Congress: maximum employment and stable prices in the
United States.
The Federal Reserve conducts monetary policy by using a variety of tools to manage financial con-
ditions that encourage progress toward its dual mandate objectives. Monetary policy most directly
affects the current and expected future path of short-term interest rates; the anticipated path of
short-term interest rates then affects overall financial conditions including longer-term interest
rates, stock prices, the exchange value of the dollar, and many other asset prices. Through these
channels, monetary policy influences the decisions of households and businesses, thus affecting
overall spending, investment, production, employment, and inflation in the United States (figure 3.1).
Conducting monetary policy effectively involves a number of important elements including a basic
strategy that guides the adjustment of the stance of policy over time, a policy process involving
the coordinated actions of the Federal Reserve’s two decisionmaking bodies—the Board of Gover-
nors (Board) and the Federal Open Market Committee (FOMC)—a communications effort with the
public to describe the rationale for the Federal Reserve’s policy decisions, a range of tools used
to implement the desired stance of policy, and an institutional framework that involves appropri-
ate independence of the Federal Reserve in conducting policy while remaining fully accountable to
Congress and the American people for its actions.
The Federal Reserve’s Monetary Policy Mandate and
Strategy and Why It Matters
The Federal Reserve was created by Congress in 1913 to provide the nation with a safer, more
flexible, and more stable monetary and financial system. In 1977, Congress amended the Federal
Reserve Act (FRA) to provide greater clarity about the goals of monetary policy. The amended FRA
directs the Board of Governors and the FOMC to conduct monetary policy “so as to promote
Figure 3.1. The Fed’s statutory mandate: maximum employment and stable prices
The Federal Reserve conducts monetary policy in pursuit of the goals set for it by Congress. The mandated goals
are considered essential to a well-functioning economy for households and businesses.
FOMC monetary
policy decision
Affects current and
expected short-term
interest rates
Affects overall financial
conditions
Influences decisions
of households and
businesses
Progress toward
maximum
employment and
stable prices
%
%
22 The Fed Explained: What the Central Bank Does
Fed Chair on accountability and transparency
“We are committed to providing clear explanations about our policies and activities. Congress has given us an
important degree of independence so that we can effectively pursue our statutory goals based on objective analysis
and data. We appreciate that our independence brings with it an obligation for transparency so that you and the public
can hold us accountable.”
Chair Jerome Powell, July 11, 2019
https://www.federalreserve.gov/newsevents/testimony/powell20190710a.htm
effectively the goals of maximum employment, stable prices, and moderate long-term interest
rates.”
Because long-term interest rates remain mod-
erate in a stable economy with low expected
inflation, this set of goals is often referred to
as the dual mandate, comprising the coequal
objectives of maximum employment and price
stability. This dual mandate still exists today
and ties monetary policy to the broader goal of
fostering a productive and stable U.S. economy.
Though Congress specifies the goals for monetary policy, it established the Federal Reserve as
an independent agency to ensure that its decisions are based on facts and objective analysis and
serve the best interests of all Americans. Studies have shown that central bank independence is
an important factor that supports the ability of monetary policy to achieve solid economic perfor-
mance and stable prices over time. At the same time, the Federal Reserve must be accountable to
Congress and the American people for its actions. It does so by being transparent about its policy
deliberations and actions through a range of official communications.
Understanding How the Fed Interprets and Achieves Its Maximum
Employment and Price Stability Mandates
To promote public understanding of how the Federal Reserve interprets its statutory mandate,
the FOMC released its Statement on Longer-Run Goals and Monetary Policy Strategy for the first
time in January 2012. The statement, which was reaffirmed every January until 2020, lays out the
goals for monetary policy, articulates the policy framework the Committee uses, and serves as the
foundation for the Committee’s policy actions. It is also intended to enhance the transparency, ac-
countability, and effectiveness of monetary policy.
FOMC composition helps ensure broad perspective
The FOMC consists of the seven members of the
Board of Governors; the president of the Federal
Reserve Bank of New York; and 4 of the remaining 11
Reserve Bank presidents, who serve one-year terms
on a rotating basis. See section 1 on page vi for an
overview of the Federal Reserve System and the FOMC.
Conducting Monetary Policy 23
In August 2020, the Committee released a revised statement after conducting an 18-month review
of its strategic framework for monetary policy. The new statement reaffirmed many key aspects
of the previous statement but also included some innovations to reflect important changes in the
economy that have become apparent in recent years. In particular, the Committee acknowledged
that the level of the federal funds rate con-
sistent with maximum employment and price
stability over the longer run has declined rela-
tive to its historical average and so the federal
funds rate is likely to be constrained by its
effective lower bound more frequently than in
the past. Reflecting this possible outcome, the
Committee stated that it is prepared to use
its full range of tools to achieve its maximum
employment and price stability goals.
Employment. In the statement, the FOMC recognized that the maximum level of employment is a
broad-based and inclusive goal that is not directly measurable and changes over time for reasons
unrelated to monetary policy. Consequently, the Committee does not set a fixed goal for employ-
ment but bases its policy decisions on assessments of the shortfalls of employment from its max-
imum level. The Committee considers a wide range of indicators in making these assessments.
Inflation. In the statement, the Committee reaffirmed its judgment that inflation at the rate of 2
percent, as measured by the annual change in the price index for personal consumption expendi-
tures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. The
Committee noted that longer-term inflation expectations that are well anchored at 2 percent foster
price stability and moderate long-term interest rates and enhance the Committee’s ability to pro-
mote maximum employment in the face of significant economic disturbances. In order to anchor
longer-term inflation expectations at this level, the Committee noted that it seeks to achieve infla-
tion that averages 2 percent over time.
Working toward the two goals. The statement noted that in setting monetary policy, the FOMC
seeks over time to mitigate short falls of employment from the Committee’s assessment of its
maximum level and deviations of inflation from its longer-run goal. Most of the time, the Federal
Reserve’s goals for employment and inflation are complementary. The FOMC could, however, face
situations where its goals are pulling policy in opposite directions. In these circumstances, the
Committee indicated that it will take into account the employment shortfalls and inflation devia-
tions as well as the potentially different time horizons over which employment and inflation are
projected to return to their desired levels.
A fresh look at the monetary policy framework
In 2019, the Fed launched a comprehensive and
public review of the monetary policy framework—the
strategy, tools, and communication practices—it em-
ploys to achieve its mandate. See the Board’s website
for more information on the process and results:
https://www.federalreserve.gov/monetarypolicy/
review-of-monetary-policy-strategy-tools-and-communi-
cations.htm.
24 The Fed Explained: What the Central Bank Does
The Conduct of Monetary Policy
Monetary policy affects the U.S. economy—and the achievement of the dual mandate—primarily
through its influence on interest rates and overall financial conditions. With this in mind, the FOMC
decides on the appropriate position or “stance” of monetary policy. Over time, the Committee has
raised and lowered its target range for the policy rate, which is the federal funds rate (figure 3.2).
When the FOMC changes the target range for the federal funds rate, other interest rates and finan-
cial conditions more broadly adjust in response, thus affecting household and business spending
decisions (see figure 3.1).
Short-term interest rates. Short-term interest rates—for example, the rate of return paid to hold-
ers of U.S. Treasury bills or commercial paper (a short-term debt security) issued by private com-
panies—are affected by changes in the target range for the federal funds rate. Short-term interest
rates would decline if the FOMC reduced its
target range for the federal funds rate, or if
unfolding events or Federal Reserve communi-
cations led the public to think that the FOMC
would soon reduce the target range for the
federal funds rate to a level lower than previ-
ously expected. Conversely, short-term interest
rates would rise if the FOMC increased the federal funds rate target range, or if unfolding events
or Federal Reserve communications prompted the public to believe that the target range for the
federal funds rate would soon be moved to a higher level than had been anticipated.
Longer-term interest rates and asset prices. Longer-term interest rates and the prices for a wide
range of financial and nonfinancial assets, including stocks, bonds, and real estate, respond to
changes in the current and expected path of the federal funds rate. That is, medium- and longer-
term interest rates are affected by how people expect the federal funds rate to change in the
future. For example, if borrowers and lenders think, today, that the FOMC is likely to lower its target
for the federal funds rate substantially over the next several years, medium- and longer-term inter-
est rates today will incorporate those expectations, and those rates then will be lower than would
otherwise be the case.
Generally speaking, the effect on short-term interest rates of a single change in the FOMC’s target
range for the federal funds rate will be somewhat larger than the effect on longer-term rates be-
cause long-term rates typically reflect the expected course of short-term rates over a long period.
Monetary policy: Easing and tightening defined
The FOMC changes monetary policy primarily by rais-
ing or lowering its target range for the federal funds
rate. Lowering the target range represents an “easing”
of monetary policy, while increasing the target range is
a “tightening” of policy.
Conducting Monetary Policy 25
However, the influence of a change in the FOMC’s target range for the federal funds rate on longer-
term interest rates can also be substantial if it has clear implications for the expected course of
short-term rates over a considerable period.
Effects on spending. The level of longer-term interest rates affects household and business
spending decisions, which in turn influence the level of economic output, employment, and infla-
tion. For example, lowering mortgage rates will make buying a house more affordable, encouraging
some individuals who were previously renters to purchase homes. As more individuals purchase
homes, employment rises among homebuilders and many other types of home-supply industries.
Lower mortgage rates may also allow some existing homeowners to refinance their mortgages
at lower rates and thus free up income for spending on many other types of goods and services.
In addition, lower interest rates on consumer loans may spur greater spending on durable goods
(long-lasting manufactured goods) such as televisions and automobiles. The increased demand for
all goods and services will boost employment across a variety of industries. Corresponding to the
increased demand and change in employment, prices will adjust.
Figure 3.2. The federal funds rate over time
The effective federal funds rate is the interest rate at which depository institutions—banks, savings institutions
(thrifts), and credit unions—and government-sponsored enterprises borrow from and lend to each other overnight
to meet short-term business needs. The target for the federal funds rate—which is set by the Federal Open Market
Committee—has varied widely over the years in response to prevailing economic conditions.
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Percent
Effective federal funds rate
Target federal funds rate
Target federal funds range
8
7
6
5
4
3
2
1
0
26 The Fed Explained: What the Central Bank Does
Factors Affecting the Stance of Monetary Policy
In determining the appropriate stance of monetary policy, the FOMC assesses how a variety of
factors affect the current and projected path of the economy. These factors influence the FOMC’s
decisions regarding the appropriate stance of monetary policy.
Anticipated Factors
Many factors affect spending, output, employment, and inflation. Some of these factors can
be anticipated and factored into the FOMC’s deliberations. For example, the government influ-
ences demand in the economy through changes in taxes and spending programs, which are
often anticipated. Indeed, the economic effects of a tax cut may precede its actual implemen-
tation if businesses and households increase their spending in anticipation of lower taxes. In
addition, forward-looking financial markets may build anticipated fiscal events into the level
and structure of interest rates.
Demand Shocks
Other factors that affect spending on goods and services can come as a surprise and can influ-
ence the economy in unforeseen ways. Examples of these “demand shocks” include shifts in
consumer and business confidence or unexpected changes in the credit standards that banks
and other lenders apply when they consider making loans. Once a demand shock is identified,
the FOMC may seek to offset the effects of that shock on the economy by adjusting the stance of
monetary policy.
For instance, in 2020, the global economy was suddenly and severely hit with the coronavirus
(COVID-19) pandemic. This public health crisis disrupted economic activity, significantly affected
financial conditions, and posed risks to the economic outlook. In light of these developments, the
FOMC swiftly adjusted the stance of monetary policy, including using some nontraditional policy
measures. (See “2020 and Beyond: Taking Aggressive Action Amid the Global Pandemic” on page
34 for more discussion.)
Other times, however, because data and other information on the state of the economy are not
available immediately, it can take time before a demand shock is identified and the FOMC re-
sponds. Because traditional changes in the stance of monetary policy affect the economy with a
lag, policy actions today may take several quarters or more before their effects on spending and
inflation take hold. Thus, demand shocks can push the economy away from the Federal Reserve’s
goals of maximum employment and price stability for a time.
Conducting Monetary Policy 27
Supply Shocks
Other shocks can affect the production of goods and services and their prices by altering the
costs associated with production or the technology used in production. Examples of such “supply
shocks” include crop losses due to extreme weather and slowdowns in productivity growth relative
to what would have occurred otherwise—these sorts of adverse supply shocks tend to raise prices
and reduce output (and also employment). A disruption in the oil market that reduces the supply
of oil and increases its price substantially can also raise other prices and reduce output because
oil is an input to the production of many products.
In the face of these adverse supply shocks, policymakers can attempt to counter the loss of out-
put by easing monetary policy and making financial conditions more conducive to spending; alter-
natively, policymakers can attempt to counter the rise in prices by tightening policy. As discussed,
in these situations, the FOMC has indicated it would take into account the employment shortfalls
and inflation deviations in achieving its goals.
Of course, the economy can also experience beneficial supply shocks, such as technological
breakthroughs or reductions in the cost of important raw materials, and these beneficial supply
shocks can both lower prices and boost output.
How Monetary Policy Decisions Are Made: The Deliberative Process
How are monetary policy decisions made? The members of the Board of Governors and the presi-
dents of the 12 Federal Reserve Banks gather for eight regularly scheduled joint meetings of the
Board and FOMC each year to discuss economic and financial conditions and deliberate on mon-
etary policy. Normally, this meeting is held at the Board’s offices in Washington, D.C.; if necessary,
FOMC participants meet by video conference for these meetings or at other times.
FOMC Meetings: Assessing an Evolving U.S. and World Economy
At its meetings, the FOMC considers how the U.S. economy is likely to evolve in the near and
medium term, along with risks to the outlook for the economy. With this assessment, it then deter-
mines the appropriate monetary policy setting to help move the economy to the Federal Reserve’s
goals of maximum employment and 2 percent inflation over the longer run. The FOMC also consid-
ers how it can effectively communicate its expectations for the economy and its policy decisions to
the public. For a closer look at FOMC meeting deliberations, see box 3.1.
28 The Fed Explained: What the Central Bank Does
How the FOMC Determines the Appropriate Stance of Monetary Policy
During the FOMC meeting, policymakers discuss a broad range of information to help them assess
trends in the U.S. economy and to judge the appropriate stance of monetary policy. They analyze
the most up-to-date economic data; consider surveys of households, businesses, and financial
market participants; and review reports from the Federal Reserve staff and other sources.
Overall, while reviewing all the information and analysis, policymakers keep in mind the linkages
between the level of the federal funds rate, other short-term interest rates, broader financial condi-
Box 3.1. What Happens at an FOMC Meeting
In preparation for each Federal Open Market Committee (FOMC) meeting, policymakers analyze
economic and financial developments and evaluate the implications of these developments for the
economic outlook and risks to the outlook.
The materials that they and their staffs review include a wide range of U.S. and international economic
and financial data, statistical and judgmental economic forecasts, and analyses of alternative policy
approaches. Participants also consult business, consumer, and financial industry contacts to hear
their perspectives on economic and financial conditions and the outlook.
Reserve Bank input gathered. The staff of the Federal Reserve Banks collect and summarize infor-
mation on current economic conditions in their Districts. An overall summary, commonly known as
the Beige Book, is released to the public two weeks before the FOMC meeting. (The Beige Book is
available at https://w
ww. federalreserve.gov/monetarypolicy/beigebook/default.htm.) At about the
same time, the staff of the Federal Reserve Board distributes to all FOMC participants its analysis of
the economy, its economic forecasts, and an analysis of several policy options that span the range
of plausible monetary policy responses to the current and expected economic situation. Economic
research groups at the Reserve Banks separately brief their Bank presidents on relevant economic de-
velopments and policy choices. Using these materials, FOMC participants formulate their preliminary
views on the economic outlook and the appropriate policy response in preparation for their meeting in
Washington.
Economic situation: FOMC participants receive briefings and present their views. During the first
part of the meeting, the Federal Reserve governors and Reserve Bank presidents receive briefings that
review the operations of the System Open Market Desk at the Federal Reserve Bank of New York and
recent economic and financial developments in the United States and abroad. Each Bank president
around the table then takes a turn presenting their views on economic conditions in his or her District,
and both the presidents and governors offer their assessments of recent developments and the out-
look.
Monetary policy: FOMC participants briefed and discuss appropriate stance of policy; members
vote. After a staff presentation on options for monetary policy, participants again share their individual
judgments of how policy should be conducted over the period prior to the next FOMC meeting, how
they expect policy to evolve over the medium run, and how the Committee’s policy intentions should be
communicated to the public. While all participants are included in the discussions, the policy decision
rests with the voting members of the FOMC—the members of the Board of Governors, the president
of the Federal Reserve Bank of New York, and 4 of the remaining 11 Bank presidents (on a rotating
basis).
For more information on the FOMC and other key Federal Reserve entities, see section 2 on page 6.
For an in-depth look at what happens at an FOMC meeting, see the speech that former Federal Re-
serve Governor Elizabeth A. Duke delivered in October 2010, “Come with Me to the FOMC,” available
at https://www.federalreserve.gov/newsevents/speech/duke20101019a.htm.
Conducting Monetary Policy 29
tions, and the actions of households and businesses. They also take into account uncertainties
and risks in their analysis. The FOMC meeting concludes with a decision on the stance of policy.
FOMC Statement and Chair’s Press Conference
Starting in 1994, the Federal Reserve released a statement to the public when the FOMC made a
change in the stance of monetary policy. A few years thereafter, the Committee began to release
a statement after every meeting. The statement summarizes the Committee’s judgment about
recent economic developments and the economic outlook, states the FOMC’s policy decision, and
provides information about the factors that the FOMC will consider in setting policy as economic
and financial developments evolve.
At times, the statement provides “forward guid-
ance”—that is, information about the Commit-
tee’s intentions for the federal funds rate in
the future. The statement may also contain
information about policy actions that may af-
fect the size and composition of the Federal
Reserve’s balance sheet. Forward guidance
and balance sheet policies were important
tools used in the aftermath of both the 2007–09 financial crisis and the 2020 COVID-19 shock,
when short-term interest rates were near zero. The postmeeting statement concludes by noting
which FOMC members voted for an action, and which members, if any, dissented from it.
Beginning in 2011, the Chair held press conferences immediately following the conclusion of four
FOMC meetings during the year. Then, starting in 2019, the Chair started holding press conferenc-
es after each FOMC meeting. Each press conference begins with the Chair presenting an opening
statement and then taking questions from members of the media. These press conferences allow
the Chair to explain the rationale behind the policy decision and how it relates to the Committee’s
dual mandate.
Communicating Policy Regularly and Clearly
The Federal Reserve has a long-standing commitment to communicate regularly with the public
and Congress concerning its monetary policy activities and the pursuit of its dual mandate. While
some communications are required by statute, most represent an effort by the Federal Reserve to
increase the transparency and accountability of its policy decisions and operations. The Federal
Reserve also engages in significant outreach to the public in order to enhance its understanding
of economic issues and the effects of its policies.
Besides the regular FOMC postmeeting statements and the Chair’s press conferences that explain
the FOMC’s decisions, there are many other avenues for communications. Some of these com-
Learn more about the context for monetary policy
decisions
The release of postmeeting communications provides
the broad context for FOMC policy decisions. Visit the
Board’s website to view postmeeting releases and oth-
er communications that provide the context for each
FOMC meeting at https://www.federalreserve.gov
/monetarypolicy/fomccalendars.htm.
30 The Fed Explained: What the Central Bank Does
munications are tied to FOMC meetings and
released on set dates. Other communications
are associated with unanticipated events and
released at the times of the events.
FOMC meeting minutes. Detailed minutes of
FOMC meetings are released three weeks after
each meeting. The minutes cover all policy-
related topics that receive a significant amount
of attention during the meeting. They describe
the views expressed by the participants, the
risks and uncertainties attending the outlook,
and the reasons for the Committee’s deci-
sions. The minutes can help the public interpret economic and financial developments and better
understand the Committee’s decisions. As an official record of the meeting, the minutes identify
all attendees and include votes on all authorized policy operations.
Summary of Economic Projections. Beginning in late 2007, the Federal Reserve began publishing
a summary of the economic projections of individual FOMC participants four times each year in
the “Summary of Economic Projections.” The FOMC publishes these projections at the same time
it releases its policy statement after its regularly scheduled meetings. The projections are partici-
pants’ individual assessments of the most likely outcomes for real gross domestic product (GDP)
growth, the unemployment rate, and inflation consistent with each participant’s assessment of the
appropriate setting of the federal funds rate over the medium term and over the longer run. Also
included are measures of participants’ assessment of the uncertainty and risks associated with
their outlooks for these variables. Participants base their respective projections on assumptions
about the factors likely to affect economic outcomes.
Testimonies to Congress, speeches, and transcripts. The FOMC’s communication of its policy ac-
tions and intentions extends well beyond the postmeeting statements, minutes, and press confer-
ences. By statute, the Federal Reserve Chair testifies twice each year on economic developments
and monetary policy before the congressional committees that oversee the Federal Reserve. At
those times, the Board of Governors delivers the semiannual Monetary Policy Report to Congress
that discusses the conduct of monetary policy and economic developments and prospects for
the future. In addition, the Chair and other Board members appear frequently before Congress to
report and answer questions on economic and financial market developments and on monetary
and regulatory policy. Many Federal Reserve policymakers regularly give public speeches. And a
The Fed’s commitment to its goals
“Overall, our new Statement on Longer-Run Goals
and Monetary Policy Strategy conveys our continued
strong commitment to achieving our goals, given the
difficult challenges presented by the proximity of in-
terest rates to the effective lower bound. In conduct-
ing monetary policy, we will remain highly focused
on fostering as strong a labor market as possible for
the benefit of all Americans. And we will steadfastly
seek to achieve a 2 percent inflation rate over time.”
Chair Jerome Powell, August 27, 2020
https://www.federalreserve.gov/newsevents/
speech/powell20200827a.htm
Conducting Monetary Policy 31
wide range of documents, including transcripts of the FOMC meetings and staff analysis prepared
for each meeting, is made available after a five-year lag.
Committee policy statements. In addition to
the regular FOMC statements following every
meeting, the FOMC also issues statements
from time to time providing additional infor-
mation on specific topics. Three examples of
such statements discussed in this section are
the statement of the Committee’s longer-run
goals and monetary policy strategy, state-
ments regarding balance sheet normalization
principles and plans, as well as its statement
regarding monetary policy implementation in the longer-run.
Collecting information from the public. FOMC policymakers collect a vast amount of informa-
tion from the public to help inform them on the setting of the appropriate stance of monetary
policy. Reserve Bank presidents meet with contacts in their Districts before each FOMC meeting
to discuss District as well as national economic issues. The Federal Reserve conducts numerous
surveys at the District level and the national level that inform the Committee about financial and
economic conditions. In addition, the Federal Reserve publishes various financial and economic
data that are used by the FOMC as well as the public more broadly in evaluating the health of the
economy.
Monetary Policy Evolution in Recent Decades
Since the mid-1990s, the FOMC has focused on conducting monetary policy by adjusting the level
of short-term interest rates with the goal of influencing overall financial conditions in a way that
will promote the attainment of the Committee’s dual mandate objectives. This approach, which
is followed by many central banks, seeks to adjust policy in a systematic and transparent way in
response to the observed and expected paths for employment and inflation. Since 2007, with
extraordinary shocks hitting the global economy, the Federal Reserve has expanded its policy tools
to include some less-conventional policy measures as needed.
Monetary Policy during and after the 2007–09 Financial Crisis
The crisis in global financial markets that began during the summer of 2007 became particularly
severe during 2008. Early on, the Federal Reserve responded by expanding its lending to banks
that were experiencing shortages of liquidity through its standard discount window. In addition, the
Federal Reserve introduced several emergency lending programs that were designed to address
financial institutions’ needs for short-term liquidity, to help alleviate strains in many markets, and
Regular congressional testimony and reporting
promote accountability and transparency
The Board submits the Monetary Policy Report to Con-
gress semiannually. This report contains discussions
of the conduct of monetary policy and economic devel-
opments and prospects for the future. At the time this
report is released, the Chair testifies in front of the
Senate Committee on Banking, Housing, and Urban Af-
fairs and in front of the House Committee on Financial
Services. See the Board’s website at https://www.
federalreserve.gov/monetarypolicy/mpr_default.htm.
32 The Fed Explained: What the Central Bank Does
to support the flow of credit to households and
businesses. The Federal Reserve also estab-
lished dollar liquidity swap arrangements with
several foreign central banks to address global
dollar funding pressures.
Another way that the Federal Reserve respond-
ed to the crisis was through adjustments to its
traditional policy tool, the federal funds rate.
Beginning in the fall of 2007, the FOMC began
cutting its target for the federal funds rate and, by the end of 2008, the target had been reduced
from a level of 5¼ percent to a range of 0 to ¼ percentage point (see figure 3.2).
Although the Federal Reserve’s initial responses to the crisis helped financial markets to recover
and function more normally, the recession in the U.S. economy that began in December 2007 was
particularly severe and long-lasting. With the federal funds rate near zero, the FOMC turned to two
less-conventional policy measures—forward guidance and large-scale asset purchases—to provide
additional policy accommodation to support economic activity and stem disinflationary pressures.
The FOMC’s use of forward guidance influenced expectations about the future course of monetary
policy. Because households and businesses can use this information in making decisions about
spending and investment, forward guidance
about future monetary policy can influence
financial and economic conditions today. Over
the course of several years, the FOMC used
various forms of forward guidance and, by
December 2012, the FOMC’s statement was
pointing to the economic conditions that the
Committee expected to see before it would
begin to consider raising its target range for
the federal funds rate.
In terms of large-scale asset purchases, between late 2008 and October 2014, the Federal Re-
serve purchased longer-term securities through a series of programs with the aim of putting down-
ward pressure on longer-term interest rates, easing broader financial market conditions, and thus
supporting economic activity and job creation. These purchases reduced the cost and increased
the availability of credit for households and businesses.
Clear usage of forward guidance
In 2008, the FOMC lowered the target range for the
federal funds rate to the effective lower bound and
provided forward guidance that indicated the target
would likely be exceptionally low for some time. A
timeline of the FOMC’s setting of the policy rate and
use of forward guidance is available at https://www.
federalreserve.gov/monetarypolicy/timeline-forward-
guidance-about-the-federal-funds-rate.htm.
Unprecedented actions to foster maximum
employment and stable prices
The Federal Reserve responded aggressively to the
financial crisis that emerged in the summer of 2007,
including the implementation of a number of programs
designed to support the liquidity of financial institu-
tions and foster improved conditions in financial
markets.
For more on the monetary policy actions taken at that
time, see https://www.federalreserve.gov/monetary-
policy/bst_crisisresponse.htm.
Conducting Monetary Policy 33
Reflecting the FOMC’s multiyear asset purchase programs and decision to reinvest maturing and
prepaying securities, total assets of the Federal Reserve increased significantly by the end of
2014, from $870 billion in August 2007 to about $4.5 trillion, or 25 percent as a ratio to nominal GDP.
2015–19: Normalizing Monetary Policy in a Normalizing Economy
By 2015, the economic expansion had been ongoing for several years and unemployment had
declined noticeably. In addition, labor market conditions were projected to continue to improve,
and inflation was projected to move up to 2
percent. With this backdrop, the FOMC decided
that it would begin normalizing the stance of
monetary policy in order to continue to fos-
ter its macroeconomic objectives. The term
“normalization” refers to steps the FOMC took
to return both short-term interest rates as well
as the size and composition of the Federal Re-
serve’s balance sheet to more-normal levels.
To be transparent about this process and allow market participants to prepare for Federal Reserve
normalization actions, the FOMC made public its policy normalization principles and plans. In
particular, it announced the plan to first raise the federal funds rate from near zero and then to
normalize the size and composition of the balance sheet. To that end, the Committee gradually
raised its target range for the federal funds rate between December 2015 and December 2018.
By the end of 2018, the federal funds rate target range stood at 2¼ to 2½ percent.
In terms of balance sheet policy, the FOMC began reducing the size of its asset holdings in late
2017 by gradually phasing out the reinvestment of maturing and prepaying securities. By early
2019, the Federal Reserve’s balance sheet declined to a bit under 20 percent as a ratio of nomi-
nal GDP.
As in the period prior to the 2007–09 financial crisis, during this period, the FOMC normalized the
stance of policy by adjusting the level of short-term interest rates up in response to the observed
and expected future paths for the unemployment rate and inflation. However, after several years
of increasing the target range for the federal funds rate, the level of interest rates still remained
much lower than in the past. Many factors contributed to this lower level—well-anchored inflation
expectations, demographics, globalization, slower productivity growth, and greater demand for safe assets.
In this lower interest rate environment, the risk of shocks to the economy that can push the fed-
eral funds rate to the effective lower bound is much higher than before the financial crisis. And,
in fact, the FOMC found itself swiftly lowering the policy target range to the effective lower bound
Large-Scale Asset Purchase (LSAP) programs
supported credit for households and businesses
From the end of 2008 through October 2014, the
Federal Reserve greatly expanded its holding of longer-
term securities with the goal of putting downward pres-
sure on longer-term interest rates and thus supporting
economic activity and job creation by making financial
conditions more accommodative.
More information on LSAPs is available at https://
www.federalreserve.gov/monetarypolicy/bst_
openmarketops.htm.
34 The Fed Explained: What the Central Bank Does
in March 2020, at the onset of the COVID-19 pandemic, and turning to tested, additional policy
tools—forward guidance and balance sheet policy.
2020 and Beyond: Taking Aggressive Action Amid the Global Pandemic
The COVID-19 pandemic, still evolving at the time of this publication, is fundamentally a global
public health crisis. The coronavirus, as well as measures taken to limit its spread and protect
public health, including social distancing, triggered deep disruptions in economic activity—includ-
ing a surge in job losses and a sharp decline in GDP—and severe strains in financial markets
around the globe. The Federal Reserve’s initial response to these extraordinary developments was
guided by its mandate to promote maximum employment and stable prices as well as its role in
fostering the stability of the financial system.
The actions and programs introduced were targeted at supporting the flow of credit to households,
businesses, nonprofits, and municipalities. In March 2020, the FOMC lowered the policy interest
rate to near zero. It also introduced forward guidance, which evolved to signal that the Committee
expected to maintain this near-zero target range until the economy was essentially at the FOMC’s
employment and inflation goals.
In addition to these steps, the Federal Reserve took forceful measures in four areas:
1. open market operations to restore market functioning;
2. actions to improve liquidity conditions in short-term funding markets;
3. programs, in coordination with the Treasury Department, to facilitate more directly the flow of
credit; and
4. measures to encourage banks to use their substantial capital and liquidity buffers built up over
the past decade to support the economy during this difficult time.
Many of these measures increased the size of the Federal Reserve’s balance sheet; total assets
stood near $7 trillion or 35 percent as a ratio of nominal GDP by mid-2020 (see box 3.2, “The
Fed’s Response to the COVID-19 Shock Is Reflected in Its Balance Sheet”).
Monetary Policy Tools
Once the FOMC determines the stance of policy appropriate to achieve its dual mandate objec-
tives, it must then make sure this stance is effectively implemented. The Board and FOMC have
many policy implementation tools at their disposal to ensure that the policy stance is being trans-
mitted to financial markets. In normal times, the key tools are administered interest rates and
open market purchases and sales of securities.
Conducting Monetary Policy 35
Interest on reserve balances. Depository institutions hold funds in reserve accounts at their
regional Federal Reserve Banks. Beginning in October 2008, the Federal Reserve began paying
interest on required and excess reserve balances. Between October 2008 and March 2020 the in-
terest rates on required and excess reserves were set to the same rate. Because reserve require-
ments no longer served as an important tool for implementing monetary policy, beginning in March
2020, required reserves were set to zero and all reserve balances began earning the interest rate
on excess reserves. As of July 29, 2021, the Federal Reserve eliminated references to an interest
on required reserves rate and to an interest on excess reserves rate and replaced them with a
single interest rate on reserve balances (IORB) rate.
By raising or lowering the IORB rate, the Federal Reserve sets a floor on the rates at which banks
are willing to lend excess cash in their reserve balance accounts at the Federal Reserve to private
Box 3.2. The Fed’s Response to the COVID-19 Shock Is
Reflected in Its Balance Sheet
During the first few months of the coronavirus (COVID-19) pandemic, the Fed’s balance sheet
increased from $4.3 trillion in mid-March 2020 to nearly $7.2 trillion in early June 2020.
The largest contribution to the expansion of the balance sheet was a $2.1 trillion increase in holdings
of Treasury and agency mortgage-backed securities (figure A). This increase reflected the sizable asset
purchases conducted to support the smooth functioning of the markets in which these assets are
issued and traded, markets that are vital to the flow of credit in the economy, and the transmission
of monetary policy to broader financial conditions. Other assets that boosted the size of the balance
sheet included an increase in liquidity and lending programs (figure B). In particular, central bank li-
quidity swaps, which were deployed to help ease strains in global funding markets, and limited liability
corporations (LLCs), which were implemented to support the flow of credit, saw notable utilization dur-
ing the first few months of the COVID-19 shock.
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
2016 2017 2018 2019 2020
$ billions
Weekly
Treasury securities
Agency securities
Other assets
A. Total assets, $ billions B. Outstanding level of liquidity and lending, $ billions
Weekly
Repo
Loans
LLCs
Swaps
$ billions
20202019
July 3 Aug. 28 Oct. 30 Jan. 1 Mar. 4 Apr. 29 July 1
900
800
700
600
500
400
300
200
100
0
A detailed discussion of the movement in the individual line items on the Federal Reserve’s balance sheet during the first few
months of the COVID-19 pandemic are found in the August 2020 Report on the Federal Reserve’s Balance Sheet, https://www.
federalreserve.gov/publications/files/balance_sheet_developments_report_202008.pdf.pdf.
36 The Fed Explained: What the Central Bank Does
counterparties. The IORB rate thus affects the federal funds rate and other short-term market
interest rates. (See box 3.3 for a discussion of how interest on reserve balances has proven to be
an effective tool for transmitting the FOMC’s target range for the federal funds rate to other inter-
est rates in the economy.)
Open market operations. Over the years, the Federal Reserve has relied upon open market opera-
tions as a tool of policy implementation. In conducting an open market operation, the Open Market
Desk at the Federal Reserve Bank of New York (or, the Desk) permanently or temporarily buys or
sells securities issued or guaranteed by the U.S. Treasury or U.S. government agencies. When the
Box 3.3. Interest on Reserve Balances as a Key Tool of
Monetary Policy Implementation
The Federal Reserve uses interest on reserve balances as a key tool to anchor the federal funds rate
in the target range. The interest on reserve balances (IORB) rate acts as a benchmark for banks
when determining the interest rate to charge in their lending activities.
In particular, banks should require a rate in lending to households and businesses and others at least
as high as they can earn on balances maintained in their reserve accounts at the Federal Reserve. As
a result, the setting of the IORB rate affects borrowing and lending in overnight money markets as well
as influences broader financial markets.
When the FOMC increased the target range for the federal funds rate between late 2015 and the end
of 2018, there was a corresponding change to the interest on required and excess reserves rates to
move the federal funds rate into the target range. Other overnight money market rates also moved
up (figure A). Rates in short-term funding markets—such as commercial paper rates and Treasury bill
rates—moved higher as well (figure B). In 2019 and 2020, when the FOMC lowered the target range
for the federal funds rate, the Federal Reserve lowered the interest rates on required and excess
reserves and short-term rates declined. These increases and decreases in the general level of short-
term rates, together with the expected future path of short-term rates, then influenced the level of
other financial asset prices and overall financial conditions in the economy.
Eurodollar
Treasury GCF repo
Federal funds
0
25
50
75
100
125
150
175
200
225
250
201820172016
Interest on excess reserves
Target range
Daily
Basis points
A. Overnight money market rates
Note: The upper bound of the target range is also the interest on excess reserves rate
until June 13, 2018, after which the upper bound is 5 basis points higher. GCF is
General Collateral Finance.
Source: For Treasury GCF repo, DTCC Solutions LLC, and affiliate of The Depository Trust
& Clearing Corporation; for federal funds, Federal Reserve Bank of New York; for
Eurodollar, Bloomberg; for interest on reserves and target range, Federal Reserve Board.
3-month Treasury bill
3-month AA financial
commercial paper
0
25
50
75
100
125
150
175
200
225
250
201820172016
Interest on
excess reserves
Target range
Daily
Basis points
B. Term money market rates
Note: The upper bound of the target range is also the interest on excess reserves rate
until June 13, 2018, after which the upper bound is 5 basis points higher.
Source: For U.S. Treasury bill, Department of the Treasury; for AA financial commercial
paper, interest on reserves, and target range, Federal Reserve Board.
Conducting Monetary Policy 37
securities are bought or sold, reserves in the banking system are increased or decreased, respec-
tively.
The Federal Reserve Act requires that the Desk conduct its purchases and sales in the open mar-
ket. To do so, the Desk has established relationships with private-sector counterparties that are
active in the market for U.S. government secu-
rities. For example, when the Federal Reserve
permanently purchases a security, the Desk
buys eligible securities from primary dealers
at prices determined in a competitive auction.
The Federal Reserve pays for those securities
by crediting the reserve accounts of the correspondent banks of the primary dealers. (The corre-
spondent banks, in turn, credit the dealers’ bank accounts.) In this way, the open market purchase
leads to an increase in reserve balances.
A temporary purchase operation (a repurchase agreement or “repo”) is a transaction in which the
Desk purchases a security from an eligible counterparty with an agreement to sell back that same
security at a specified price at a specific time in the future.
Overnight reverse repurchase facility. Today, the FOMC uses a standing overnight reverse repur-
chase facility as a tool to help keep the federal funds rate in the target range. The facility effec-
tively puts a floor on the federal funds rate.
An overnight reverse repurchase agreement is an open market operation where the FOMC stands
ready to sell securities to the designated counterparties. The FOMC sets an overnight reverse
repurchase agreement offering rate (ON RRP rate), which is the maximum interest rate the Federal
Reserve is willing to pay in an ON RRP operation. When an institution uses the ON RRP facility, it
essentially makes a deposit at the Fed overnight, receiving a government security as collateral.
The next day, the transaction is “unwound”—the Fed buys back the security, and the institution
earns interest on the cash it deposited at the Fed. The actual interest rate that a counterparty
receives is determined through an auction process. The amount of ON RRP provided is limited
only by the quantity of available Treasury securities in the Federal Reserve’s portfolio. As a result,
except in very unusual circumstances, the auction rate will be equal to the ON RRP offered rate.
In general, any counterparty to the facility should be unwilling to invest funds overnight in money
markets at a rate below the ON RRP rate.
Purchases and sales of securities. Before the 2007–09 financial crisis, the Federal Reserve fre-
quently used permanent and temporary purchases and sales of securities to affect the supply of
reserves and hence conditions in the federal funds market to maintain the federal funds rate at
the target set by the FOMC. The size of these operations varied day-to-day depending on market
Interest on reserve balances
Detailed information on the Fed’s primary tool, interest
on reserve balances, is available on the Federal Re-
serve Board’s website at https://www.federalreserve.
gov/monetarypolicy/reqresbalances.htm.
38 The Fed Explained: What the Central Bank Does
conditions but tended to be of modest size. Under the current operational framework, the FOMC
seeks to maintain an ample supply of reserves in the banking system so that active use of open
market operations to fine tune daily levels of reserves is not required. However, under the ample-
reserves framework, the Federal Reserve will still need to conduct open market operations to
maintain an ample supply of reserves over time.
In addition, the Federal Reserve may utilize open market purchases during times of stress or to
provide more monetary policy support to the economy. During the 2007–09 financial crisis and
subsequent recession—at a time when the
federal funds rate was near zero and the
Committee wanted to put downward pressure
on yields of a variety of longer-term securities
held by private investors—the FOMC conduct-
ed four large-scale asset purchase programs.
When the Federal Reserve buys longer-term securities in the open market, the remaining stock of
securities available for purchase by the public declines, which pushes the prices of those securi-
ties up and thus depresses their yields.
In the early months of the 2020 COVID-19 shock, the FOMC purchased Treasury securities and
agency mortgage-backed securities in the amounts needed, which were quite sizable, to support
smooth market functioning. Over time, the size of these purchases slowed, and the FOMC turned
to using these open market operations to help foster both smooth market functioning and accom-
modative financial conditions, with the aim to support the flow of credit to households and busi-
nesses.
Discount window lending. Discount window lending is available as a backup source of liquidity
for depository institutions. The discount window serves as a useful tool for promoting financial
stability by providing temporary funding to banks that are experiencing liquidity pressures. Borrow-
ers pledge collateral to secure loans from the discount window and the rate charged on discount
window loans is generally somewhat above the prevailing level of market interest rates. By provid-
ing ready access to liquidity at a fixed rate, the discount window helps to damp upward pressures
on the federal funds rate and other short-term bank funding rates.
Reserve requirements. Reserve requirements specify a quantity of reserves—vault cash and
balances at a Federal Reserve Bank—that a depository institution must hold against transaction
accounts and other selected deposit liabilities. The Federal Reserve Board establishes reserve
requirements that apply for all banks.
Before the global financial crisis, reserve requirements were a key factor in the implementation
of monetary policy, as these requirements influenced banks’ demand for reserves. Today, with a
Learn more about the Fed’s toolkit
The Federal Reserve has many traditional and non-
traditional policy implementation tools to promote a
healthy economy. A discussion of each of the active
tools is found at https://www.federalreserve.gov/
monetarypolicy/policytools.htm.
Conducting Monetary Policy 39
much larger level of reserves in the banking system, reserve requirements are not a key factor
influencing reserve demand for many banks. Partly reflecting this fact, the Board of Governors
announced in March 2020 that it was reducing reserve requirements to zero so that this tool is no
longer active.
Nontraditional tools. During times of severe economic downturns the Federal Reserve can em-
ploy lending tools to support the flow of credit to households and businesses. Many, but not all,
of these tools are emergency lending programs that rely on section 13(3) of the Federal Reserve
Act, a provision that allows the Board of Governors to establish broad-based lending facilities in
unusual and exigent circumstances with approval of the Secretary of the Treasury. Most of these
programs provide a backstop source of funding to targeted markets, generally with the aim of sup-
porting the flow of credit to households and businesses. When economic and financial conditions
improve, emergency lending programs are discontinued.
How Monetary Policy Is Implemented
How does the Federal Reserve ensure that its stance of policy is achieved? It relies on an imple-
mentation framework. There are two broad operating frameworks that central banks use to imple-
ment policy, and the Federal Reserve has successfully used both regimes in the past few decades.
Before the 2007–09 financial crisis, the FOMC operated in a regime with limited reserves in the
banking system; today it implements policy in a regime with ample reserves. (See box 3.4 for a
discussion of the evolution of reserve balances.) The regimes not only differ by the level of re-
serves in the banking system, but also by the key tools used to control short-term interest rates.
Limited-Reserves Regime
Prior to the 2007–09 financial crisis, the Federal Reserve supplied a limited, or scarce, amount
of reserves to the banking system—just enough to satisfy banks’ limited demand for reserves at
the FOMC’s target federal funds rate. On a daily basis, the Federal Reserve would purchase or sell
securities through open market operations to inject or remove reserves from the banking system
to keep the federal funds rate near the FOMC’s target. It was through these daily adjustments in
the amount of reserves that the federal funds rate and other short-term interest rates, as well as
broader financial conditions, were influenced so as to affect household and business decisions.
Ample-Reserves Regime
Today and going forward, the Federal Reserve is implementing policy with a much more plentiful
amount of reserves. In this regime, even large fluctuations in the supply of reserves do not trans-
late into movements in the federal funds rate or other short-term interest rates. In this framework,
the Federal Reserve relies on two administered rates—the interest on reserve balances rate and
40 The Fed Explained: What the Central Bank Does
the ON RRP offering rate—to steer short-term market interest rates toward the policy target range.
By paying interest on reserve balances and offering ON RRPs, the Federal Reserve provides safe,
liquid investments for banks and nonbank financial institutions that are ON RRP counterparties.
These two rates set a floor on the rate that banks and other lenders are willing to accept in lend-
ing out and, hence, help anchor short-term interest rates. (See figure 3.3 for how these adminis-
tered interest rates ultimately influence the decisions of households and businesses.)
When the FOMC lifted rates off from the zero lower bound in late 2015, the Board set the interest
on required and excess reserves rates at the top of the federal funds rate target range and the
Box 3.4. Evolution of Reserves in the Banking System
The Federal Reserve controls the quantity of reserves in the banking system. Over the past few de-
cades, the level of reserve balances has moved substantially, reflecting the various ways the Federal
Open Market Committee (FOMC) has conducted and implemented monetary policy.
In the decade before the 2007–09 financial crisis, the supply of reserves was limited and monitored
daily. The level was determined to maintain the federal funds rate at the target level set by the FOMC.
Throughout this period, reserve balances averaged less than $20 billion.
2007–17. During the financial crisis and subsequent recession, when the federal funds rate was near
the zero lower bound, the FOMC conducted a series of large-scale asset purchase programs to help
stimulate the economy and keep inflation close to the Committee’s objective, which increased reserves
substantially; reserve balances peaked at $2.7 trillion or 15 percent as a ratio of nominal GDP in late
2014.
2017–19. Once the economy recovered sufficiently and the federal funds target range was away from
zero, the FOMC redeemed maturing and prepaying securities up to a predetermined, monthly limit.
These redemptions, in combination with growth in nonreserve liabilities on the Federal Reserve’s bal-
ance sheet—such as currency—reduced reserves substantially between October 2017 and August
2019. In October 2019, the FOMC announced its intentions to maintain over time ample reserve bal-
ances at or above the level that prevailed in early September 2019, which was about $1.5 trillion or
7 percent of nominal GDP.
2020. Then in 2020, faced with the coronavirus (COVID-19) pandemic, the FOMC turned to large-scale
asset purchases to help stabilize key financial markets. The Federal Reserve also established emer-
gency lending in several important areas. These actions again boosted the level of reserves in the
banking system. As of the end of June 2020, reserves stood at $2.9 trillion or about 15 percent of
nominal GDP.
Figure A. Reserves evolve to help stabilize the economy
3,500
3,000
2,500
2,000
1,500
1,000
500
0
.18
.16
.14
.12
.10
.08
.06
.04
.02
0
Reserves, $ billions
Reserves, GDP ratio
Billions of dollars
Percent
Jan
2007
Jan
2011
Jan
2013
Jan
2015
Jan
2017
Jan
2019
May
2020
Jan
2009
Conducting Monetary Policy 41
Figure 3.3. How the Federal Reserve implements monetary policy
When the Federal Open Market Committee (FOMC) sets monetary policy that, for example, requires lowering the
policy interest rate, the Federal Reserve also lowers its administered interest rates. Fed counterparties then make
investment decisions by comparing the Fed’s administered rates and market interest rates. This comparison causes
market rates to decline, which increases borrowing opportunities for households and businesses. These actions
allow the FOMC to make progress toward its dual mandate of maximum employment and price stability.
FOMC
FOMC decides to make policy more
accommodative (“ease” policy)
The Fed instructs the Desk to
reduce the overnight reverse
repurchase agreement (ON RRP)
offering rate
Desk counterparties compare market
rates with the Fed’s offering rate to
decide where to invest their cash
Banks compare market rates with
the Fed’s IORB rate to decide where
to invest their cash
With lower rates in the economy, households and
businesses see an increased opportunity to borrow
for purchases, which influences employment,
inflation, and output.
The comparison of the Fed’s administered
rates with market rates encourages the
latter to move down
The Fed reduces its
interest on reserve
balances (IORB) rate
%
INTEREST RATES
COMPARE RATES
%
%
OPEN MARKET DESK
DESK
COUNTERPARTIES
BANKS
GROCERIES
INDIVIDUALS AND BUSINESSES
FOMC set the ON RRP rate at the bottom of the range. Over time, as the FOMC moved the stance
of policy up or down, the Federal Reserve adjusted the interest on required and excess reserves
rates as well as the ON RRP rate in a manner to encourage federal fund trades at rates within the
policy target range. (Figure 3.3 shows how these administered interest rates ultimately influence
the decisions of households and businesses).
In January 2019, the FOMC announced “it intends to continue to implement monetary policy in
a regime in which an ample supply of reserves ensures that control over the level of the federal
42 The Fed Explained: What the Central Bank Does
funds rate and other short-term interest rates
is exercised primarily through the setting of
the Federal Reserve’s administered rates, and
in which active management of the supply of
reserves is not required.” Table 3.1 reviews the
Federal Reserve’s traditional implementation
tools in use in an ample-reserves regime.
In recent years, the Federal Reserve has suc-
cessfully implemented monetary policy with a
varying degree of ample reserves in the banking system. In September 2019, some market stress-
es began to emerge suggesting that the level of reserves may have been close to falling below an
ample level; for the remainder of that year the Federal Reserve consistently conducted open mar-
ket operations to maintain over time reserve balances at or above the level that prevailed in early
September of that year. Then, in early 2020, the COVID-19 shock hit the global economy. Swift and
forceful actions by the Federal Reserve to stabilize economic and financial conditions and reduce
risks to the economic outlook were implemented and significantly boosted the level of reserves
Table 3.1 Traditional tools in an ample-reserves regime
In recent years, the Federal Reserve has successfully implemented monetary policy with a varying degree of ample
reserves in the banking system.
Tool Definition In practice
Interest on reserve balances
(IORB)
Interest paid on funds that banks hold
in their reserve balance accounts at
their Federal Reserve Bank.
Because banks are unlikely to lend funds in
the federal funds market for less than they
get paid in their reserve balance account at
the Federal Reserve, IORB is an effective
tool for guiding the federal funds rate. In
fact, interest on reserve balances is the
primary tool for moving the federal funds
rate within the target range.
Overnight reverse repurchase
agreement (ON RRP) facility
The Federal Reserve’s standing offer
to many large nonbank financial
institutions to deposit funds at the
Fed and earn interest.
Because large, nonbank financial
institutions who are counterparties to the
ON RRP facility are unlikely to lend funds
for lower than the ON RRP offering rate, the
ON RRP facility acts as a supplementary
tool for moving the federal funds rate within
the target range.
Open market operations The Federal Reserve’s buying and
selling of securities issued or
guaranteed by the U.S. Treasury or
U.S. government agencies.
Open market operations will be used to
maintain an ample supply of reserves.
Discount window The Federal Reserve’s lending to
banks (the “discount window”) at the
discount rate.
Because banks are unlikely to borrow at a
rate that’s higher than the discount rate,
the discount window helps put a ceiling on
the federal funds rate.
Learn more about how the Fed uses “ample
reserves”
A primer on what an ample-reserves regime is and
how it works is available at
https://www.federalreserve.gov/econres/feds/
the-feds-ample-reserves-approach-to-implementing-
monetary-policy.htm.
A shorter, educators piece that also compares the
ample and limited-reserves regimes is available at
https://research.stlouisfed.org/publications/page1-
econ/2020/08/03/the-feds-new-monetary-policy-tools.
Conducting Monetary Policy 43
in the banking system. (See subsection “2020 and Beyond: Taking Aggressive Action Amid the
Global Pandemic” on page 34 for more details.)
Finally, the Federal Reserve’s actions to implement monetary policy are reflected in the Federal
Reserve’s balance sheet. Key assets and liabilities are reported to the public each week. (See box
3.5 for more details about key line items of the Federal Reserve’s balance sheet.) The vast major-
Box 3.5. Gauging Monetary Policy through the Fed’s
Balance Sheet
The Federal Reserve’s balance sheet, published weekly, contains a great deal of information about
the scale and scope of its operations. For decades, market participants have closely studied the
evolution of the Federal Reserve’s balance sheet to understand important details about the imple-
mentation of monetary policy.
The table below shows the major asset and liability categories on the Federal Reserve’s balance sheet
as of June 24, 2020. On the asset side of the balance sheet, securities holdings represented the vast
majority of assets. Treasury securities holdings stood at nearly $4.2 trillion, while agency securities
holdings were $1.9 trillion. Some of the other assets on the balance sheet reflected liquidity and credit
market facilities that the Federal Reserve put in place to help fight against the negative economic and
financial market consequences of the coronavirus (COVID-19) pandemic.
On the liabilities side of the balance sheet, deposits of depository institutions (i.e., reserve balances),
currency in circulation, and the Treasury’s General Account each represented a substantial share.
Reserve balances, which stood at $2.9 trillion, are deposits held at Federal Reserve Banks by deposi-
tory institutions, including commercial banks, savings banks, credit unions, thrift institutions, and most
U.S. branches and agencies of foreign banks. These balances allow banks to facilitate daily payment
flows, both in ordinary times and in stress scenarios, without borrowing funds or selling assets. Cur-
rency stood at $1.9 trillion. U.S. currency is an important medium of exchange and store of value, both
domestically and abroad. Despite the increasing use of electronic means of payment, currency remains
widely used in retail transactions. The Treasury’s General Account held nearly $1.6 trillion, reflecting in
part the cash needs for the fiscal spending related to the Coronavirus Aid, Relief, and Economic Secu-
rity Act and other stimulus measures.
Table A. Simplified view of the Federal Reserve balance sheet, as of June 24, 2020
The Federal Reserve publishes data weekly regarding its balance sheet.
Assets (billions of dollars) Liabilities (billions of dollars)
Treasury securities held outright 4,197 Deposits of depository institutions 2,938
Agency debt and mortgage-backed
securities holdings
1,946 Federal Reserve notes in circulation 1,915
U.S. Treasury, General Account 1,587
Other assets 939 Capital and other liabilities 642
Total 7,082 Total 7,082
Note: The H.4.1 statistical release, “Factors Affecting Reserve Balances,” is published every Thursday at https://www.
federalreserve.gov/releases/h41/.
44 The Fed Explained: What the Central Bank Does
ity of the Federal Reserve’s assets are securities holdings. During times of severe stress, the Fed
may introduce liquidity and credit market facilities and usage of these facilities increases the level
of reserves.
46 Promoting Financial System Stability
4
Promoting Financial System
Stability
The Federal Reserve monitors financial system
risks and engages at home and abroad to help
ensure the system supports a healthy economy for
U.S. households, communities, and businesses.
What Is Financial Stability? .............................47
Monitoring Risk across the Financial System ................48
Macroprudential Supervision and Regulation of Large,
Complex Financial Institutions .........................55
Domestic and International Cooperation and Coordination .......57
Promoting Financial System Stability 47
The Federal Reserve was created in 1913 to promote greater financial stability and help avoid
banking panics, such as those that had plunged the country into deep economic contractions in
the late nineteenth and early twentieth centuries.
Over the past century, as the U.S. and global financial systems have evolved, the Federal Re-
serve’s role in promoting financial stability has necessarily changed with it. The 2007–09 financial
crisis and the subsequent deep recession revealed shortcomings in the financial system infra-
structure and the framework for supervising and regulating it (figure 4.1). Indeed, reforms enacted
under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act)—
the landmark legislative response to the 2007–09 crisis— assigned the Federal Reserve new
responsibilities in the effort to promote financial system stability and keep pace with changing
dynamics and innovation in the broader economy.
What Is Financial Stability?
A financial system is considered stable when financial institutions—banks, savings and loans, and
other financial product and service providers—and financial markets are able to provide house-
holds, communities, and businesses with the resources, services, and products they need to
invest, grow, and participate in a well-functioning economy.
Figure 4.1. The financial system: key participants and linkages
Key participants in the U.S. and global financial system include the lenders and savers who are matched up with
borrowers and spenders through various markets and intermediaries. The Federal Reserve monitors the financial
system to ensure the linkages among entities are well-functioning and adjusts its policymaking or engagement with
other policymakers to address any emerging concerns.
Indirect finance
Financial intermediaries
Lender-savers
Households
Business firms
Governments
Foreign entities
Borrower-spenders
Business firms
Governments
Households
Foreign entities
Direct finance
Financial markets
Investing/
funding
Investing/
funding
Investing/
funding
Investing/
funding
Source: Adapted from Frederic S. Mishkin and Stanley G. Eakins, Financial Markets and Institutions. 7th Edition (Boston: Prentice
Hall, 2012), 16.
48 The Fed Explained: What the Central Bank Does
These resources and services include
• business lines of credit, mortgages, student loans, and the other critical offerings of a sophisti-
cated financial system; and
• savings accounts, brokerage services, and retirement accounts, among many others.
Effective Linking of Savers and Lenders with Borrowers and Spenders
A healthy and stable financial system links, at the lowest possible cost, savers and investors
seeking to grow their money with borrowers and businesses in need of funds. If this critical role of
intermediation between savers and borrowers is disrupted in times of stress, the adverse impact
will be felt across the economy.
And such disruption can carry a very high price. As a result, financial stability in its most basic form
could be thought of as a condition where financial institutions and markets are able to support con-
sumers, communities, and businesses even in an otherwise stressed economic environment.
Keeping Institutions and Market Structures Resilient
To support financial stability, it is critical that financial institutions and market structures are
resilient, so that they are able to bend but not break under extreme economic pressures. Such
a dynamic does not mean that market prices will never rise or fall quickly. Volatility may reflect
changes in economic conditions and would be a concern with respect to financial stability only
when institutions and markets are not adequately prepared. Financial stability depends on firms
and critical financial market structures having the financial strength and operational skills to man-
age through volatility and continue to provide their essential products and services to consumers,
communities, and other businesses.
Monitoring Risk across the Financial System
The Federal Reserve and other bank regulators have long supervised individual banks and finan-
cial institutions to make sure they are run in a “prudent” and “safe and sound” manner and are
not taking excessive risks. The goal of this traditional “microprudential” supervisory approach is
to ensure that individual banks and financial institutions are less likely to fail and to help avoid
any associated adverse circumstances for their customers.
In the heat of the 2007–09 financial crisis, however, it became clear this microprudential focus did
not adequately identify risks that developed across and between markets and institutions; these
Promoting Financial System Stability 49
risks threatened to set off a cascade of failures that could have undermined the entire financial
system. Thus, a central element of the Dodd-Frank Act is the requirement that the Federal Reserve
and other financial regulatory agencies look across the entire financial system for risks, adopting
a macroprudential approach to supervision and regulation.
Whereas a traditional—or microprudential—approach to supervision and regulation focuses on
the safety and soundness of individual institutions, the macroprudential approach centers on the
stability of the financial system as a whole (see section 5, “Supervising and Regulating Financial
Institutions and Activities,” on page 62, for more on micro- and macroprudential supervision).
Types of Financial System Vulnerabilities and Risks
Federal Reserve staff regularly and systematically assess a standard set of vulnerabilities as part
of a Federal Reserve System macroprudential financial stability review:
• asset valuations and risk appetite
• leverage in the financial system
• funding risk
• borrowing by businesses and households
Box 4.1. Financial Stability and the Founding of the Federal
Reserve
Financial stability considerations were a key element in the founding of the Federal Reserve System.
Indeed, it was created in response to the Panic of 1907, which was at the time the latest in a series
of severe financial panics that befell the nation in the late nineteenth and early twentieth centuries.
The 1907 panic led to the creation of the National Monetary Commission, whose 1911 report was a
major impetus to the Federal Reserve Act, signed into law by President Woodrow Wilson on December
23, 1913. Upon enactment, the process of organizing and opening the Federal Reserve Board of Gov-
ernors and the Federal Reserve Banks across the country began. On November 16, 1914, the Federal
Reserve System began full-fledged operations.
In the words of one Federal Reserve Act author, U.S. Senator Robert Latham Owen of Oklahoma, “It
should always be kept in mind that . . . it is the prevention of panic, the protection of our commerce,
the stability of business conditions, and the maintenance in active operation of the productive energies
of the nation which is the question of vital importance.”
For more information on the Federal Reserve founding, see The Federal Reserve Act: Its Origin and Prin-
ciples, available on the Federal Reserve Bank of St. Louis website (https://fraser.stlouisfed.org/docs/
publications/books/fra_owen_1919.pdf).
50 The Fed Explained: What the Central Bank Does
These vulnerability assessments inform internal Federal Reserve discussions concerning both
macroprudential supervision and regulatory policies, as well as monetary policy (figure 4.2). They
also inform Federal Reserve interactions with broader monitoring efforts, such as those by the
Financial Stability Oversight Council (FSOC) and the Financial Stability Board (FSB).
Asset Valuations and Risk Appetite
Elevated asset valuations constitute a fundamental vulnerability because the unwinding of high
prices can be destabilizing in the financial system and economy, especially if the assets are widely
held and the values are supported by excessive leverage, maturity transformation, or risk opacity.
Moreover, stretched asset valuations may be an indicator of a broader buildup in risk-taking.
However, it is very difficult to judge whether an
asset price is over valued relative to fundamen-
tals. As a result, analysis typically considers a
range of possible valuation metrics, develop-
ments in areas where asset prices are rising
especially rapidly or into which investor flows
have been considerable, or the implications
of unusually low or high levels of volatility in
certain markets.
Assessing resilience of the U.S. financial system
The Financial Stability Report assesses the resilience
of the U.S. financial system. Through the report, the
Board intends to inform the public of U.S. financial
stability and increase transparency and accountabil-
ity of the assessments. The report is available on
the Federal Reserve Board’s website (https://www.
federalreserve.gov/publications/financial-stability-
report.htm).
Figure 4.2. Four standard components of financial system vulnerability review
Four vulnerability assessments inform the broad efforts undertaken by the Federal Reserve—with entities both in
the United States and abroad—to monitor financial system stability.
Asset valuations and
risk appetite
The “unwinding” of
high prices of assets
(e.g., housing prices
in the mid-2000s) can
destabilize the
financial system and
the economy
Funding
risk
Traditional banks,
money market funds,
and exchange-traded
funds are among the
institutions that might
experience a “run” by
investors that
amplifies an
economic downturn
Borrowing by
businesses and
households
If credit exposure in
U.S. households and
nonfinancial
businesses is high,
these borrowers often
curtail spending and
disengage from other
economic activity and
may contribute to a
severe downturn
Financial system
leverage
Financial system
intermediaries (such
as traditional banks,
insurance companies,
and hedge funds) with
significantly more
debt than equity can
amplify an economic
downturn
Source: Financial Stability Report, “Overview,” May 2019 (available on the Federal Reserve Board’s website at https://www.
federalreserve.gov/publications/2019-may-financial-stability-report-overview.htm).
Promoting Financial System Stability 51
Leverage in the Financial System
Highly leveraged financial system intermediaries—those with significantly more debt than equity—
can amplify the effect of negative shocks in the financial system and broader economy (figure 4.3).
For example, if a highly leveraged institution needs to shrink its balance sheet in response to an
otherwise standard economic downturn, the resulting contraction in credit will have broader eco-
nomic implications. Moreover, sufficiently large losses for highly leveraged institutions can lead to
“fire sales,” where assets are unloaded quickly at extremely low prices. Fire sales, in turn, increase
the potential for runs on banks—and even on nonbanks—if liabilities have short maturities.
The Federal Reserve monitors leverage in the banking sector with the help of an extensive data
collection program. Monitoring efforts include the Dodd-Frank Act stress tests for large banking
Figure 4.3. Monitoring leverage in the financial system
The collective financial strength of the banking sector—and its prevailing activities—can be an important indicator in
understanding risks to the nation’s financial stability. The Federal Reserve focuses on metrics, such as the ratio of
common equity to risk-weighted assets in the banking sector, which has risen post-crisis as a reflection of tougher
capital standards for major banking institutions
Percent
0
2
4
6
8
10
12
14
16
18
2019
Q1
2017
Q1
2015
Q1
2013
Q1
2011
Q1
2009
Q1
2007
Q1
2005
Q1
2003
Q1
2001
Q1
1999
Q1
1997
Q1
Total (tier 1 + tier 2)
Common equity tier 1 ratio
Leverage ratio*
Note: Prior to 2014:Q1, the numerator of the common equity tier 1 ratio is tier 1 common capital. Beginning in 2014:Q1 for
advanced-approaches bank holding companies (BHCs) and in 2015:Q1 for all other BHCs, the numerator is common equity tier 1
capital. The data for the common equity tier 1 ratio start in 2001:Q1. As of 2019, an advanced-approaches BHC is defined as a
large internationally active banking organization, generally with at least $700 billion in total consolidated assets or at least $75
billion in total on-balance-sheet foreign exposure. The shaded bars indicate periods of business recession as defined by the National
Bureau of Economic Research.
* Leverage ratio is the ratio of tier 1 capital to total assets.
Source: Federal Reserve Board, FR Y-9C, Consolidated Financial Statements for Holding Companies.
52 The Fed Explained: What the Central Bank Does
institutions and the Financial Stability Report for all banks as well as the overall financial sector.
Additionally, periodic surveys of nonbank providers of leverage through the Senior Credit Officer
Opinion Survey offer valuable insights on nonbank financial leverage.
Funding Risk and Maturity Transformation by the Financial System
One key benefit provided by the financial system is to transform short-maturity (or liquid) liabilities
into long-maturity (illiquid) assets. This function is done primarily through the traditional banking
system or other depository institutions, but it also occurs outside the banking system, for exam-
ple, through money market mutual funds.
Liquidity and maturity transformation is productive in the sense that it allows investment projects
to be funded with long-term financing while still satisfying the liquidity needs of lenders. However,
as seen during the 2007–09 financial crisis, the mismatch between long-term assets and short-
term funding creates systemic vulnerabilities that can threaten the broader economy (see box 4.2,
“Responding to Financial System Emergencies”).
When a systemwide shock results in all lend-
ers demanding liquidity at the same time, insti-
tutions engaged in this maturity transformation
are at risk of being run. Deposit insurance
provides protection within the traditional bank-
ing system. Nevertheless, some assets such
as repurchase agreements (or “repos”), asset-
backed commercial paper, or money market
funds are also subject to run risk and, indeed, came under considerable pressure during the cri-
sis. For this reason, the Federal Reserve actively monitors, as best it can given available data and
measurement, both liquidity risk and the degree of maturity transformation in the financial system.
Borrowing by Businesses and Households
Excessive credit in the private nonfinancial sector can provide a transmission channel for a disrup-
tion in financial markets to affect the real economy (figure 4.4). Highly indebted households and
nonfinancial businesses may have a difficult time withstanding negative shocks to incomes or
asset values, and may be forced to curtail spending in ways that amplify the effects of financial
shocks. In turn, losses among households and businesses can lead to mounting losses at finan-
cial institutions, creating an adverse feedback loop. The Federal Reserve monitors measures of
vulnerabilities in the nonfinancial sector, including, for example, leverage and debt service burdens
as well as underwriting standards on new loans to households and businesses.
Monitoring leverage in the nonbank sector
The Federal Reserve’s quarterly Senior Credit Officer
Opinion Survey on Dealer Financing Terms provides
information about the availability and terms of credit
in securities financing and over-the-counter derivatives
markets. See the Board's website at https://www.
federalreserve.gov/data/scoos.htm.
Promoting Financial System Stability 53
This monitoring program is complemented by a broader effort to foster greater transparency in fi-
nancial markets through improved data collec tion and enhanced disclosures by regulated financial
market participants.
Greater transparency helps lead to meaningful implementation of macroprudential regulatory and
supervisory policies. These policies are meant to address market vulnerabilities before they be-
come critical issues and to pre-position the financial system to be better able to absorb shocks.
Why Proactive Monitoring of Domestic and Foreign Markets Matters
The changing nature of risks and fluctuations in financial markets and the broader economy
require timely monitoring of domestic and foreign financial markets and their effect on financial
institutions. They also require monitoring of the nonfinancial sector to identify buildups of vulner-
abilities that might require further study or policy action.
To this end, the Federal Reserve maintains
a flexible, forward-looking financial stability
monitoring program to help inform policymak-
ers of the financial system’s vulnerabilities to
a range of potential adverse events or shocks.
Such a monitoring program is a critical part
of a broader Federal Reserve System effort to
assess and address vulnerabilities in the U.S.
financial system. In the case of individual in-
stitutions, the Federal Reserve may take more
direct action and in various ways (for more information, see “How the Federal Reserve Regulates
Financial Institutions” on page 75 in section 5, “Supervising and Regulating Financial Institutions
and Activities”).
Examining Causes, Effects, and Remedies for Financial Instability
A macroprudential approach to ensuring financial stability builds on a substantial and growing
body of research on the factors that lead to vulnerabilities in the financial system and how govern-
ment policies can mitigate such risks.
The Federal Reserve actively engages in financial stability research to improve understanding of
issues related to financial stability and to engage with the broader research community on crucial
policy matters. This engagement often involves collaboration with researchers at other domestic
and international institutions.
Microprudential supervision and regulation
The Federal Reserve also “microprudentially” super-
vises and regulates the operations of large financial
institutions—that is, it monitors the safety and sound-
ness of these and other individual institutions—and
integrates this monitoring into its macroprudential
supervisory and regulatory efforts.
For more information, see section 5, “Supervising and
Regulating Financial Institutions and Activities,” on
page62.
54 The Fed Explained: What the Central Bank Does
Box 4.2. Responding to Financial System Emergencies
The idea that a central bank should provide liquidity to support the financial system was refined by
nineteenth-century economist Walter Bagehot, who suggested that during times of financial panic
or crisis, a central bank should lend quickly and freely, at a penalty rate of interest, to any borrower
with good collateral.
When a major shock—like a natural disaster, a terrorist attack, or a financial panic—occurs that
severely stresses the financial system, people, businesses, and financial institutions need access to
money and credit. Indeed, having this liquidity available can improve confidence in the economy and
restore calm to markets, bolstering the stability of the financial system.
General authority during times of crisis. To provide liquidity during times of crisis, the Federal Re-
serve—like many central banks—is empowered to function as a “lender of last resort” (LOLR), and it
uses different tools to fulfill this role.
In an emergency, the Federal Reserve has the power to provide liquidity to depository institutions using
standard, traditional tools, like open market operations and discount window lending. Under section
13(3) of the Federal Reserve Act, the U.S. central bank also has authority to provide liquidity to nonde-
pository institutions in “unusual and exigent circumstances.” Although the Federal Reserve has rarely
exercised this LOLR clause enacted in 1932, it did use it during the 2007–09 financial crisis, as well
as during the coronavirus disease COVID-19 pandemic, to prevent harm to the U.S. economy.
Broad-based lending only. Under amendments enacted under the Dodd-Frank Act, emergency lending
programs under section 13(3) of the Federal Reserve Act must be broad-based and not designed to
support a single institution, among other requirements. In addition, Congress requires that the Federal
Reserve ensure that taxpayers are protected against losses. Consistent with this, actions taken under
section 13(3) authority are taken with the approval of the Treasury secretary.
For a fuller discussion of how each of these lending tools works, see section3, “Conducting Monetary
Policy,” on page 16.
Special Programs Implemented by the Fed Due to "Unusual and Exigent" Circumstances
In the spring of 2020, in response to the COVID-19 shock, the Federal Reserve established a number
of emergency lending programs designed to support the credit needs of households and businesses.
These programs led to significant changes to the Federal Reserve’s balance sheet.
Emergency lending facilities Expanded open market operations
• Primary Dealer Credit Facility
• Commercial Paper Funding
Facility
• Money Market Mutual Fund
Liquidity Facility
• Commercial Paper Funding
Facility
• Main Street Lending Program
• Municipal Liquidity Facility
• Paycheck Protection Program
Lending Facility
• Term Asset-Backed Securities
Loan Facility
• Primary Market Corporate
Credit Facility
• Secondary Market Corporate
Credit Facility
Expanding its traditional tool of
open market operations allowed
the Federal Reserve to support
the functioning of credit markets,
put downward pressure on longer-
term interest rates, and help to
make broader financial conditions
more accommodative through the
purchase of longer-term securities
for its portfolio.
Source: Federal Reserve Credit and Liquidity Programs and the Balance Sheet, Crisis Response. See the Monetary Policy section of
the Federal Reserve Board’s website, https://www.federalreserve.gov/monetarypolicy.htm. See also the COVID-19 Resources page
of the Federal Reserve Board’s website, https://www.federalreserve.gov/funding-credit-liquidity-and-loan-facilities.htm.
Promoting Financial System Stability 55
Macroprudential Supervision and Regulation of Large,
Complex Financial Institutions
Large, complex financial institutions interact with financial markets and the broader economy in a
manner that may—during times of stress and in the absence of an appropriate regulatory frame-
work and effective supervision—lead to financial instability. The Federal Reserve promotes the
safety and soundness of these institutions through robust supervision and regulation programs,
two components of which are integral to its macroprudential efforts.
Monitoring Systemically Important Financial Institutions
The macroprudential approach informs Federal Reserve supervision of systemically important
financial institutions (SIFIs)—including large bank holding companies, the U.S. operations of cer-
tain foreign banking organizations, and financial market utilities. In addition, the Federal Reserve
serves as a “consolidated supervisor” of nonbank financial companies that the FSOC has deter-
mined should be supervised by the Federal Reserve Board and subject to prudential standards.
(See “Domestic and International Cooperation and Coordination” on page 57 for more information
on the FSOC.)
Figure 4.4. Monitoring borrowing in the nonfinancial sector
Borrowing by households and nonfinancial sector businesses can also influence financial stability. The Federal
Reserve focuses on metrics, such as the ratio of household and nonfinancial business credit to nominal U.S. gross
domestic product. This ratio has dropped below peaks reached around the time of the 2007–09 crisis.
Household
Business
Total
Ratio
0
.2
.4
.6
.8
1.0
1.2
1.4
1.6
1.8
1980
Q1
1983
Q1
1986
Q1
1989
Q1
1992
Q1
1995
Q1
1998
Q1
2001
Q1
2004
Q1
2007
Q1
2010
Q1
2013
Q1
2016
Q1
2019
Q1
Note: The shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research.
Source: Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States.”
56 The Fed Explained: What the Central Bank Does
The Federal Reserve actively monitors indicators of the riskiness of SIFIs, both individually as well
as through interlinkages in the broader network of financial institutions, to help identify vulner-
abilities. It also imposes certain regulatory requirements on SIFIs in order to limit potentially risky
activities by these institutions and to mitigate spillover of distress into the broader economy. If a
SIFI were to become distressed, disruptions in the financial system could arise from direct losses
imposed on SIFI counterparties, contagion, fire sales, or a loss of critical services.
SIFIs are also subject to additional capital and
liquidity regulations imposed by the Federal
Reserve in order to help mitigate some of the
additional risks they pose to the financial sys-
tem as a whole, given their size and intercon-
nectedness.
Moreover, during the 2007–09 financial crisis,
the lack of effective resolution strategies con-
tributed to the pernicious spillovers of distress
at or between individual institutions and from
those institutions to the broader economy. The Federal Reserve, in collaboration with other U.S.
agencies, has continued to work with large financial institutions to develop a range of recovery and
resolution strategies in the event of their distress or failure. Improvements in resolution planning
are intended to, among other things, mitigate adverse effects from perceptions of “too big to fail”
and contribute to more orderly conditions in the financial system if institutions face strains or fail.
(For more information on recovery and resolution planning activity, see section 5, “Supervising and
Regulating Financial Institutions and Activities,” on page 62.)
Stress Testing of Key Financial Institutions
One important element of enhanced supervision of SIFIs is the stress testing process, which
includes the Dodd-Frank Act stress tests and the stress capital buffer rule. In addition to fostering
the safety and soundness of the participating institutions, the stress test program includes macro-
prudential elements such as
• examination of the loss-absorbing capacity
of institutions under a common macroeconomic
scenario that has features similar to the strains
experienced in a severe recession and which
includes, as appropriate, identified salient
risks;
Countercyclical Capital Buffer
The Countercyclical Capital Buffer (CCyB) is an ele-
ment of the Federal Reserve’s regulatory toolkit. It is
a macroprudential tool designed to support lending
and economic activity when economic conditions de-
teriorate. It augments minimum capital requirements
when there is an elevated risk of above-normal losses,
thus making capital requirements countercyclical, as
required by the Dodd-Frank Act.
For more information, see https://www.
federalreserve.gov/newsevents/pressreleases/
bcreg20160908b.htm.
“Stress testing” of large financial institutions
In 2020, 33 institutions participated in the Federal
Reserve stress testing process, which occurs an-
nually. For more information, see the “Stress Tests
and Capital Planning” web page, located on the
Board’s website (https://www.federalreserve.gov/
bankinforeg/stress-tests-capital-planning.htm).
Promoting Financial System Stability 57
• conducting horizontal testing across large institutions to understand the potential correlated
exposures; and
• consideration of the effects of counterparty distress on the largest, most interconnected firms.
The macroeconomic and financial scenarios that are used in the stress tests have proved to be an
important macroprudential tool. The Federal Reserve adjusts the severity of the macroeconomic
scenario used in the stress tests in a way that
counteracts the natural tendency for risks to
build within the financial system during periods
of strong economic activity. The scenarios can
also be used to assess the financial system’s
vulnerability to particularly significant risks and
to highlight certain risks to institutions partici-
pating in the testing.
Intersection of Financial Stability and Monetary Policy
Promotion of financial stability strongly complements the primary goals of monetary policy—maxi-
mum employment and price stability. Asmoothly operating financial system promotes the efficient
allocation of savings and investment, facilitating economic growth and employment. And price
stability contributes not only to the efficient allocation of resources in the real economy (that is,
the part of the economy that produces goods and services), but also to reduced uncertainty and
efficient pricing in financial markets that, in turn, supports financial stability.
Domestic and International Cooperation and Coordination
Economic and financial volatility in any country can have negative consequences for the world, but
sizable and significant spillovers are almost assured from an economy that is large.
In its role promoting financial stability, the Federal Reserve cooperates and coordinates with many
other domestic and international regulatory and policy entities. The FSOC is an important forum
for cooperation with other domestic agencies (figure 4.5). The primary venues for international
cooperation occur through the Basel Committee on Banking Supervision and the FSB.
Domestic Engagement through the Financial Stability
Oversight Council
The FSOC, created in 2010 under the Dodd-Frank Act and chaired by the U.S. Treasury Secretary,
draws on the expertise of the Federal Reserve and other regulators to proactively identify risks to
financial stability, promote market discipline, and respond to emerging threats. The Chair of the
Financial stability policy and research
The Federal Reserve works to identify threats to finan-
cial stability and develop effective policies to address
those threats through its Division of Financial Stability.
This division monitors financial markets, institutions,
and structures and also conducts research on finan-
cial stability issues. For more information, see the
complete list of Federal Reserve Board working papers
(https://www.federalreserve.gov/financial-stability.htm).
58 The Fed Explained: What the Central Bank Does
Figure 4.5. The framework for monitoring U.S. financial system stability
The Financial Stability Oversight Council(FSOC), a blend of federal and state regulators, meets routinely to
coordinate on financial stability topics that might affect the U.S. economy and makes publicly available its meeting
minutes, annual report, and various other studies and statements. For more information, see the FSOC website
(https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/fsoc).
1
Non-voting member serves two-year term.
2
Non-voting member.
Federal Reserve Board
Chair
FSOC Chair
(Secretary
of the Treasury)
Commodity Futures Trading
Commission Chairperson
Comptroller of the
Currency
Consumer Financial
Protection Bureau Director
National Credit Union
Administration Chairman
Federal Deposit
Insurance Corporation
Chairperson
Federal Housing
Finance Agency
Director
Insurance
expert
(presidential
appointee;
Senate-confirmed for a
six-year term)
Securities
and Exchange
Commission
Chairman
Director
of the Federal
Insurance Office
2
(Department
of the Treasury)
Director of the Office of
Financial Research
2
(Department of the Treasury)
State banking supervisor
1
(designated by the
state banking supervisors)
State insurance
commissioner
1
State securities
commissioner or
officer
1
(designated by the
state securities
commissioners)
(designated by the
state insurance
commissioners)
Financial
Stability
Oversight
Council
Promoting Financial System Stability 59
Federal Reserve is a member of the FSOC, and
the Federal Reserve works to support the ac-
tivities of the FSOC and other U.S. government
agencies in the pursuit of financial stability.
Through collaborative participation in the
FSOC, U.S. financial regulators monitor not
only institutions but the financial system as a
whole. The Federal Reserve plays an important role in this macroprudential framework: it assists
in monitoring financial risks, analyzes the implications of those risks for financial stability, and
identifies steps that can be taken to mitigate those risks.
Engagement with Regulatory Authorities Abroad
The Federal Reserve participates in international bodies, such as the Basel Committee on Banking
Supervision and the FSB, to address issues
associated with the interconnected global
financial system and the global activities of
large U.S. financial institutions (figure 4.6).
Through both venues, the Federal Reserve is
engaged with the international community in
monitoring the global financial system and pro-
moting the adoption of sound policies across
countries.
Regular reporting on FSOC activities
The Financial Stability Oversight Council (FSOC) meets
routinely to coordinate on financial stability topics that
might affect the U.S. economy and publishes both its
monthly meeting minutes and annual report. For more
information, see the FSOC website (https://home.
treasury.gov/policy-issues/financial-markets-financial-
institutions-and-fiscal-service/fsoc).
Central banks around the world
The central bank concept dates to 1668 when Swe-
den’s Riksbank was formed.
As of June 2019, there were 179 central banks and
monetary authorities around the world, and the Fed-
eral Reserve interacts with many of them in its efforts
to promote financial stability in the U.S. and global
economies.
See https://www.bis.org/cbanks.htm for a listing of
central banks.
60 The Fed Explained: What the Central Bank Does
Figure 4.6. Monitoring financial system stability requires global cooperation
What happens in the global economy can influence—sometimes greatly—the stability of the U.S. economy. Because
the U.S. dollar is a widely used global currency and because the world’s economies are interdependent, the Federal
Reserve works closely with central banks and other public authorities around the world to address international
financial issues and promote financial stability.
International authority/
deliberative body
Overview/Federal Reserve engagement
Financial Stability Board
Established: 2009
Location: Basel, Switzerland
Website: https://www.fsb.org
The Financial Stability Board (FSB), successor to the Financial Stability Forum, promotes stability
in the international financial system through enhanced cooperation among various national and
international supervisory bodies and international financial institutions. The Federal Reserve Board and
other U.S. agencies participate in FSB efforts, which specifically seek to coordinate the development
of regulatory, supervisory, and other financial sector policies.
Central banks
Established: 1668 or later
Location: Throughout the world
Website: https://www.bis.org/central_bank_hub_
overview.htm
Nearly all developed and developing nations maintain central banks to promote a sound and stable
financial system and well-functioning economies. Indeed, Federal Reserve officials engage regularly
and collectively with other central banks to discuss broad trends affecting the global financial system;
one-on-one bank engagement also occurs in special circumstances where coordination and coopera-
tion can help keep the global financial system operating smoothly.
Bank for International Settlements
Established: 1930
Location: Basel, Switzerland
Website: https://www.bis.org
The Bank for International Settlements seeks, among other things, to foster discussion and facilitate
collaboration among central banks and supports dialogue with other authorities that are responsible
for promoting financial stability. The Federal Reserve participates in the deliberations of this financial
organization, whose members include 60 member central banks, representing countries from around
the world that together make up about 95 percent of world gross domestic product.
G7 & G20
Established: 1975 (as G6)
Location: Varies by nation hosting
Website: Varies by nation hosting
The Group of Seven (G7) is an informal bloc of industrialized democracies (also including Canada,
France, Germany, Italy, Japan, and the United Kingdom) that meets annually to discuss global eco-
nomic issues. Federal Reserve officials engage regularly with the G7 and G20 to discuss macroeco-
nomic policy surveillance, the international financial system, and a wide range of policy issues, such as
development and policy proposals to encourage strong, sustainable, and balanced growth.
International Monetary Fund
Established: 1945
Location: Washington, D.C.
Website: https://www.imf.org
The International Monetary Fund (IMF) works to “foster global monetary cooperation, secure financial
stability, facilitate international trade, promote high employment and sustainable economic growth,
and reduce poverty around the world.” The Federal Reserve is a member of the International Monetary
and Financial Committee, which advises and reports to the IMF Board of Governors on the supervision
and management of the international monetary and financial system, including on responses to
unfolding events that may disrupt the system.
Organisation for Economic
Co-operation and Development
Established: 1961
Location: Paris, France
Website: https://www.oecd.org
The Organisation for Economic Co-operation and Development (OECD) promotes “policies that
will improve the economic and social well-being of people around the world.” The Federal Reserve
participates in several OECD forums to discuss current economic issues and projections for the global
economic outlook, and to promote policies that will improve global economic well-being.
World Bank
Established: 1944
Location: Washington, D.C.
Website: https://www.worldbank.org
The World Bank functions as a cooperative of 189 member countries. These member countries, or
shareholders, are represented by a board of governors, who are the ultimate policymakers at the World
Bank. Generally, the governors are member countries’ ministers of finance or ministers of develop-
ment. The Federal Reserve interacts informally with the World Bank, largely through the International
Monetary Fund.
62 The Fed Explained: What the Central Bank Does
5
Supervising and Regulating
Financial Institutions and
Activities
The Federal Reserve promotes the safety and
soundness of individual financial institutions and
monitors their impact on the financial system as a
whole.
Overview of the Federal Reserve’s Financial Institution Oversight ..63
How the Federal Reserve Supervises Financial Institutions ......69
How the Federal Reserve Regulates Financial Institutions .......75
Supervising and Regulating Financial Institutions and Activities 63
The Federal Reserve regulates and supervises financial institutions to ensure that they operate
safely. In addition, the Federal Reserve monitors the financial system as a whole by identifying and
analyzing potential risks to financial institutions, the broader financial system, and the economy. A
safe, sound, and efficient banking and financial system contributes to a strong economy.
Overview of the Federal Reserve’s Financial
Institution Oversight
The Federal Reserve engages in a range of activities to promote a safe and sound financial sys-
tem. It does this through the distinct, but complementary, activities of regulation and supervision
(see figure5.1). Regulation entails establishing the rules within which financial institutions must
operate—in other words, issuing specific rules and guidelines governing the formation, operations,
activities, and acquisitions of financial institutions. Once the rules and regulations are estab-
lished, supervision—which involves monitoring and examining financial institutions—seeks to
ensure that an institution complies with those rules and regulations, and that it operates in a safe
and sound manner.
Figure 5.1. How the regulation and supervision process works
When Congress passes a law that impacts the financial industry, the Federal Reserve—sometimes in cooperation
with other federal agencies—often issues regulations that determine how the law will be implemented.
REGULATION
CONGRESS
votes to approve
legislation; President
signs into law
CONGRESS
votes to approve
legislation; President
signs into law
FEDERAL RESERVE
BOARD
drafts, proposes, and
invites public comment
on regulations that
specify how laws are
implemented
AMERICAN PUBLIC
institutions, individuals,
and others review
proposed regulations
and respond with
comments and
suggestions
AMERICAN PUBLIC
institutions, individuals,
and others review
proposed regulations
and respond with
comments and
suggestions
FEDERAL RESERVE
considers public input,
finalizes regulations,
and issues and
disseminates final
regulations publicly,
including rationale
for actions
FEDERAL RESERVE
BOARD
considers public input,
finalizes regulations,
and issues and
disseminates final
regulations publicly,
including rationale
for actions
SUPERVISION
FEDERAL RESERVE
issues and disseminates
publicly the procedures
Reserve Bank examiners
will use to evaluate
institutions’ compliance
with laws and
regulations
FEDERAL RESERVE
BOARD
issues and disseminates
publicly the procedures
Reserve Bank examiners
will use to evaluate
institutions’ compliance
with laws and
regulations
REGULATED
INSTITUTIONS
implement internal
practices to ensure that
they are in compliance
with regulations
REGULATED
INSTITUTIONS
implement internal
practices to ensure that
they are in compliance
with regulations
FEDERAL RESERVE
EXAMINERS
conduct on- and off-site
examinations/inspections
of regulated institutions
to determine their
compliance with
regulations
FEDERAL RESERVE
EXAMINERS
conduct on- and off-site
examinations/inspections
of regulated institutions
to determine their
compliance with
regulations
FEDERAL RESERVE
BANKS
train examiners to
evaluate institutions’
compliance with
regulations
FEDERAL RESERVE
BANKS
train examiners to
evaluate institutions’
compliance with
regulations
64 The Fed Explained: What the Central Bank Does
Entities the Federal Reserve Oversees
By law, the Federal Reserve is responsible for supervising and regulating certain segments of the
financial industry to ensure they employ safe and sound business practices and comply with all
applicable laws and regulations (figure5.2).
Figure 5.2. The Federal Reserve oversees a broad range of financial entities
Bank holding companies constitute the largest segment of institutions supervised by the Federal Reserve, but the
Federal Reserve also supervises state member banks, savings and loan holding companies, foreign banks operating
in the United States, and other entities.
(Number of
institutions/entities,
year-end 2020)
Bank holding companies
(3,413)
State
member
banks
(734)
Designated
financial market
utilities
3
(8)
State member
banks’ foreign
branches (47)
Edge Act and
agreement
corporations
2
(35)
Foreign banking
organizations operating
in the U.S.
1
(160)
Domestic
financial holding
companies
(556)
Savings and
loan holding
companies
(328)
1
Foreign banking organizations primarily operate in the U.S. through branches, agencies, and representative offices, as well
as through state member banks, U.S. intermediate and bank holding companies, and Edge Act and agreement corporations.
2
Edge Act and agreement corporations are subsidiaries of banks or bank holding companies, organized to allow international bank-
ing and financial business.
3
Financial market utilities (FMUs) are multilateral systems that provide the essential infrastructure for transferring, clearing, and
settling payments, securities, and other financial transactions among financial institutions or between financial institutions and
within those systems. The Federal Reserve supervises FMUs, including those that have been designated systemically important
by the Financial Stability Oversight Council.
Note: Entities supervised are not mutually exclusive; for example, bank and savings and loan holding companies may own other
supervised entities listed.
For more information, see the “Supervision and Regulation” section of the Board’s 2020 Annual Report, https://www.federalreserve.
gov/publications/annual-report.htm.
Bank Holding Companies (Including Financial Holding Companies)
Banks are often owned or controlled by another company, called a bank holding company (BHC).
The Federal Reserve has supervisory and regulatory authority for all BHCs, regardless of whether
subsidiary banks of the holding company are national banks, state “member” banks, or state
“nonmember” banks (see a complete discussion of “State Member Banks” beginning on page
65). It also has supervisory authority over any nonbank subsidiary of a BHC that is not functionally
regulated by another federal or state regulator, such as a leasing subsidiary.
Supervising and Regulating Financial Institutions and Activities 65
BHCs that meet certain criteria are permitted to become financial holding companies (FHCs, also
under Federal Reserve supervisory and regulatory authority). These entities may own nonbank
companies, including merchant banking investments and entities that engage in other activities,
such as securities underwriting and dealing, insurance underwriting, and insurance agency ac-
tivities. The Federal Reserve coordinates its supervisory efforts with the functional regulator of
nonbank subsidiaries, such as the U.S. Securities and Exchange Commission (SEC) in the case of
a broker-dealer, and state insurance regulators in the case of an insurance company.
State Member Banks
The Federal Reserve is the primary federal supervisor of state-chartered banks that have chosen to
join the Federal Reserve System. Such domestically operating banks are called “state member banks.”
The primary federal supervisor of a domestic bank (figure5.3) is generally determined by two key
factors: (1) whether the bank chooses to operate under a federal or state charter and (2) whether
the bank is a member of the Federal Reserve System.
Figure 5.3. Oversight of the financial industry is shared among federal regulators
The primary supervisor of a domestic banking organization is generally determined by the type of institution it is and
the governmental authority that granted it permission to commence business.
Certain
“systemically
important”
financial
market
utilities
(FMUs)
“Systemically
important”
nonbank
financial
institutions
(SIFIs)
Edge Act &
agreement
corporations
Federal credit
unions
1
Savings &
loan holding
companies
Federal
savings
associations
Nonbanking
subsidiaries
State-
chartered
savings
associations
FBO
branches
in the U.S.
FBO
agencies
in the U.S.
FBO
representative
offices in
the U.S.
FBO
nonbanking
activities
in the U.S.
Federal
branches &
agencies of
FBOs
Foreign banking
organizations
(FBO) operating
in the U.S.
Foreign
branches of
member
banks
State-
chartered
member
banks
State-
chartered
nonmember
banks
National
banks
Bank holding
companies
Nonbanking
subsidiaries
Note: Figure 5.3 focuses on the federal banking regulators. Other federal regulators oversee the financial industry as well, including
the Securities and Exchange Commission, the Commodities Futures Trading Commission, and the Consumer Financial Protection
Bureau, among others.
1
Federal credit unions are not considered part of the banking industry, but offer similar if more limited services than banks.
66 The Fed Explained: What the Central Bank Does
Banks chartered by a state government entity are referred to as state banks; banks that are char-
tered by the Office of the Comptroller of the Currency (OCC), an independent bureau of the U.S.
Department of the Treasury, are referred to as national banks.
State banks that are not members of the Federal Reserve System (collectively referred to as
“state nonmember banks”) are supervised by the Federal Deposit Insurance Corporation (FDIC). In
addition to being supervised by the Federal Reserve or the FDIC, state banks are also supervised
by their chartering state. In contrast, the OCC supervises national banks that choose to charter at
the federal level.
U.S. Banks’ International Operations
The Federal Reserve has supervisory and regulatory responsibility for the international operations
of state member banks and BHCs (figure5.4). These responsibilities include
• authorizing the establishment of foreign branches of national banks and state member banks,
and regulating the scope of their activities;
• chartering and regulating the activities of Edge Act and agreement corporations (as noted be-
low, specialized institutions used for international and foreign business);
• authorizing the foreign investments of member banks, Edge Act and agreement corporations,
and BHCs, and regulating the activities of foreign firms acquired by such investors; and
• establishing supervisory policies and practices regarding foreign lending by state member
banks.
Figure 5.4. U.S. banks operate globally
The Federal Reserve is responsible for examining the international operations of member banks and bank holding
companies. These banking organizations do business in more than 80 countries on six continents.
North
America
South
America
Africa
Europe
Asia
Australia
Note: For more information on the international activities of U.S. banking organizations, see the “Supervision and Regulation”
section of the Board’s Annual Report, https://www.federalreserve.gov/publications/annual-report.htm. Also see the E.16 statistical
release: “Country Exposure Lending Survey and Country Exposure Information Report,” https://www.ffiec.gov/E16.htm.
Supervising and Regulating Financial Institutions and Activities 67
U.S. banking organizations may conduct a wide range of overseas activities. The Federal Reserve
has broad discretionary powers to regulate the foreign activities of state member banks and BHCs
so that, in financing U.S. trade and investments abroad, these U.S. banking organizations can be
competitive with institutions of the host country without compromising the safety and soundness
of their global or U.S. operations.
Consistent with the principle of risk-focused supervision, the Federal Reserve conducts examina-
tions of the international operations of state member banks, Edge Act and agreement corpora-
tions, and BHCs as a component of its overall assessment of the financial, operational, and
compliance risks of supervised institutions
and the risk-management processes and
procedures to control such risks. The Federal
Reserve conducts examination activities of
international operations both at the U.S. head
offices of supervised institutions and abroad.
Examinations conducted abroad are done with
the cooperation of host-country supervisors.
Foreign Banks’ U.S. Operations
The International Banking Act of 1978 (IBA) created a federal regulatory structure for the activities
of foreign banks with U.S. branches and agencies. The IBA also 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 generally gives foreign banking organizations
operating in the United States the same powers as U.S. banking organizations and subjects them
to the same restrictions and obligations that apply to the domestic operations of U.S. banking
organizations.
The Foreign Bank Supervision Enhancement Act of 1991 increased the responsibility and the
authority of the Federal Reserve to regularly examine the U.S. operations of foreign banks. The
Federal Reserve coordinates the supervisory program for the U.S. operations of foreign banking
organizations with other federal and state banking agencies. Since a foreign banking organization
may have both federally chartered/licensed and state-chartered/licensed offices in the United
States and nonbanking operations, the Federal Reserve plays a key role in assessing the condition
of the organization’s entire U.S. operations and the foreign banking organization’s ability to sup-
port its U.S. operations.
A foreign banking organization with U.S. non-branch assets of $50 billion or more is required to
establish an intermediate holding company (IHC) over its U.S. subsidiaries. IHCs are generally
subject to requirements that are consistent with those that apply to U.S. BHCs.
Bank charters affect which agency supervises
The current U.S. supervisory system for banks, in
which an institution may be either federally or state-
chartered, and may belong to the Federal Reserve
System or not, has evolved historically. The Federal
Reserve shares supervisory and regulatory responsi-
bility for domestic banks with other federal regulators
and with individual state banking departments.
68 The Fed Explained: What the Central Bank Does
Edge Act and Agreement Corporations
Edge Act and agreement corporations are U.S. financial institutions that carry out international
banking and financing operations, some of which the parent banks themselves are not permitted
to undertake under existing laws. These corporations, which are examined annually, may act as
holding companies, provide international banking services, and finance industrial and financial
projects abroad, among other activities.
Savings and Loan Holding Companies
Savings and loan holding companies (SLHCs)
directly or indirectly control either a savings
association or another SLHC. Savings associa-
tions can choose either a federal or a state
charter. Federally chartered savings associa-
tions are supervised by the OCC, while state-
chartered savings associations are generally
supervised by the FDIC and their chartering
state. The Federal Reserve supervises and regulates all SLHCs regardless of the charters of the
subsidiary savings associations. As with BHCs, an SLHC that meets certain criteria may also elect
to be treated as an FHC.
Certain Insurance Holding Companies
The Federal Reserve is responsible for the consolidated supervision of insurance holding compa-
nies that are SLHCs. While the activities of insurance companies may differ from the activities of
state member banks and BHCs, the Federal Reserve’s principal supervisory objectives for insur-
ance holding companies remain protecting the safety and soundness of the consolidated firms
and their subsidiary depository institutions. To achieve these objectives, the Federal Reserve
coordinates supervisory activities with state insurance regulators, who continue to have oversight
of insurance legal entities.
Financial Market Utilities
Financial market utilities (FMUs) and financial institutions participating in payment, clearance, and
settlement (PCS) activities comprise the nation’s financial infrastructure. This infrastructure sup-
ports millions of financial transactions every day and encompasses many transactional elements:
large-value PCS systems for financial transactions, including central counterparties, foreign-
exchange settlement systems, and large-dollar funds transfer systems. The smooth and reliable
functioning of this financial infrastructure at all times is vitally important to the stability of the
financial system and the health of the broader economy.
Finding data on institutions supervised by the
Federal Reserve
The National Information Center (https://www.ffiec.
gov/NPW) is a repository, maintained by the Federal Fi-
nancial Institutions Examination Council, that provides
data about banks and other institutions, including both
domestic and foreign banking organizations operating
in the United States.
Supervising and Regulating Financial Institutions and Activities 69
For more information on regulation and supervision of the payment and settlement system, see
“Regulating and Supervising the Payment System” on page 104.
Nonbank Financial Companies
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act)
assigned the Federal Reserve the authority and responsibility to supervise and regulate certain
nonbank financial companies that the Financial Stability Oversight Council (FSOC) has determined
should be subject to Board supervision and prudential standards.
These firms—whose failure could pose a threat to U.S. financial stability—are subject to com-
prehensive, consolidated supervision and regulation by the Federal Reserve. This provision of the
Dodd-Frank Act addresses an important regulatory gap that existed before the 2007–09 financial
crisis.
Other Federal Authorities and Entities
The Federal Reserve shares responsibility for ensuring financial institutions operate safely and
soundly. Based on a bank’s activities and how it is formed, it may be supervised and regulated by
a regulator other than the Federal Reserve (fig-
ure5.3). Federal and state regulators collabo-
rate, for example by sharing data and examina-
tion findings where appropriate, to ensure that
supervision and regulation of financial institu-
tions are effective, efficient, and consistent.
Two councils—comprised of federal and state
regulators and including Federal Reserve repre-
sentatives—play important coordinating roles
in the supervision and regulation of financial
institutions: the FSOC, and the Federal Financial Institutions Examination Council (FFIEC). For infor-
mation on the FSOC, see the “Promoting Financial System Stability” section (figure4.5). The FFIEC
is a formal interagency body that includes representatives of the Federal Reserve Board, the FDIC,
the OCC, the Consumer Financial Protection Bureau, the National Credit Union Administration, and
the State Liaison Committee. For more information on the FFIEC, visit https://www.ffiec.gov.
What does “systemically important” mean?
If the Financial Stability Oversight Council (FSOC) de-
termines that a nonbank financial company’s material
financial distress—or the nature, scope, size, scale,
concentration, interconnectedness, or mix of its activi-
ties—could pose a threat to U.S. financial stability, the
company is often referred to as being “systemically
important and requires supervision by the Federal
Reserve.” Similarly, the FSOC may designate certain
financial market utilities as systemically important.
70 The Fed Explained: What the Central Bank Does
How the Federal Reserve Supervises Financial Institutions
In overseeing the institutions under its authority, the Federal Reserve seeks primarily to promote
their safe and sound functioning, as well as their compliance with all applicable laws and regula-
tions that govern their activities.
Examinations and Inspections
The main objective of the Federal Reserve’s supervisory process is to assess and help ensure the
overall safety and soundness of individual banking organizations. This evaluation includes an as-
sessment of an organization’s risk-management systems, financial condition, and compliance with
applicable laws and regulations.
Supervision of the largest institutions includes regular horizontal examinations—comparing the
activities of similar firms to ensure safe and sound practices—and firm-specific supervisory activi-
ties to assess their financial resiliency and risk-management practices. Supervision of smaller
institutions largely entails point-in-time examinations and off-site monitoring.
Supervision of Large, Complex Institutions
The Federal Reserve applies heightened prudential standards to the largest, most complex U.S.
holding companies and foreign banking organi-
zations. These standards become progressive-
ly more stringent as the risk profile or systemic
importance of that regulated entity increases.
Standards include enhanced risk-based capital
and leverage requirements, liquidity require-
ments, stress tests, and resolution plan (that
is, “living will”) requirements.
The Large Institution Supervision Coordinating Committee (LISCC) program supervises the firms
that pose elevated risks to U.S. financial stability (figure 5.5). The LISCC program is a national
program that uses both horizontal and firm-specific supervisory activities to assess the financial
resiliency and risk-management practices of banking organizations that present elevated risk to
U.S. financial stability and nonbank financial companies that the FSOC has determined should be
supervised by the Board.
Supervision of Smaller Regional and Community Banks
The Federal Reserve supervises and regulates smaller banks based on a variety of factors, includ-
ing size, condition, risk profile, and organizational structure.
Who conducts examinations and inspections?
Examinations and inspections are conducted by Fed-
eral Reserve examiners, professionals who work at lo-
cal Federal Reserve Banks. They are rigorously trained
to keep abreast of ever-evolving laws and regulations
to which regulated entities are subject.
Supervising and Regulating Financial Institutions and Activities 71
By statute, state member banks must be examined at least once every 12 months. Banks that
have assets of less than $3billion and that also meet certain management, capital, and other
criteria are examined less frequently (once every 18 months). Banks that are in troubled condition
are examined more frequently. The Federal Reserve coordinates its examinations of state member
banks with those of the chartering state’s bank supervisor and it may alternate examinations with
the bank’s state supervisor.
The objectives of an examination are, essentially, to
1. provide an objective evaluation of a bank’s soundness;
2. determine the level of risk involved in the bank’s transactions and activities;
3. ascertain the extent of the bank’s compliance with banking laws and regulations;
4. evaluate the adequacy of the bank’s corporate governance and assess the quality of its board
of directors and management; and
5. identify those areas where corrective action is required to strengthen the bank, improve its fi-
nancial and managerial condition, and ensure compliance with applicable laws and regulations.
Figure 5.5. Federal Reserve supervisory program for the largest, most complex institutions
The Large Institution Supervision Coordinating Committee (LISCC) is a collaborative body providing Systemwide and
cross-disciplinary perspectives on the supervision of banking organizations and nonbank financial companies that
present elevated risk to U.S. financial stability.
1
LISCC
Execute firm-specific examinations and monitoring in coordination with the
portfolio programs, maintain a broad-based understanding of the safety and
soundness of their assigned firm, and recommend supervisory plans and ratings
Assesses the effectiveness of LISCC firms’ capital planning processes and the
sufficiency of their capital positions
Assesses the effectiveness of LISCC firms’ preparedness for recovering from a
severe stress and for being resolved in an orderly manner without threatening
financial stability
Assesses the effectiveness of LISCC firms’ boards of directors, management of
business lines, and independent risk management and controls
Identifies and explores emerging risks to inform supervisory planning, prioritization,
and policymaking, and to facilitate risk awareness among the other portfolio
programs and the dedicated supervisory teams
Operating
Committee
(OC)
Sets priorities for
and oversees the
execution of the
LISCC supervisory
program
Office of
the OC
Provides
infrastructure for
and oversight of the
operational and
strategic functions
of the LISCC
program
Dedicated
Supervisory
Teams
Governance
and Controls
Program
Capital
Program
Liquidity
Program
Recovery and
Resolution
Program
Monitoring
and Analysis
Program
Assesses the effectiveness of LISCC firms’ liquidity risk management practices
and the sufficiency of their liquidity positions
1
For more information on the LISCC supervisory program structure and a list of firms in the LISCC portfolio, see
https://www.federalreserve.gov/supervisionreg/large-institution-supervision.htm.
72 The Fed Explained: What the Central Bank Does
Supervision of community banks that are state member banks is primarily through a point-in-time,
full-scope examination. Supervision of regional banks is slightly more intensive, and consists of a
limited number of risk-focused examinations and continuous monitoring.
The Federal Reserve generally conducts an annual full-scope inspection of BHCs and SLHCs with
consolidated assets of $3billion or greater, as well as smaller BHCs or SLHCs that have signifi-
cant nonbank activities or elevated risk profiles. Regional banks and holding companies are as-
signed ratings annually, based on continuous supervisory work conducted throughout the year.
In the case of small, noncomplex BHCs and SLHCs whose consolidated assets are primarily held
by subsidiaries, Federal Reserve examiners rely heavily on off-site monitoring and on the results
of examinations of the company’s subsidiary banks or savings associations by the primary federal
or state authorities. This approach minimizes duplication of supervisory activities and reduces
burden for smaller financial institutions.
Results of an Examination or Inspection
Supervisory Ratings
The results of examination or inspection-related supervisory activities are reported to the board of
directors and management of the bank, BHC, or SLHC in a confidential report or letter of examina-
tion or inspection, which can include confidential supervisory ratings of the condition of the institu-
tion. Each state member bank receives a composite rating, which reflects the Federal Reserve’s
overall assessment and individual component ratings of the bank’s capital adequacy, asset quality,
management, earnings, liquidity, and sensitivity to market risk (CAMELS). Ratings range from “1”
to “5,” with “1” being the best. The CAMELS supervisory rating for banks and other depository
institutions is a tool that all U.S. federal and state banking agencies use to convey to financial
institutions the agencies’ assessment of the institution and to identify institutions whose opera-
tions raise concern or require special attention.
Each domestic BHC and non-insurance, non-commercial SLHC also receives a supervisory rating.
The largest BHCs and SLHCs, which have $100billion or more of total assets, and IHCs of foreign
banking organizations receive ratings on three areas: capital planning and positions, liquidity risk
management and positions, and governance and controls. There is no composite rating for this
rating scale, known as the Large Financial Institution or LFI rating scale. Examiners assign ratings
for each of these aspects of a firm’s performance on a four-point scale:
• Broadly Meets Expectations
• Conditionally Meets Expectations
• Deficient-1
• Deficient-2
“Broadly Meets Expectations” is the best rating and “Deficient-2” is the worst.
Supervising and Regulating Financial Institutions and Activities 73
BHCs and SLHCs with less than $100billion in consolidated assets are rated on a different scale,
known as the RFI rating scale. These firms receive a composite rating, which reflects the Federal
Reserve’s assessment and ratings of the company’s risk management, financial condition, and
potential impact on affiliated depository institutions (RFI/C(D)). Ratings range from “1” to “5,” with
“1” being the best (figure5.6).
Figure 5.6. Depository institutions and holding companies receive ratings based on the
result of examinations and inspections
Ratings, which are assigned to an institution after an examination or inspection, provide a summary measure of the
examination’s findings.
Rating system CAMELS RFI/C(D) LFI
Applicability Depository institutions Bank holding companies (BHCs)
Savings and loan holding companies (SLHCs)*
Large BHCs
Large SLHCs
Intermediate holding companies**
Components • Capital adequacy
• Asset quality
• Management
• Earnings
• Liquidity
• Sensitivity to market risk
• Risk management
– effectiveness of the banking organization’s
risk management and controls; board and
senior management oversight; policies,
procedures, and limits; risk monitoring
and management information systems;
and internal controls
• Financial condition
– an assessment of the banking organiza-
tion’s capital, asset quality, earnings, and
liquidity
• potential Impact of the parent company and
nondepository subsidiaries on the affiliated
depository institutions
• the consolidated Composite condition of the
institution
• the CAMELS rating of the affiliated Deposi-
tory institutions
• Capital planning and positions
• Liquidity risk management and
positions
• Governance and controls
Results For CAMELS and RFI/C(D) ratings systems, institutions score on a scale of 1 (best) to 5
(worst) for each factor.
Each Large Financial Institution
or component is rated based on a
four-point non-numeric scale: Broadly
Meets Expectations (best), Condition-
ally Meets Expectations, Deficient-1,
and Deficient-2 (worst)
* BHCs and non-insurance, non-commercial SLHCs with total consolidated assets less than $100 billion.
** BHCs and all non-insurance, non-commercial SLHCs with total consolidated assets of $100 billion or more; and U.S.
intermediate holding companies of foreign banking organizations with combined U.S. assets of $50 billion or more.
Examination Report
In addition to assigning ratings, examiners also prepare a detailed report that, besides formally
communicating the ratings, (1) describes the institution’s activities and management structure,
74 The Fed Explained: What the Central Bank Does
(2) assesses the institution’s performance, and (3) recommends changes or improvements in
certain policies and procedures.
Enforcement
If the Federal Reserve determines that a supervised institution has problems that affect its safety
and soundness, or that the institution is not in compliance with applicable laws and regulations,
the Federal Reserve may, by law, take action to ensure that the institution undertakes corrective
measures. For more information about enforcement actions, see the Board’s website, https://
www.federalreserve.gov/supervisionreg/legal-developments.htm.
Risk-Focused Approach to Consolidated Supervision
Consolidated supervision of holding companies encompasses the parent company and its sub-
sidiaries, and allows the Federal Reserve to understand the organization’s structure, activities,
resources, and risks, as well as to address
financial, managerial, operational, or other
deficiencies before they pose a danger to
the holding company’s subsidiary depository
institution(s).
In supervising financial institutions, the Federal Reserve takes a risk-focused approach, which fo-
cuses on business activities of a supervised financial institution that may pose the greatest risk.
This approach results in an efficient and rigorous oversight of firms that pose increased risk to the
financial system. To implement this approach, the Federal Reserve:
1. identifies the greatest risks and emerging risks to a supervised institution; and
2. assesses the ability of the institution’s management to identify, measure, monitor, and control
these risks.
For the largest financial institutions, which have grown in both size and complexity in recent years,
this risk-focused approach is typically implemented through a continuous process of on-site super-
vision rather than through point-in-time examinations.
Off-Site Monitoring
In its ongoing off-site supervision of banks and holding companies, the Federal Reserve uses au-
tomated systems to (1) proactively identify institutions with poor or deteriorating financial profiles
and (2) help detect adverse trends developing in the banking industry.
For example, the Federal Reserve’s Supervision and Regulation Statistical Assessment of Bank
Risk (SR-SABR) system uses an econometric modeling framework to identify weak and potentially
How the Federal Reserve enforces consumer- and
community-oriented laws and regulations
To learn more about the Federal Reserve’s enforce-
ment of consumer protection laws and regulations,
see section7, “Promoting Consumer Protection and
Community Development,” on page 112.
Supervising and Regulating Financial Institutions and Activities 75
weak banks. By using this system, the Federal Reserve can more effectively direct examiner re-
sources to those institutions needing supervisory attention.
Participation in Supervisory Colleges
With the growth of the international operations of large global financial institutions, the Federal
Reserve and other U.S. and foreign banking supervisors have broadened and formalized coop-
erative arrangements through “supervisory
colleges.” Supervisory colleges are multilateral
working groups of relevant supervisors that are
formed to promote effective, ongoing consoli-
dated supervision of the overall operations of
an international banking group. Cooperation
within the working groups involves bilateral and
multilateral contacts and formal and informal
information-sharing arrangements.
Crisis Management Groups
The Federal Reserve participates in crisis management groups with other state and U.S. regula-
tory agencies and foreign banking supervisors responsible for the oversight of large cross-border
banking groups. The purpose of crisis management groups is to enhance preparedness for, and fa-
cilitate the management and resolution of, a financial crisis affecting a large global banking group.
This cooperation involves bilateral and multilateral contacts and formal and informal dialogue
focused on the development of a framework for early intervention triggers around recovery efforts
and resolution planning.
Box 5.1. Microprudential versus Macroprudential Supervision
The Federal Reserve takes a two-pronged approach to its oversight of financial institutions:
1. The microprudential approach seeks to ensure the safety and soundness of individual institutions
and involves in-depth examinations and inspections of the structure, operations, and compliance of
individual entities regulated by the Federal Reserve.
2. The macroprudential approach focuses on the soundness and resilience of the financial system as
a whole and addresses how the actions of one institution, or set of institutions, can impact other
institutions and the U.S. economic and financial system overall.
These two approaches to supervision are complementary. The financial system as a whole is more
likely to be stable if its constituent organizations are sound. And traditional, firm-specific oversight
provides the knowledge base for a more systemic, macroprudential approach. It is not possible to un-
derstand developments in the financial system as a whole without a clear view of developments within
key firms and markets.
Financial Sector Monitoring
Ensuring the safe and efficient functioning of the
nation’s banking system requires that the Federal Re-
serve consider more than the safety and soundness
of individual organizations.
This duty requires that the Federal Reserve also con-
sider factors that can affect the stability of the entire
financial system, including the interactions between
firms and markets (see section 4, on page 46).
76 The Fed Explained: What the Central Bank Does
How the Federal Reserve Regulates Financial Institutions
The Federal Reserve issues regulations and policy statements or other forms of supervisory guid-
ance to supervised institutions to ensure its approach to supervision and regulation keeps up with
a changing financial and banking landscape. Regulations can be restrictive (limiting the scope of
an institution’s activities), prescriptive (requiring institutions to take certain actions), or permissive
(authorizing institutions to engage in certain activities).
New regulations may be adopted or existing
ones revised—for example, in response to new
laws enacted by Congress or because of evolv-
ing risk conditions in the financial marketplace.
If Congress enacts a legislative change—per-
haps in response to a past crisis or problem,
or to adapt the nation’s banking laws to re-
spond to changes in the marketplace—the Federal Reserve might issue regulations to ensure that
institutions comply with the new law (see figure5.7 for a list of Federal Reserve regulations and
the topics they address).
Regulation of the financial system must continuously evolve in response to changing laws and
conditions in the marketplace in order to ensure that supervised institutions operate in a safe and
sound manner.
Box 5.2. A Further Evolution: Taking Corrective Action to
Address Troubled Institutions
The Federal Deposit Insurance Corporation Improvement Act of 1991 requires regulators to take
prompt corrective action (PCA) to address the problems of troubled depository institutions. The
intent of PCA is to minimize the long-term cost to the Deposit Insurance Fund of resolving such
institutions.
The PCA framework specifies mandatory actions that regulators must take, as well as discretionary ac-
tions they must consider taking, when a bank’s capital position declines or is deemed to have declined
below certain threshold levels as a result of an unsafe or unsound condition or practice.
The state of a bank’s capital position is measured based on risk-based capital and leverage ratios
derived from the bank’s Call Report data. Based on its levels of these ratios, a bank can be deemed
(1)well-capitalized, (2)adequately capitalized, (3)undercapitalized, (4)significantly undercapitalized,
or (5)critically undercapitalized. The law provides for increasingly stringent corrective provisions as a
bank is placed in progressively lower capital categories.
Undercapitalized and significantly undercapitalized institutions likely would be required to submit and
implement an acceptable plan to restore capital. A critically undercapitalized bank faces receivership
unless its condition improves and the activities that expose it to risk are restricted.
Finding orders and agreements online
All formal enforcement orders issued by the Federal
Reserve and all written agreements executed by
Federal Reserve Banks are available to the public in
the News & Events section of the Federal Reserve
Board’s website, https://www.federalreserve.gov/
newsevents.htm.
Supervising and Regulating Financial Institutions and Activities 77
Capital Adequacy and Planning
A key goal of banking regulation is to ensure that banks maintain sufficient capital. Capital can act
as a buffer to absorb unexpected losses. To be resilient, a bank must maintain enough capital to
support the risks associated with its exposures and activities.
Risk-Based Capital and Leverage Requirements
The Federal Reserve and the other federal banking agencies have established capital require-
ments for
• insured depository institutions;
• BHCs, IHCs, and SLHCs that are organized in the United States, including any such company
that is owned or controlled by a foreign organization.
Capital requirements include risk-based requirements and leverage requirements. The Federal
Reserve also conducts regular stress tests on large banking organizations. For the largest, most
systemically important firms, the Federal Reserve has imposed an additional capital surcharge
designed to reduce the threat that a failure of any of these firms would pose to financial stability.
Community banks can opt to follow a simpler capital rule that consists solely of a leverage ratio
requirement.
Capital Planning and Stress Testing
The Federal Reserve has worked to ensure that large, complex financial institutions strengthen
their capital positions and capital planning processes. One aspect of this has been working with
firms to bolster their internal processes for assessing capital needs. The Federal Reserve has de-
veloped and implemented a regular supervisory review of the capital plans of the largest banking
organizations.
The Federal Reserve’s Dodd-Frank Act stress test includes annual supervisory and company-run
stress tests for the largest banking organizations. The supervisory stress test assesses whether
firms are sufficiently capitalized to absorb losses during stressful conditions while meeting obliga-
tions to creditors and counterparties and continuing to be able to lend to households and busi-
nesses.The Board integrates the stress test with its non-stress capital requirements through the
stress capital buffer into one forward-looking and risk-sensitive capital framework.
For more information about stress tests, see section 4, “Promoting Financial System Stability,”
on page 46 and visit the Board’s website at https://www.federalreserve.gov/supervisionreg/dfa-
stress-tests.htm.
78 The Fed Explained: What the Central Bank Does
Figure 5.7. Federal Reserve regulations by topic
The Federal Reserve maintains and ensures compliance with the following regulations, which implement federal
banking laws and govern the operations of regulated institutions.
Regulation (by letter and name) Description
Banks and banking
F
Limitations on Interbank Liabilities Prescribes standards to limit the risks that the failure of one depository institution would pose to
another
H
Membership of State Banking Institutions in the
Federal Reserve System
Defines the requirements for membership of state-chartered banks in the Federal Reserve System
and sets out the rules member banks must follow in the areas of investments and loans, securities-
related activities, capital adequacy, real estate lending and appraisal standards, bank security
procedures, suspicious-activity reports, Bank Secrecy Act compliance, and ownership or control of
financial subsidiaries
I
Issue and Cancellation of Federal Reserve Bank
Capital Stock
Sets out stock-subscription requirements for all banks joining the Federal Reserve System
K
International Banking Operations Governs the international banking operations of U.S. banking organizations and the operations of
foreign banks in the United States
L
Management Official Interlocks Generally prohibits a management official from serving two nonaffiliated depository institutions,
depository institution holding companies, or any combination thereof, in situations where the man-
agement interlock would likely have an anticompetitive effect
O
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
Q
Capital Adequacy of Bank Holding Companies,
Savings and Loan Holding Companies, and State
Member Banks
Establishes minimum capital requirements and overall capital adequacy standards for bank holding
companies, savings and loan holding companies, and state member banks
R
Exceptions for Banks from the Definition of Broker in
the Securities Exchange Act of 1934
Defines the scope of securities activities that banks may conduct without registering with the Securi-
ties Exchange Commission as a securities broker and implements the most important exceptions
from the definition of the term broker for banks
S
Reimbursement for Providing Financial Records;
Recordkeeping Requirements for Certain Financial
Records
Establishes rates and conditions for reimbursement to financial institutions for providing customer
records to a government authority and prescribes recordkeeping and reporting requirements for
insured depository institutions making domestic wire transfers and for insured depository institutions
and nonbank financial institutions making international wire transfers
W
Transactions Between Member Banks and Their
Affiliates
Implements sections 23A and 23B of the Federal Reserve Act, which establish certain restrictions on
and requirements for transactions between a member bank and its affiliates
KK
Swaps Margin and Swaps Push-Out Establishes margin and capital requirements for covered swap entities and implements the prohibi-
tion against federal assistance to swap entities
NN
Retail Foreign Exchange Transactions Sets standards for banking organizations regulated by the Federal Reserve that engage in certain
types of foreign exchange transactions with retail consumers
VV
Proprietary Trading and Certain Interests in and
Relationships with Covered Funds
Establishes prohibitions and restrictions on proprietary trading and investments in or relationships
with covered funds by certain banking entities
(continued on next page)
Supervising and Regulating Financial Institutions and Activities 79
Figure 5.7. Federal Reserve regulations by topic (continued)
Regulation (by letter and name) Description
Holding companies and nonbank financial companies
Y
Bank Holding Companies and Change in Bank
Control
Regulates the acquisition of control of banks and bank holding companies by companies and individuals,
defines and regulates the nonbanking activities in which bank holding companies (including financial
holding companies) and foreign banking organizations with U.S. operations may engage, and establishes
capital planning requirements for large bank holding companies
LL
Savings and Loan Holding Companies Regulates the acquisition of control of savings associations, defines and regulates the activities of savings
and loan holding companies, sets forth procedures under which directors and executive officers may be
appointed or employed, and establishes capital planning requirements for large savings and loan holding
companies
MM
Mutual Holding Companies Regulates the reorganization of mutual savings associations to mutual holding companies and the creation
of subsidiary holding companies of mutual holding companies, defines and regulates the operations of
mutual holding companies and their subsidiary holding companies, and sets forth procedures for securing
approval for these transactions
OO
Securities Holding Companies Outlines the procedures and requirements for securities holding companies to elect to be supervised by
the Federal Reserve
QQ
Resolution Plans Requires large, systemically significant bank holding companies and nonbank financial companies to
submit annual resolution plans
RR
Credit Risk Retention Requires sponsors of securitization transactions to retain risk in those transactions
TT
Supervision and Regulation Assessments of
Fees
Establishes an annual assessment of fees on certain bank holding companies, savings and loan holding
companies, and nonbank financial companies supervised by the Federal Reserve
WW
Liquidity Risk Measurement, Standards, and
Monitoring
Establishes a minimum liquidity standard and stable funding standard for certain Board-regulated institu-
tions on a consolidated basis
XX
Concentration Limits Establishes a financial sector concentration limit that generally prohibits a financial company from merging
or consolidating with, or acquiring, another company if the resulting company’s liabilities would exceed
10 percent of the aggregated liabilities of all financial companies
YY
Enhanced Prudential Standards Implements the enhanced prudential standards mandated by the Dodd-Frank Wall Street Reform and
Consumer Protection Act for large bank holding companies
Federal Reserve Credit
A
Extensions of Credit by Federal Reserve Banks Governs borrowing by depository institutions and others at the Federal Reserve discount window
Monetary policy and reserve requirements
D
Reserve Requirements of Depository
Institutions
Sets uniform requirements for all depository institutions to maintain reserves either with their Federal
Reserve Bank or as cash in their vaults
Securities credit transactions
T
Credit by Brokers and Dealers Governs extension of credit by securities brokers and dealers, including all members of national securities
exchanges (see also Regulations U and X)
U
Credit by Banks and Persons Other Than
Brokers or Dealers for the Purpose of Purchas-
ing or Carrying Margin Stock
Governs extension of credit by banks or persons other than brokers or dealers to finance the purchase or
the carrying of margin securities (see also Regulations T and X)
X
Borrowers of Securities Credit Applies the provisions of Regulations T and U to borrowers who are subject to U.S. laws and who obtain
credit within or outside the United States for the purpose of purchasing securities
Note: For a list of consumer and community affairs-related regulations, see figure 7.2, “Federal consumer financial protection laws and
regulations applicable to banks,” on page 116. For a list of regulations governing the U.S. payment system, see figure6.11, “Federal
Reserve regulations governing the payment system,” on page 109. To view the full text of these and other Federal Reserve regulations,
visit https://www.ecfr.gov/cgi-bin/ECFR?page=browse and select “Title 12” of the Code of Federal Regulations.
80 The Fed Explained: What the Central Bank Does
Liquidity Standards
While adequate capital is essential to the safety and soundness of financial institutions and the
financial system as a whole, adequate liquidity is also vitally important. Capital adequacy and li-
quidity are interdependent, particularly in times
of stress. While capital serves as a cushion
against possible losses, liquidity is the ability
to meet obligations as they come due.
The Federal Reserve has established height-
ened liquidity requirements for large BHCs,
as well as foreign banking organizations with
significant U.S. operations. These standards
require these institutions to maintain a mini-
mum liquidity buffer based on an institution’s internal 30-day liquidity stress test results. The
standards also establish specific related responsibilities for boards of directors and risk commit-
tees, require firms to establish specific internal quantitative limits to manage liquidity risk, and
establish specific requirements for a firm to monitor its liquidity risk.
The federal banking agencies established a standardized minimum liquidity coverage ratio, or LCR,
for large and internationally active firms. The LCR requires large firms with more significant risk
profiles that meet certain criteria to hold high-quality, liquid assets that can be converted easily
and quickly into cash. In addition, the federal banking agencies established a net stable funding
ratio, or NSFR, which requires large banks to maintain a minimum level of stable funding over a
one-year period, relative to each institution’s assets, derivatives, and commitments. The aim of the
NSFR requirement is to support the ability of banks to lend to households and businesses in both
normal and adverse economic conditions by reducing liquidity risk and enhancing financial stability.
Supervisory Policy Statements and Guidance
Besides issuing regulations, the Federal Reserve issues policy statements and guidance for exam-
iners and financial institutions in the form of public supervision and regulation (or SR) letters.
Importantly, supervisory statements and guidance do not have the force and effect of law. Rather,
they outline supervisory expectations or principles related to a specific law or regulation or to
general safety and soundness. Statements and guidance articulate the agencies’ general views
regarding appropriate practices for a given subject area, and provide insight to industry and super-
visory staff in a transparent way that helps to ensure consistency in the supervisory approach. In
some situations, supervisors may refer to supervisory guidance in communications to regulated
institutions to help explain supervisory findings and highlight practices to consider when institu-
tions address issues.
How do capital and liquidity differ?
Capital acts as a financial cushion to absorb
unexpected losses and generally is the difference
between a firm’s assets and its liabilities. Liquidity is
a measure of the ability and ease with which a firm’s
assets can be converted to cash. To remain viable, a
financial institution must have enough liquid assets
to meet its near-term obligations, such as withdrawals
by depositors and short-term debt obligations that are
coming due.
Supervising and Regulating Financial Institutions and Activities 81
The Federal Reserve often works closely with other supervisors in crafting these policy statements
and guidance. For example, it participates in supervisory and regulatory forums and provides sup-
port for the work of the FFIEC. In addition, the Federal Reserve and other U.S. supervisors partici-
pate in international forums such as the Basel Committee on Banking Supervision (BCBS) and the
Financial Stability Board to discuss a range of regulatory and supervisory topics and coordinate
approaches, where possible.
To see specific supervision and regulation letters, visit the Board’s website, https://www.federalre-
serve.gov/supervisionreg/srletters/srletters.htm.
Oversight of the Banking System Structure
The Federal Reserve administers several federal statutes that govern the formation, acquisition,
and mergers of BHCs, state member banks, SLHCs, and foreign banking organizations.
Under these statutes, the Federal Reserve
has authority to approve or deny a variety of
proposals that directly or indirectly affect the
structure of the U.S. banking system at the
local, regional, and national levels; the interna-
tional operations of domestic banking organiza-
tions; or the U.S. banking operations of foreign
banks.
Specifically, the Federal Reserve administers
several federal statutes that apply to BHCs, FHCs, state member banks, and foreign banking
organizations, including the Bank Holding Company Act, the Bank Merger Act, the Change in Bank
Control Act of 1978 (CIBCA), the Federal Reserve Act, and the IBA. As a result of the Dodd-Frank
Act, the Federal Reserve also administers section 10 of the Home Owners’ Loan Act that applies
to SLHCs, and administers the CIBCA with respect to SLHCs.
Promotion of Market Discipline: Public Disclosure and Accounting
Policy Requirements
Public disclosure helps market observers and participants assess the strength of individual finan-
cial institutions, and the Federal Reserve’s role in this regard is a critical element in promoting
market discipline. Market discipline, likewise, is an important complement to supervision.
Improved safety and soundness is often realized by heightened market discipline achieved through
improved financial reporting and disclosure requirements. Such requirements can serve both
institution-specific and system-specific purposes.
Financial disclosures by state member banks
State member banks that issue securities registered
under the Securities Exchange Act of 1934 must
disclose certain information of interest to investors,
including annual and quarterly financial reports and
proxy statements. By statute, the Federal Reserve
administers these requirements and has adopted
financial disclosure regulations for state member
banks that are substantially similar to the Securities
and Exchange Commission’s regulations for other
public companies.
82 The Fed Explained: What the Central Bank Does
Market discipline can help to restrain imprudent risk-taking by limiting funding of institutions per-
ceived to be relatively risky, and in this way can complement the efforts of supervisors.
Accordingly, the Federal Reserve plays a significant role in promoting sound accounting policies
and meaningful public disclosure by financial institutions. Through its supervision and regulation
functions, the Federal Reserve seeks to strengthen the accounting, audit, and control standards
related to financial institutions.
The Basel Accords: Global Prudential Standards for Banks
Because of the interconnectedness of the global banking system, the United States participates
in the BCBS, the primary global standard-setter for the prudential regulation of banks. The Basel
Committee’s mandate is to strengthen the regulation, supervision, and practices of banks world-
wide for the purpose of enhancing global financial stability.
Members of the Basel Committee work together to formulate broad supervisory standards and
guidelines and to recommend best practices to the committee’s member countries. Basel Com-
mittee members strive to ensure that their supervised financial institutions are held to high,
consistent standards and are competing on a level playing field. Individual national authorities are
expected to take steps to implement these standards in their respective jurisdictions, as appropri-
ate (figure5.8). While the standards from international organizations like the BCBS do not go into
force automatically in the United States, the Federal Reserve and the other agencies have sought
to adopt regulations for internationally active U.S. financial institutions that are broadly consistent
with the Basel standards, so that minimum standards exist across the global financial system.
Figure 5.8. International evolutions: The Basel Capital Accord
With other federal banking agencies, the Federal Reserve drafts and finalizes rules that are consistent with the
capital adequacy standards set by the Basel Committee. Since 1988, there have been three iterations of the Basel
Capital Accords; each iteration is phased in over a multiyear period.
Basel I Basel II Basel III
1988 2004 2009–11
• Increased capital requirements for
internationally active banking organizations.
• Reduced international competitive
inequities.
• Increased comparability of institutions’ capital
positions.
• Introduced measures for market risk for
institutions with trading activities of
$1 billion or more.
Building on Basel I, Basel II introduced a three-
pillar framework for assessing capital adequacy:
• Pillar 1: Minimum regulatory capital
requirements more closely align banking
organizations’ capital requirements with their
underlying risks, including operational risk.
• Pillar 2: Supervisory oversight requires
supervisors to evaluate banking organizations’
capital adequacy and to encourage better
risk-management techniques.
• Pillar 3: Market discipline calls for enhanced
public disclosure of banking organizations’ risk
exposures.
Building on Basel II, and in the wake of the
2007–09 financial crisis, Basel III included
measures to
• improve the quality of regulatory capital to
include instruments that are fully able to
absorb unexpected losses, with a particular
focus on common equity;
• increase the minimum quantity of capital that
banking organizations are required to maintain
as a proportion of their risk-weighted assets
and provide incentives for banking organiza-
tions to conserve capital; and
• require global systemically important U.S.
and foreign banks to maintain additional
capital based on measures of their systemic
importance.
84 The Fed Explained: What the Central Bank Does
6
Fostering Payment and
Settlement System Safety
and Efficiency
The Federal Reserve works to promote a safe,
efficient, and accessible system for U.S. dollar
transactions.
Overview of Key Federal Reserve Payment System Functions .....86
Providing Services to Banks and the Federal Government .......86
The U.S. Payment System Today and Reserve Bank Services .....88
Regulating and Supervising the Payment System ............104
Providing Banking System Liquidity ......................108
Exploring and Implementing Payment System Improvements ....109
Fostering Payment and Settlement System Safety and Efficiency 85
An efficient, effective, and safe U.S. and global payment and settlement system is vital to the U.S.
economy, and the Federal Reserve plays an important role in advancing those objectives.
The U.S. dollar payment and settlement system is composed of payment instruments, systems,
and institutions that have changed over time. The Federal Reserve provides currency and operates
some elements of this system.
This system facilitates financial transactions, purchases of goods and services, and the attendant
movement of money at all levels of the U.S. economy—on behalf of individuals and institutions,
buyers and sellers, consumers and businesses, investors and securities issuers—and supports
interactions between the U.S. economy and others around the world. The importance of the pay-
ment system in our daily lives makes its safe and proper functioning essential to the health of the
U.S. financial system and overall economy.
Figure 6.1. The Federal Reserve’s role in everyday transactions
Whether you’re paying your babysitter, shopping for groceries, or getting your paycheck, you’re operating within the
payment system. The Federal Reserve plays an important role in maintaining that system’s integrity.
WHOLESALE PAYMENTS
Services like the Federal Reserve’s Fedwire
Funds and Fedwire Securities services help to
process large-value financial transactions
among businesses, banks, and individuals.
Customer A’s
bank
Customer B’s
bank
Business with
payroll payment
Employees
AUTOMATED
CLEARINGHOUSE (ACH)
The Federal Reserve plays a key role in
processing small-value electronic credit or
debit transfers, such as direct deposits of
payroll or recurring bill payments.
CURRENCY
The Federal Reserve issues paper
currency (Federal Reserve notes). Federal
Reserve Banks ensure adequate supply of
paper currency around the country.
Parent with cash
Babysitter
CHECKS
Federal Reserve Banks collect checks
deposited by banks and return unpaid
checks to the bank on which
the check is drawn.
Homeowner
with check
Plumber
86 The Fed Explained: What the Central Bank Does
Overview of Key Federal Reserve Payment
System Functions
The Federal Reserve performs several key functions with the respect to the U.S. payment system.
These functions help keep cash, check, and electronic transactions moving reliably through the
U.S. economy on behalf of consumers, businesses, and others participating in the economy. They
include
• providing services to depository institutions and the U.S. federal government,
• regulating certain aspects of the payment system and supervising certain financial market
utilities,
• providing intraday liquidity to payment system participants, and
• analyzing the system to help identify and implement improvements.
All these functions underpin U.S. financial markets and private-sector clearing, payment, and
settlement arrangements; support the implementation of monetary policy; and contribute to the
overall stability of the U.S. financial system and economy.
The Federal Reserve Board of Governors (Board) in Washington, D.C., and the 12 Federal Reserve
Banks (Reserve Banks) located around the nation have distinct but complementary responsibili-
ties with regard to the payment system.
In general, the Board is responsible for developing regulations and supervisory policies for ele-
ments of the payment system that fall within the Federal Reserve’s jurisdiction. The Reserve
Banks help supervise entities under the Federal Reserve’s jurisdiction pursuant to these regula-
tions and policies.
The Reserve Banks take the lead in providing accounts and payment services to depository
institutions, the federal government, and certain other entities (such as government-sponsored
enterprises and international organizations), subject to oversight by the Board. The Reserve Banks
also provide—subject to Board policies—intraday and overnight credit. Finally, both the Board and
the Reserve Banks engage in payment system research and act as catalysts to improve the safety
and efficiency of the payment system.
Providing Services to Banks and the Federal Government
The 12 Reserve Banks and their various branches provide a range of payment and settlement
services to the banking industry and the federal government. The Reserve Banks
• maintain accounts for depository institutions,
• transfer funds electronically,
Fostering Payment and Settlement System Safety and Efficiency 87
• collect checks,
• distribute and receive currency and coin, and
• settle payments and eligible securities transactions by debiting and crediting the appropriate
accounts at the Reserve Banks.
The Reserve Banks also act as fiscal agents of the U.S. government and certain other entities. In
other words, they act as the “government’s bank” and maintain the operating cash account of the
U.S. Department of the Treasury; process payments to and from the Treasury’s Federal Reserve
account; and issue, transfer, and redeem U.S. government securities.
The Federal Reserve has provided payment services to the banking industry since shortly after
the Reserve Banks were established in 1914. At the time, these services were for the most part
(1) available only to banks that were members of the Federal Reserve System and (2) provided
without explicit charge.
Monetary Control Act of 1980
Congress reaffirmed and expanded the Federal Reserve’s role as a service provider with the enact-
ment of the Monetary Control Act of 1980 (MCA), which gave all depository institutions access to
Box 6.1. Major Events in the History of the Federal Reserve’s
Role in the U.S. Payment System
The Federal Reserve System was created by Congress to eliminate the severe financial crises that
had periodically swept the nation by the early 1900s, particularly of the sort that occurred in 1907.
1907 Many banks and clearinghouses refuse to clear checks drawn on certain other banks, lead-
ing to the failure of otherwise solvent banks.
1913 Congress creates the Federal Reserve System, giving it the authority to establish a nation-
wide check-clearing system to eliminate system inefficiencies and inequities.
1918 The Federal Reserve Banks establish Fedwire, the world’s first wire transfer system.
1974 The Federal Reserve Banks begin operating their automated clearinghouse service.
1980 The Monetary Control Act reaffirms the Federal Reserve’s role in providing payment services.
2003 The Check Clearing for the 21st Century Act enables the transformation of the check-collec-
tion system from a paper-based to a virtually all-electronic system. The Board drafted this
law, collaborating with various payment system stakeholders, and the Federal Reserve Banks
provided services to accelerate this transformation.
2010 The Dodd-Frank Wall Street Reform and Consumer Protection Act emphasizes the Federal
Reserve’s role in promoting financial stability and mitigating systemic risk in the financial
system and expands its supervision of systemically important financial market utilities and
payment, clearing, and settlement activities.
88 The Fed Explained: What the Central Bank Does
the same pricing for the Federal Reserve’s payment services and required the Federal Reserve to
price specific types of services to recover fully the costs of providing these services over the long run.
The MCA also encourages competition between the Reserve Banks and private-sector providers of
payment services by requiring the Reserve Banks to recover not only their actual costs of providing
priced services, but also the costs that would
be incurred and profits that would be earned if
a private firm had provided these services.
The Reserve Banks offer certain payment
services in competition with the private sector.
The Board has adopted clear policies to avoid
conflicts of interest within Reserve Banks that
could arise from providing priced payment ser-
vices and carrying out monetary, supervisory,
and lending responsibilities.
The U.S. Payment System Today and
Reserve Bank Services
The U.S. payment system has evolved significantly since the Federal Reserve was established in
1913. At that time, cash and checks were the predominant means of payment. Since then, and
especially since the 1990s, the U.S. payment system has shifted away from the use of checks
and toward the use of electronic payments.
In 2018, 162 billion noncash transactions valued at approximately $1,252 trillion passed through
the U.S. payment system. Measured by annual aggregate value, wire transfers, automated clear-
inghouse (ACH) payments, and checks were the leading payment methods in the United States.
Measured by annual aggregate number, however, debit cards, credit cards, and ACH payments were
the leading payment methods ( figure6.2). Today’s prominence of electronic payments reflects a
long-term shift away from the use of checks, particularly in transactions between consumers and
businesses.
The Federal Reserve’s noncash payment and settlement services are typically categorized as retail
or wholesale payment services. The check and ACH services are generally called retail payment
services, and the Fedwire Funds Service, the Fedwire Securities Service, and the National Settle-
ment Service (NSS) are generally called wholesale services. These terms reflect the lower typical
value of the retail services. However, lower-value Fedwire transactions and higher-value check or
ACH transactions are also used by individuals and businesses, respectively, to meet their payment
needs.
Federal Reserve Bank service fees
Under the Monetary Control Act and the Board’s
Principles for Pricing Federal Reserve Bank Services,
the Board is required to set fees for Reserve Bank
services to recover the actual and imputed costs
of providing these services to the banking industry.
The services include check clearing and collection,
wire transfer of funds, automated clearinghouse, net
settlement, securities services, and new services
the Reserve Banks may offer. For the most up-to-date
schedule of fees, go to https://www.frbservices.org/
resources/fees/index.html.
Fostering Payment and Settlement System Safety and Efficiency 89
In addition to providing noncash payment services, the Federal Reserve ensures that the cash
(currency and coin) in circulation is sufficient to meet the public’s demand and that depository
institutions have ready access to Reserve Bank cash services.
Retail Payment Services
Retail payments tend to be lower-value payments—such as check, ACH, and debit and credit card
payments—used more frequently in everyday transactions. The Federal Reserve plays a key role in
processing retail payment transactions through its check and ACH services.
The U.S. payment system has evolved greatly to better serve all participants in the economy. Inno-
vations and reforms have ushered in greater convenience in many ways, notably the ways individu-
als and institutions conduct transactions between and among themselves.
Check Service and Its Origins
Perhaps no aspect of the payment system illustrates its evolution better than the nation’s check-
clearing system. The Federal Reserve plays a key role in this system, serving as a major provider
of paper and electronic services to depository institutions. In 2019, it collected more than 4billion
checks, worth more than $8trillion.
In the early 1900s—before the creation of the Federal Reserve System—the nation’s check sys-
tem was paper-based and used primarily for transactions between banks (interbank transactions)
Figure 6.2. Total noncash payments (Federal Reserve and private sector), 2019
Wire transfers (1,134.6)
ACH (69.9)
Checks (25.8)
Credit cards (4.0)
Debit cards (3.2)
Annual value of payments
(trillions of U.S. dollars)
Debit cards (84.8)
Credit cards (44.1)
ACH (30.8)
Checks (12.5)
Wire transfers (.29)
Annual number of payments
(billions)
Note: All figures include on-us transactions (payments in which the acquirer and the issuer are the same institution).
ACH Automated clearinghouse.
Source: Committee on Payments and Market Infrastructures 2019 Red Book Statistics, which is available on the Bank for
International Settlements website at https://stats.bis.org/statx/toc/CPMI.html.
90 The Fed Explained: What the Central Bank Does
and between businesses. The check-collection system at that time was quite inefficient; for ex-
ample, banks commonly routed checks circuitously to avoid presentment fees, which are fees that
banks receiving checks imposed on banks presenting checks for payment. Such routing resulted
in extensive delays and inefficiencies in the
check-collection system.
When the Reserve Banks were established
in 1914, Congress expected them to improve
the efficiency of the check-collection system,
which would benefit the depositors of checks
by speeding up the process and eliminating
the practice of paying checks at less than their
full face value. This practice of not remitting payment for checks at face value was called “nonpar
banking.” In 1917, Congress amended the Federal Reserve Act to prohibit banks from charging the
Reserve Banks presentment fees and to authorize nonmember banks as well as member banks to
collect checks through the Federal Reserve System.
Since then, the Federal Reserve has worked with the private sector to improve the efficiency
and cost-effectiveness of the check-collection system (figure 6.3). In its early years, the Federal
Reserve took a number of steps to reduce nonpar banking. The prevalence of nonpar banking was
substantially reduced by the 1920s but did not totally disappear in this country until 1980.
In the 1970s, check volume increased significantly, so the Federal Reserve established additional
check-processing offices, called regional check-processing centers, in new locations throughout
the country to improve further the efficiency of check clearing. In the 1980s, the Reserve Banks
began to offer expanded return check services based on the new expeditious return rules adopted
by the Board pursuant to the Expedited Funds
Availability Act. In expanding their return check
services, the Reserve Banks played a major
role in speeding the return of unpaid checks to
banks of first deposit—banks in which checks
are initially deposited for collection.
Electronic Check Processing
The Federal Reserve served as a catalyst for the transition of the U.S. economy to today’s elec-
tronic check-processing arrangements (including check truncation). As a general matter, the faster
and more resilient electronic check-clearing and check-return methods have markedly improved the
efficiency of the nation’s payment system while at the same time proving less costly and less error
prone.
What is the automated clearinghouse (ACH)?
The ACH is a nationwide electronic network, devel-
oped jointly by the private sector and the Federal Re-
serve, for the exchange of electronic files of payment
instructions among financial institutions, typically on
behalf of customers. ACH transactions are payment
instructions to either debit or credit an originator’s
deposit account at an originating depository institu-
tion. The ACH was developed in the early 1970s as a
more efficient alternative to paper checks.
What are “clearing” and “settlement”?
Clearing is the transfer and confirmation of informa-
tion between the payer’s financial institution and the
payee’s financial institution. Settlement is the actual
transfer of funds between the payer’s financial institu-
tion and the payee’s financial institution.
Fostering Payment and Settlement System Safety and Efficiency 91
In the 1990s, the Reserve Banks began offering electronic check presentment services to banks.
By the early 2000s, about 20 to 25percent of the checks the Reserve Banks handled were deliv-
ered electronically to paying banks through these services. Overall, most banks continued to sim-
ply demand that original checks be presented
for payment. As a result, the nation’s check-
clearing system remained dependent on paper
and vulnerable to disruptions in transportation
networks.
In 2003, Congress passed the Check Clearing for the 21st Century Act (Check 21 Act), which
facilitated electronic check processing by creating a new type of paper document, called a substi-
tute check, which is the legal equivalent of the original check. The Check 21 Act enables banks to
remove original paper checks from the check- collection system (called check truncation) and send
digital images of checks electronically to banks with which they have agreements to do so, and
send substitute checks to banks with which they do not. By creating widespread opportunities for
What is check truncation?
Check truncation is the practice of converting a paper
check to electronic information, which is forwarded to
the bank on which it was written.
Figure 6.3. What are all those numbers on your checks?
Public- and private-sector coordination and cooperation have led to dramatic improvements in the check-collection
process, resulting in more efficient payment and settlement for individuals and institutions.
Your Name
1234 Your Street
Anywhere, US 10112
Date
$
PAY TO THE
ORDER OF
DOLLARS
Your Bank
5678 Bank Street
Anywhere, US 10112
MEMO
Bank routing number
The Federal Reserve and the banking
industry developed the bank routing
number system to facilitate the
sorting, bundling, and shipment of
paper checks. The routing number
identifies the bank on which a check
is drawn.
Account number
Individual account
numbers are
assigned to each
account.
MICR
In the 1950s, the magnetic ink character (MICR)
system for encoding pertinent data on checks
was developed so that the data could be read
electronically. The MICR system contributed
significantly to the automation of check
processing. In the 1960s, the Federal Reserve
Banks began to require MICR-encoding of all
checks deposited with them.
92 The Fed Explained: What the Central Bank Does
the truncation of checks and associated cost savings, the act has resulted in the nation’s inter-
bank check- collection processes becoming almost entirely electronic.
The banking system and the Federal Reserve itself have been able to almost completely eliminate
the costly dedicated air and ground transportation networks that were once used to deliver checks
around the country on a daily basis. Further, banks’ transition to electronic check processing has
enabled them to offer their customers new products and improved service.
Check volume in the United States peaked in the mid-1990s (figure 6.4), when about 50billion
checks were written annually. Since that time, check volume has declined significantly as electron-
ic forms of payment, such as debit cards, credit cards, and ACH payments, have become increas-
ingly popular. In response to the growth in electronic check processing and the reduced number of
checks being written, the Reserve Banks substantially reduced their costs and physical infrastruc-
ture associated with processing checks. The number of Reserve Bank offices processing paper
checks declined from 45 in 2003 to just 1 beginning in 2010.
Figure 6.4. Checks collected by the Federal Reserve, selected years, 1920–2019
The number of checks written has been declining as individuals and institutions rely increasingly on electronic
means to execute transactions.
Millions of items
424
905
1,184
1,955
3,419
7,158
15,716
18,595
16,994
7,712
20192010200019901980197019601950194019301920
4,389
For more information about the number and value of checks collected, visit the Payment Systems section of the Federal Reserve
Board’s website, https://www.federalreserve.gov/paymentsystems.htm.
Fostering Payment and Settlement System Safety and Efficiency 93
Automated Clearinghouse Service
The ACH is a nationwide electronic payment system, developed jointly by the private sector and
the Federal Reserve in the early 1970s as a more efficient alternative to checks. At that time, it
seemed that the increasing volume of paper checks used by businesses and consumers would
eventually exceed the ability of the existing equipment to process and sort the checks efficiently.
How ACH Works
The ACH has grown into a major nationwide electronic payment mechanism that processes files of
electronic funds transfers (payments). In general, ACH transactions are either credit or debit trans-
fers (figure 6.5). In an ACH credit transfer, an individual, corporation, or other entity (originator)
“pushes” or sends funds from its account to that of the receiver. In a debit transfer, the receiver
authorizes an originator to “pull” funds from the receiver’s account.
The Reserve Banks and the Electronic Payments Network, a private organization, are currently the
two national ACH operators. As an ACH operator, the Reserve Banks receive files of payments
from originating institutions, edit and sort the payments, deliver the payments to receiving institu-
tions, and settle the payments by crediting and debiting the institutions’ accounts. Unlike Fedwire
transfers, which are processed and settled immediately, ACH transactions are value-dated—that
is, the originator of the ACH transaction includes the settlement date in the payment instructions
when they originate the transaction.
In the past, the United States had several regional ACH systems, but over time, the industry
consolidated to the current structure of two national ACH systems. In 2019, the Federal Reserve
processed more than 15.5billion commercial ACH payments, worth approximately $28.1trillion,
and more than 1.7billion government ACH payments, worth approximately $5.8trillion.
The ACH was originally designed to help automate recurring payments, such as government benefit
payments, payroll payments, and consumer mortgage and utility payments. Much of the recent
Figure 6.5. Examples of automated clearinghouse transfers
Automated clearinghouse (ACH) transfers can be categorized as either “credit transfers” or “debit transfers” based
on the type of instruction sent by the originator of the transfer.
Credit transfer Debit transfer
Payroll direct deposits
Government benefit payments, such as Social Security benefits
Corporate payments to contractors and vendors
Direct debits of recurring consumer bills, such as mortgages, utility pay-
ments, and insurance premiums
Checks converted by merchants to ACH debits
One-time payments authorized over the internet or telephone
94 The Fed Explained: What the Central Bank Does
growth in ACH payments has resulted from one-time transactions such as consumer payments
initiated over the internet or telephone.
The Federal Reserve’s Role in ACH Development
The Reserve Banks became an ACH operator in large part because of the Reserve Banks’ role
as fiscal agents of the Treasury and because of the synergies between the ACH and the Federal
Reserve’s then-existing check service. The Treasury, earlier than most businesses, embraced the
use of the ACH as a potentially more efficient way to make many of the government’s payments,
particularly payrolls for military and civilian workers and benefit payments such as Social Security.
(Until the mid-1980s, most ACH volume was originated by the federal government.) The combina-
tion of commercial and government ACH payments created economies of scale earlier than might
otherwise have been the case, allowing the ACH to become a broadly used national service (figure 6.6).
Initially, the ACH system relied on magnetic tapes and paper listings to exchange ACH files. Their
use required physical transport of tapes between the participants in the ACH system, which made
use of the then-existing Reserve Bank national check-transportation infrastructure (e.g., planes
and trucks). In the mid-1990s, the Federal Reserve mandated that all institutions’ ACH payment
files be deposited electronically and all output files be delivered electronically. That is, all institu-
Figure 6.6. Commercial automated clearinghouse transactions processed by
the Federal Reserve, 1989–2019
In less than 25years, the value of commercial automated clearinghouse transactions processed by the Federal
Reserve has more than quadrupled.
20192016201320102007200420011998199519921989 20192016201320102007200420011998199519921989
Billions of dollars
3,840
6,531
7,817
10,338
12,707 12,544
14,547
16,941
19,689
21,772
28,082
Source: Commercial automated clearinghouse transactions processed by the Federal Reserve—annual data (available in the
Payment Systems section of the Federal Reserve Board’s website, https://www.federalreserve.gov/paymentsystems.htm).
Fostering Payment and Settlement System Safety and Efficiency 95
tions dealing with the Federal Reserve directly were required to have an electronic connection to
participate in the ACH.
To provide a more cost-effective mechanism for cross-border payments, the Reserve Banks
launched their first commercial international ACH service with Canada in 2001. The Reserve Banks
have since established “FedGlobal” international ACH services to Europe and Latin America.
FedNow
SM
Service
In August2019, the Board of Governors announced that the Reserve Banks will develop a new
around-the-clock, real-time clearing and settlement service, called the FedNow Service, to support
instant payments.
Instant payments allow individuals and businesses to send and receive payments within seconds
at any time of the day, on any day of the year, such that the receiver of a payment can use the
funds almost instantly. The Federal Reserve believes that instant payments have the potential to
become widely used and to yield economic benefits for individuals by providing them with more
flexibility to manage their money and make time-sensitive payments. The FedNow Service will sup-
port a nationwide infrastructure on which the financial services industry may develop innovative
instant payment services for the benefit of all Americans.
The FedNow Service will conduct real-time, payment-by-payment, final settlement of interbank obli-
gations through debits and credits to depository institutions’ balances in accounts at the Reserve
Banks. The service will incorporate clearing functionality, allowing depository institutions, in the
process of settling each payment, to exchange information needed to make debits and credits to
the accounts of their customers. The service is expected to be available in 2023.
Wholesale Payment Services
Wholesale payments—such as those related to large commercial loans and transactions involv-
ing real estate, securities, and money markets—tend to be small in number and large in value,
and typically support domestic and international commercial and financial activities. The Reserve
Banks operate services designed to support these complex, high-value transactions.
Fedwire Funds Service
The Fedwire Funds Service is a real-time gross settlement (RTGS) system through which partici-
pants are able to initiate electronic funds transfers that are processed individually in real time as
the funds transfer instructions are received by the Reserve Banks. Once processed, Fedwire funds
transfers are final and irrevocable.
96 The Fed Explained: What the Central Bank Does
Established in 1918, the Fedwire Funds Service was the world’s first RTGS system. It initially used
Morse code to communicate payment instructions via telegraph lines. Today, the Fedwire Funds
Service relies on secure, sophisticated proprietary data communications and data processing
systems to ensure that each transfer is authorized by the sender and not altered while under the
control of a Reserve Bank.
Participants—including depository institutions and other eligible financial institutions—use the
Fedwire Funds Service to handle large-value, time-critical payments, such as settling interbank
purchases and sales of federal funds; purchasing, selling, or financing securities transactions;
and disbursing or repaying large loans. Participants also use the Fedwire Funds Service to make
smaller-value funds transfers requiring immediate settlement, to make business-to-business remit-
tance payments, and to complete the U.S. dollar leg of international transactions. Fedwire funds
transfers are settled individually by transferring balances held at Reserve Banks from the sending
bank’s account to the receiving bank’saccount.
As financial markets have become more global in scope, the operating hours of the Fedwire Funds
Service have expanded to increase the amount of overlap with the hours of foreign markets. The
Fedwire Funds Service now opens at 9:00 p.m. eastern time (ET) on the night before a business
Figure 6.7. Electronic payments processed by the Fedwire Funds Service, selected years,
1987–2019
The Fedwire Funds Service is used by depository institutions and other financial institutions to make large-value,
time-critical payments.
201920152011200720031999199519911987
152,454
192,255
222,955
343,382
447,342
670,666
663,838
834,630
695,835
Billions of dollars
For more information about the number and value of transactions processed through the Federal Reserve’s Fedwire Funds Service,
visit the Payment Systems section of the Federal Reserve Board’s website, https://www.federalreserve.gov/paymentsystems.htm.
Fostering Payment and Settlement System Safety and Efficiency 97
day and closes at 7:00 p.m. ET on the business day. For example, processing on a Monday begins
at 9:00 p.m. ET on Sunday and ends at 7:00 p.m. ET on Monday. In 2019, participants used the
service to make 167million transfers worth more than $695trillion (figure 6.7).
Fedwire Securities Service
The Fedwire Securities Service is used by depository institutions and others with a Reserve Bank
account to hold, maintain, and transfer securities issued by the Treasury and other federal agen-
cies, government-sponsored enterprises, and certain international organizations, such as the
World Bank. Participants use the Fedwire Securities Service to issue and redeem securities, to
transfer securities to settle secondary market trades, to move collateral used to secure obliga-
tions, and to facilitate repurchase agreement (repo) transactions. Securities are kept in the form
of electronic records held in custody accounts.
Until the late 1960s, U.S. government securities were only available in paper form. As securities
volumes grew, banks experienced paperwork backlogs and errors. To improve market efficiency
and reduce risk, between 1965 and 1967, the Treasury began issuing securities in electronic form
and the Federal Reserve implemented computer systems to record, service, and transfer them.
The Fedwire Securities Service operates Monday to Friday from 8:30 a.m. to 3:30 p.m. ET,
though participants can reposition securities held in their accounts until 7:00 p.m. ET. In 2019,
participants used the service to initiate more than 19million securities transfers, worth almost
$350trillion (figure 6.8).
National Settlement Service
The Federal Reserve’s NSS is used by participants in multilateral clearing arrangements to settle
transactions on a multilateral basis through designated master accounts held at the Reserve
Banks. Approximately 17 NSS arrangements are currently in use by financial market utilities,
check clearinghouse associations, and other entities.
Using an automated mechanism, an agent for a multilateral clearing arrangement submits a settle-
ment file to a Reserve Bank. The settlement file contains a list of the debit or credit positions of
the settling depository institutions in the arrangement that are to be settled.
The Reserve Bank first processes each debit individually, crediting those funds to a settlement ac-
count on its books. Once the debits have been processed, the Reserve Bank transfers funds from
the settlement account to the accounts of the participants with credit positions. NSS reduces
settlement risk for clearing arrangements because the funds transferred are final and irrevocable
when the debits and credits areposted.
98 The Fed Explained: What the Central Bank Does
NSS is open Monday through Friday from 7:30 a.m. to 6:30 p.m. ET. In 2019, the Federal Reserve
processed about 9,700 net settlement service files, worth almost $21trillion.
Cash Services
The Federal Reserve Board issues the nation’s currency in the form of Federal Reserve notes to
the Reserve Banks, which, in turn, distribute currency to the public through approximately 8,400
banks, savings and loans, and credit unions. (The remaining depository institutions obtain cash
services from correspondent banks rather than directly from a Reserve Bank.) Federal Reserve
notes in circulation are liabilities of the Reserve Banks and are collateralized by the assets of the
Reserve Banks.
In contrast, coin in circulation is not a liability of the Reserve Banks. The Treasury’s United States
Mint is the issuing authority for coin. The Reserve Banks buy coin at face value from the U.S. Mint
and, in turn, sell it to depository institutions at face value. Coin held by the Reserve Banks is a
non-interest-earning asset of the Reserve Banks.
Figure 6.8. Securities transfers processed by the Fedwire Securities Service, selected
years, 1989–2019
Financial institutions and other parties use this service to hold, maintain, and transfer securities issued by the U.S.
Treasury and other federal agencies, government-sponsored enterprises, and certain international organizations,
such as the World Bank.
20192016201320102007200420011998199519921989 20192016201320102007200420011998199519921989
Billions of dollars
95,654
139,676
149,764
197,782
212,343
313,425
435,578
320,124
295,186
286,672
345,813
For more information about the number and value of transactions processed through the Federal Reserve’s Fedwire Securities
Service, visit the Payment Systems section of the Federal Reserve Board’s website, https://www.federalreserve.gov/
paymentsystems.htm.
Fostering Payment and Settlement System Safety and Efficiency 99
Establishing and Maintaining a Reliable U.S. Currency
Although the issuance of paper money in this country dates back to 1690, the U.S. government
did not issue paper currency until 1861, when Congress approved the issuance of demand Trea-
sury notes.
All currency issued by the U.S. government since then remains legal tender. Today, virtually all cur-
rency in circulation is in the form of Federal Reserve notes, which were first issued in 1914.
As the issuing authority for Federal Reserve notes, the Board has a wide range of responsibilities
related to paper money, from ensuring an adequate supply of currency to protecting and maintain-
ing confidence in the currency. To protect the integrity of Federal Reserve notes, the Board works
with the Reserve Banks, the U.S. Department of the Treasury, the Treasury’s Bureau of Engraving
Figure 6.9. Design of Federal Reserve notes aims to prevent counterfeiting
The Federal Reserve Board, the Treasury’s Bureau of Engraving and Printing, and the U.S. Secret Service primarily
redesign U.S. currency to stay ahead of counterfeiting threats and keep counterfeiting levels low.
Security thread. 3-D security ribbon. Watermark. Color-shifting ink.
Hold the note to light to see an
embedded thread running verti-
cally to the left of the portrait. The
thread is imprinted with the letters
USA and the numeral 100 in an
alternating pattern and is visible
from both sides of the note. The
thread glows pink when illuminated
by ultraviolet light.
Tilt the note back and forth while focusing
on the blue ribbon. You will see the bells
change to 100s as they move. When you
tilt the note back and forth, the bells and
100s move side to side. If you tilt it side to
side, they move up and down. The ribbon is
woven into the paper, not printed on it.
Hold the note to light and
look for a faint image of
Benjamin Franklin in the
blank space to the right of the
portrait. The image is visible
from both sides of the note.
Tilt the note to see the numeral
100 in the lower right corner of
the front of the note shift from
copper to green.
For more information on the security and design of Federal Reserve notes, go to https://uscurrency.gov.
100 The Fed Explained: What the Central Bank Does
and Printing (BEP), and the United States Secret Service to monitor counterfeiting threats for each
denomination and to redesign notes to counter these threats (figure 6.9).
Federal Reserve notes are periodically redesigned to make notes more difficult to counterfeit but
still easy to authenticate as genuine. The Board manages a program to educate the public on the
security and design features in Federal Reserve notes to help protect and maintain confidence in
U.S. currency.
The Reserve Banks also help maintain confidence in our nation’s currency by ensuring the qual-
ity and integrity of Federal Reserve notes in circulation. The Reserve Banks accept and process
deposits of currency from depository institutions and credit their accounts at the Federal Reserve.
Using high-speed sorting equipment, the Reserve Banks “piece-count” the deposits and remove
worn and soiled currency and suspected counterfeits. The fit currency that remains is packaged
and returned to the vault, to be used along with new currency to fill future orders from depository
institutions. Notes that are unfit for circulation are destroyed. Suspected counterfeit notes are
delivered to the United States Secret Service for analysis and final adjudication.
Each year, the Board determines the number of new Federal Reserve notes that are expected to
be needed and submits a print order to the BEP . The order reflects the Board’s estimate of the
additional amount of currency that the public will demand in the upcoming year and destruction
rates of unfit currency. The Board pays the BEP the cost of manufacturing new currency and ar-
ranges and pays the cost of transporting the currency from the BEP’s facilities to Reserve Bank
cash offices.
Demand for currency comes from both domestic and international sources. Domestic demand
for currency is largely based on the use of currency for transactions and is influenced primarily by
income levels, prices of goods and services, the availability of alternative payment methods, and
the opportunity cost of holding currency rather than an interest-bearing asset. In contrast, foreign
demand for U.S. currency is influenced primarily by the political and economic uncertainties as-
sociated with certain foreign currencies. As of 2019, there were more than $1.75trillion worth of
Federal Reserve notes in circulation (figure 6.10), and the Board estimates that between one-half
and two-thirds of the value of U.S. currency is held outside the United States.
Coin
The Reserve Banks’ role in coin operations is more limited than their role in currency operations.
Although the Reserve Banks store some coin in their own vaults, they also contract with armored carri-
ers that operate coin terminals to store, process, and distribute coin on behalf of the Reserve Banks.
Fostering Payment and Settlement System Safety and Efficiency 101
As the issuing authority for coins, the U.S. Mint determines annual coin production. The Reserve
Banks order coin from the U.S. Mint and pay the U.S. Mint the full face value of the coin, rather
than the cost to produce it. The U.S. Mint transports the coin to the Reserve Banks and the Re-
serve Banks’ coin terminal locations.
Fiscal Agency Services: Acting as the U.S. Government Bank
The Reserve Banks provide a range of services to the U.S. government, acting as the govern-
ment’s fiscal agent. These services include financial, account management, and securities ser-
vices, as well as application development and technology infrastructure support.
Early History of Fiscal Agency and Depository Services
The provision of fiscal agency and depository services began in 1915 when the Treasury began
transferring U.S. government funds on deposit at national banks to its account at Reserve Banks.
This action established Reserve Banks as the key intermediaries through which funds are col-
lected and disbursed for the federal government.
In 1917, the Federal Reserve performed the first public debt functions, when Reserve Banks were
authorized to receive subscriptions on the First Liberty Loan—bonds issued to help finance the
Figure 6.10. Value of U.S. currency in circulation, selected years, 1940–2019*
The Federal Reserve measures demand for U.S. currency, and the Reserve Banks ensure that depository institutions
around the country have ready access to cash.
201920102000199019801970196019501940
Billions of dollars
8.1
26.2
30.4
50.8
124.8
268.2
563.9
942.0
1,759.8
* Data include Federal Reserve notes and currency no longer issued but exclude coin and denominations larger than the $100 note.
For more information about the value and volume of currency in circulation and the volume, value, and cost of the new currency print
order, visit the Payment Systems section of the Federal Reserve Board’s website, https://www.federalreserve.gov/paymentsystems.
htm.
102 The Fed Explained: What the Central Bank Does
United States’ World War I effort. After World War I, the government’s need to borrow compelled
the Treasury to seek an operational alternative to its limited network of subtreasuries—field
offices that functioned as the government’s bank in various regions of the country. The Federal
Reserve subsumed these public debt-related activities, and the last subtreasury closed in 1921.
Reserve Bank fiscal agency services continued to grow in response to expanding government
funding requirements. For example, the financing efforts associated with World War II increased
the scope of Reserve Bank fiscal agency functions to include the sale and redemption of Series E
savings bonds beginning in 1941. While initially known as Defense Bonds and War Savings Bonds,
Series E bond issuance continued until 1980, with millions of Americans purchasing these bonds.
In the 1960s and 1970s, the Reserve Banks’ role as fiscal agents expanded to include ser-
vices—primarily securities-related services—to other federal agencies, government-sponsored
enterprises, and international organizations, either at the Treasury’s request or through a separate
congressional mandate. As noted earlier, the federal government in the 1970s became an early
user of ACH services to expedite the processing of government payments, and the ACH now plays
a central role in the government’s payments and collections.
Reserve Banks currently provide fiscal agency services to a significant number of federal entities.
Expenses associated with providing these services account for approximately 13 percent of the
Federal Reserve’s total operating costs. The Treasury and other agencies reimburse the Reserve
Banks for the cost of providing fiscal agency services.
Collections, Payments, and Account Management
The Reserve Banks accept deposits of fees and non-tax-related payments to the federal govern-
ment, pay checks drawn on the Treasury’s account at the Federal Reserve, and make and receive
electronic payments on behalf of the Treasury and government agencies. The Reserve Banks also
process U.S. postal money orders and conduct other activities on behalf of certain government
agencies.
The Reserve Banks operate multiple systems that support the collection and processing of pay-
ments to the government from the public, including Pay.gov, a Treasury program that allows the
public to use the internet to authorize and initiate payments to federal agencies. Payments can
be made to federal agencies using a U.S.-held bank account (through ACH debit), a credit or debit
card, or a digital wallet.
The Reserve Banks work closely with the Treasury and other government agencies to process pay-
ments to individuals, businesses, institutions, and government agencies. The Reserve Banks pro-
Fostering Payment and Settlement System Safety and Efficiency 103
cess federal payroll payments, Social Security and veterans’ benefits, income tax refunds, vendor
payments, and other types of payments.
Disbursements from the Treasury’s account at the Federal Reserve are processed primarily
through ACH payments or Fedwire funds transfers or, to a limited extent, by check. The increased
use of electronic payments provides the Treasury opportunities to minimize the costs and inef-
ficiencies associated with the delivery of check payments and ultimately to reduce costs to U.S.
taxpayers.
The Reserve Banks maintain the Treasury’s operating account, provide accounting and reporting
services, monitor collateral pledged to the government, and facilitate the investment of excess bal-
ances, as directed by the Treasury.
Treasury Security Auctions and Related Services
As fiscal agents, the Reserve Banks auction marketable Treasury securities and issue, maintain,
and redeem savings bonds. In addition, the Reserve Banks provide securities-related services to
federal agencies, government-sponsored enterprises, and certain international organizations under
separate statutory authority.
Historically, Reserve Banks employed large staffs to process manually paper-based Treasury bills,
notes, bonds, and savings bonds until the advent of marketable book-entry securities in the late
1960s.
Book-entry securities—which are electronic records rather than paper certificates—were created
primarily to gain efficiencies in the secondary market for Treasury securities. Beginning in 1986,
individual investors could also buy and hold marketable book-entry securities in the TreasuryDirect
system.
Over the years, the Reserve Banks have adapted and modernized their operations in support of
the Treasury’s securities programs and worked with the Treasury to respond to the declining vol-
umes of paper-based products. The Reserve Banks work with the banking industry to improve the
process used to submit savings bonds for redemption.
Using Technology to Modernize Federal Government Financial Services
In recent years, technological developments—many involving the use of internet technologies—
have provided new opportunities for the Reserve Banks to support the Treasury in modernizing fed-
eral government financial services, such as collections and payment processes, governmentwide
financial reporting, and debt collection.
104 The Fed Explained: What the Central Bank Does
The Reserve Banks also actively support the Treasury’s efforts to increase electronic payments
transactions and reduce paper-based transactions, and to re-engineer the government’s account-
ing, reporting, and reconciliation processes. The Reserve Banks have also developed tools to help
the Treasury and government agencies verify the accuracy of federal payments before they are
made and to assist in the collection of delinquent debt.
Services to Foreign Central Banks and International Organizations
As the central bank of the United States, the Federal Reserve also provides correspondent bank-
ing services to foreign central banks and monetary authorities.
The Federal Reserve Bank of New York (FRBNY) provides several types of services to these orga-
nizations, including maintaining noninterest-bearing deposit accounts (in U.S. dollars), securities
safekeeping accounts, and gold safekeeping. Some foreign official institutions direct a portion
of their daily receipts and payments in U.S. dollars through their funds accounts at the Federal
Reserve.
If an account contains excess funds, the foreign official institution may request that these funds
be invested overnight in repurchase agreements (repos) with the FRBNY. If investments are need-
ed for longer periods, the foreign official institution may provide instructions to the FRBNY to buy
securities to be held in safekeeping. Conversely, the foreign institution may provide instructions to
sell securities held in safekeeping, with the proceeds deposited in its account.
The FRBNY also provides securities-issuing and paying-agent services to international organiza-
tions such as the International Monetary Fund and the World Bank.
Regulating and Supervising the Payment System
For many decades, the Board’s authority to regulate the payment system was limited to payments
handled by the Reserve Banks. The Board used this authority to regulate check payments collect-
ed or returned through the Reserve Banks and to regulate Fedwire funds transfers.
Beginning in the 1970s, Congress directed the Board to implement several consumer protection
statutes governing payments, including the Fair Credit Billing Act of 1974, the Electronic Fund
Transfer Act of 1978, and the Expedited Funds Availability Act of 1987 (EFAA). The Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank Act) transferred the Board’s rulemaking
authority with respect to most consumer protection laws to the Consumer Financial Protection
Bureau (CFPB), but the Board shares rulemaking authority with the CFPB with respect to the funds
availability and disclosure requirements of the EFAA.
Fostering Payment and Settlement System Safety and Efficiency 105
During the last two decades, Congress has directed the Board to prescribe regulations implement-
ing a variety of other payments-related statutes (figure 6.11). For example, the Board and the
Treasury jointly promulgated regulations implementing the Unlawful Internet Gambling Enforce-
ment Act of 2006, which requires designated payment system participants to establish policies
and procedures to identify and block, or otherwise prevent or prohibit, unlawful internet gambling
transactions.
In 2010, the Dodd-Frank Act provided the Board additional authority to regulate and supervise
certain payment, clearing, and settlement systems and activities that have been designated as
systemically important, as well as prescribe rules related to debit card interchange fees. In 2011,
in accordance with the Dodd-Frank Act, the Board adopted rules limiting debit card interchange
fees of certain issuers and prohibiting network exclusivity arrangements and routing restrictions.
In 2012, pursuant to the Dodd-Frank Act, the Board adopted rules setting forth risk-management
standards for certain financial market utilities (FMUs) and requirements regarding advanced notice
to the Board from certain FMUs of material changes to their rules, procedures, or operations.
Expedited Funds Availability Act
The EFAA broadened the Federal Reserve Board’s authority to regulate interbank payments, includ-
ing payments not handled by the ReserveBanks.
Figure 6.11. Federal Reserve regulations governing the payment system
The Federal Reserve has adopted the following set of regulations, which implement certain federal laws governing
the U.S. payment system and the operations of participating institutions.
Regulation (by letter and name) Description
J Collection of Checks and Other Items by Federal
Reserve Banks and Funds Transfers Through Fedwire
Governs the collection and return of checks through the Reserve Banks and Fedwire
funds transfers
CC Availability of Funds and Collection of Checks Governs the availability of funds deposited in transaction accounts and the collec-
tion and return of checks
EE Netting Eligibility for Financial Institutions Defines financial institutions to be covered by statutory provisions that validate
netting contracts, thereby permitting one institution to pay or receive the net, rather
than the gross, amount due, even if the other institution is insolvent
GG Prohibition on Funding of Unlawful Internet
Gambling
Requires U.S. financial firms that participate in designated payment systems to
establish and implement policies and procedures reasonably designed to prevent
payments connected to unlawful internet gambling
HH Designated Financial Market Utilities Establishes standards and procedures related to the supervision of certain financial
market utilities designated as systemically important
II Debit Card Interchange Fees and Routing Establishes standards for debit card interchange fees and prohibits payment card
network exclusivity arrangements and routing restrictions for debit card trans actions
Note: For a list of regulations governing banks and banking, holding companies and nonbank financial companies, and securities
credit transactions, see section 5, “Supervising and Regulating Financial Institutions and Activities,” on page 62. For a list of
consumer and community affairs-related regulations, see section 7, “Promoting Consumer Protection and Community Development,”
on page 112.
106 The Fed Explained: What the Central Bank Does
The Board initially used this expanded authority to adopt rules to speed the return of unpaid
checks. These rules reduced the risk that banks in which checks had first been deposited would
have to make the funds from check deposits available for withdrawal (under the EFAA’s timing re-
quirements) before learning whether the check had been returned unpaid. In the 1990s, the Board
used this authority to adopt its same-day settlement rule, which improved competition between cor-
respondent banks and the Reserve Banks in the collection of checks, spurring further efficiencies.
Electronic Check Processing
To help facilitate the electronic collection and return of checks, the Check 21 Act was enacted
by Congress in 2003 and became effective in 2004. The Board adopted regulations implement-
ing the act in 2004. To improve the efficiency of the check-collection process, the Check 21 Act
enabled collecting banks to truncate all paper original checks, to send checks electronically to
banks with which they have electronic exchange agreements, and to send paper substitute checks
to banks with which they do not have such agreements. These changes materially hastened the
electronic processing of checks.
In 2017, the Board made changes to its rules to reflect the nearly complete transition of the
nation’s check-collection system from one that was largely paper-based to one that is virtually all
electronic.
Financial Market Utilities
The Federal Reserve regulates and supervises certain financial market utilities. FMUs are mul-
tilateral systems that provide the infrastructure for transferring, clearing, and settling payments,
securities, and other financial transactions among financial institutions or between financial insti-
tutions and the system. These systems include payment systems, securities settlement systems,
central securities depositories, and central counterparties.
FMUs play a critical role in the U.S. and global financial system. FMUs often give rise to risks and
interdependencies among financial institutions both within and across national borders, creat-
ing the potential for widespread financial disruptions if an FMU fails to perform as expected. The
Federal Reserve, with its mandate for financial stability, is particularly interested in the smooth
functioning of these FMUs and their robust supervision.
The Federal Reserve regulates and supervises certain FMUs under several authorities. Motivated
by financial stability objectives, the Dodd-Frank Act sets forth an enhanced supervisory framework
for FMUs that have been designated as systemically important by the Financial Stability Oversight
Council. Among other things, the Dodd-Frank Act authorizes the Board to supervise certain desig-
nated FMUs and participate in the examinations of other designated FMUs.
Fostering Payment and Settlement System Safety and Efficiency 107
The Board may also have an interest in the safety and efficiency of systems outside the United
States that provide services to financial institutions supervised by the Board or that conduct activ-
ity that involves the U.S. dollar. In these cases, the Board will seek to cooperate with relevant au-
thorities to share information, understand the risks that these systems pose to the U.S. financial
system, and promote sound risk management.
Regulation HH sets the Board’s risk-management standards for designated FMUs for which the
Board is the supervisory agency pursuant to the Dodd-Frank Act. The Federal Reserve Policy on
Payment System Risk (PSR policy) (https://www.federalreserve.gov/paymentsystems/psr_about.
htm) sets forth the Board’s views and related standards regarding risk management in payment,
clearing, settlement, and recording systems more generally, including in payment and settlement
systems operated by the Reserve Banks.
Figure 6.12. Peak and average daylight overdrafts of depository institutions, 1986–2019
The Federal Reserve measures the account balance of each depository institution at the end of each minute
during the business day. An institution’s peak daylight overdraft for a given day is its largest negative end-of-minute
balance.
$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
$200
201920162013201020072004200119981995199219891986
Billions
Average daylight overdraft
Peak daylight overdraft
Note: Quarterly averages of daily data. The Federal Reserve measures each depository institution’s account balance at the end of
each minute during the business day. An institution’s peak daylight overdraft for a given day is its largest negative end-of-minute
balance. The System peak daylight overdraft for a given day is determined by adding the negative account balances of all depository
institutions at the end of each minute and then selecting the largest negative end-of-minute balance. The average daylight overdraft
for a given day is the sum of the average per-minute daylight overdrafts for all institutions on that day. Further data regarding peak
and average daylight overdrafts is available in the Payment Systems section of the Federal Reserve Board’s website, https://www.
federalreserve.gov/paymentsystems.htm.
108 The Fed Explained: What the Central Bank Does
Providing Banking System Liquidity
For many years prior to the 2007–09 financial crisis, depository institutions in the aggregate typi-
cally held few funds overnight in their accounts at Reserve Banks relative to the trillions of dollars
of payments processed daily by the System. To ensure the U.S. payment system’s smooth func-
tioning, the 12 Reserve Banks extend intraday credit, or “daylight overdrafts” (figure 6.12).
Institutions incur daylight overdrafts in their Federal Reserve accounts because of the mismatch in
timing between the settlement of payments owed and the settlement of payments due. To address
the risk of providing such credit, the PSR policy—adopted by the Federal Reserve Board in 1985
and adjusted since then—controls institutions’ use of daylight overdrafts. The PSR policy balances
the goals of ensuring smooth functioning of the payment system with the need to manage the
direct risk to the Federal Reserve of offering institutions intradaycredit.
The PSR policy establishes various measures to control the risks associated with daylight over-
drafts. Beginning in 1985, the PSR policy set a maximum limit, or net debit cap, on depository
institutions’ daylight overdraft positions. Institutions must have regular access to the Federal
Reserve’s discount window so that they can borrow overnight from their Reserve Bank to cover
any daylight overdrafts that are not eliminated before the end of the day. Beginning in 1994, the
Reserve Banks began charging fees to depository institutions for their use of daylight overdrafts
as an economic incentive to reduce their overdrafts, thereby reducing direct Federal Reserve
credit risk and contributing to economic efficiency. In 2011, the Board revised the PSR policy to
recognize explicitly the role of the central bank in providing intraday balances and credit to healthy
depository institutions and to provide collateralized intraday credit at a zero fee.
Managing the Federal Reserve’s direct credit risk from institutions’ use of Federal Reserve intraday
credit can prove crucial because there have been periods during which Reserve Bank exposure to
daylight overdrafts has been significant and highly concentrated in a few institutions. For example,
after the collapse of Lehman Brothers in September2008, daylight overdraft activity rose to its
highest level since the Federal Reserve began measuring it in the 1980s. Since 2008, higher
overnight balances held at the Reserve Banks have been associated with lower levels of daylight
overdrafts.
Despite the decline in overall levels of daylight overdrafts, this important tool continues to play a
key role in many institutions’ efforts to efficiently settle daily payments.
Fostering Payment and Settlement System Safety and Efficiency 109
Figure 6.13. As popularity of electronic payments grows, use of checks declines
The Federal Reserve monitors trends in the payment system, such as the increasing use of electronic forms of
payment. Since 2000, the use of debit cards has experienced the most growth, while the use of checks has steadily
declined.
0
15
30
45
60
75
2018201520122009200620032000
Number of noncash payments in billions
Non-prepaid
debit cards
Credit cards
ACH
Checks
Prepaid
debit cards
Note: Years in between studies are estimated linearly.
ACH Automated clearinghouse.
Source: The 2019 Federal Reserve Payments Study (available on the Federal Reserve Board’s website, https://www.federalreserve.
gov/paymentsystems/2019-December-The-Federal-Reserve-Payments-Study.htm).
Exploring and Implementing Payment System Improvements
Conducting Research and Analysis
The Federal Reserve conducts research on a wide range of topics related to the design and activi-
ties of payment, clearing, and settlement (PCS) systems and financial market infrastructures, as
well as the role of these systems in the commercial activities of consumers, businesses, and
governments.
Both theoretical and empirical research and analysis of policy issues inform policymakers, the
industry, and the public. Research topics include
• design of financial market infrastructure and risk management for complex financial instru-
ments, including derivatives;
• analysis of technological change and market structure in payment and settlement activity;
• collection and analysis of data on the use of payment instruments and on the drivers of pay-
ment behavior; and
110 The Fed Explained: What the Central Bank Does
• the effect of Federal Reserve policies on market participants, such as the implications of day-
light overdraft policy and the effect of payment regulations.
To inform its supervision of financial market infrastructures, the Federal Reserve analyzes finan-
cial and technological trends in payments and other financial instruments. Analysis often focuses
on economic efficiency and risk, including systemic risk and the impact of financial institutions
engaged in PCS activities on financial markets’ stability. Some examples of recent research topics
include the role of central counterparties in clearing over-the-counter financial transactions and
developments and risks in the market for triparty repurchase agreements.
Serving as a Catalyst for System Improvements
As the central bank, the Federal Reserve can act as a catalyst to improve the safety and efficiency
of PCS systems, working in cooperation with the private sector and other public-sector institutions,
both domestically and internationally.
For example, to help facilitate the electronic collection and return of checks, the Federal Reserve
worked collaboratively with representatives of depository institutions, businesses, consumer
groups, and the Treasury to develop the draft legislation that became the Check 21 Act. In ad-
dition, the Federal Reserve provided leadership, working with other central banks and market
regulators to develop and, more recently, to enhance risk-management standards for systemically
important financial market infrastructures.
The Federal Reserve has also used its role as a leader and catalyst in facilitating collaboration
among industry stakeholders to identify, develop, and implement improvements in the end-to-end
speed, safety, and efficiency of U.S. payments.
Building on extensive stakeholder outreach and market research, the Board and the Reserve
Banks released the “Strategies for Improving the U.S. Payment System” paper in January2015
(available in the Payment Systems section of the Federal Reserve Board’s website, https://www.
federalreserve.gov/paymentsystems.htm). The paper communicates desired outcomes for the
U.S. payment system and outlines the strategies and tactics the Federal Reserve will pursue, in
collaboration with stakeholders, to help the country achieve these outcomes.
The Board and Reserve Banks issued “Strategies for Improving the U.S. Payment System: Federal
Reserve Next Steps in the Payments Improvement Journey” in September2017 (available in the
Payment Systems section of the Federal Reserve Board’s website, https://www.federalreserve.
gov/paymentsystems.htm). The paper communicates the Federal Reserve’s next steps for col-
laborating with the industry to move closer to achieving the desired outcomes as described in the
2015 Strategies Paper.
The Federal Reserve’s research efforts may also act as a catalyst for change. For example, the
Federal Reserve’s payments surveys help inform the strategic plans of payment system partici-
pants by providing data and insights regarding payment trends. For the latest on Federal Reserve
efforts to support innovation, visit the innovation website at https://www.federalreserve.gov/
aboutthefed/innovation.htm.
112 The Fed Explained: What the Central Bank Does
7
Promoting Consumer
Protection and Community
Development
The Federal Reserve advances supervision,
community reinvestment, and research to
improve understanding of the impacts of financial
services policies and practices on consumers and
communities.
Consumer Protection Supervision and Examination ...........114
Administering Consumer Laws and Drafting Regulations .......123
Research and Analysis of Emerging Consumer Issues ........123
Community Economic Development Activities ...............125
Promoting Consumer Protection and Community Development 113
The Federal Reserve is responsible for promoting consumer protection and community development
to help ensure a fair and transparent financial services marketplace that benefits all Americans.
The Federal Reserve understands that healthy communities and well-served consumers help sup-
port and drive economic growth. That’s why the Federal Reserve is committed to ensuring that
consumer and community perspectives inform its policy, research, and actions.
The Federal Reserve promotes consumer protection and community development in several ways,
namely
• formulating and carrying out risk-focused supervision and examination policy to ensure that
financial institutions under its jurisdiction comply with applicable consumer protection laws and
regulations and meet the requirements of community reinvestment laws and regulations;
Figure 7.1. The Federal Reserve works to ensure that the financial institutions it
supervises comply with laws that protect consumers
Federal Reserve survey data show that nearly all American families are involved in the financial services
marketplace, whether as bank account holders, credit card users, or borrowers. The Federal Reserve’s consumer-
focused supervision and regulation, research and analysis, and community engagement programs help ensure that
consumer and community perspectives inform supervisory and policy work.
Other
installment loan
Education
loan
Auto
loan
Credit card
balance
Mortgage/
HELOC
Transaction
account*
Percent of U.S. households having:
98.2
46.8
45.4
36.9
21.5
10.5
* Transaction account includes checking, savings, and money market deposit accounts; money market mutual funds; call or cash
accounts at brokerages; and prepaid debit cards.
HELOC Home equity line of credit.
Source: 2019 Survey of Consumer Finances (available in the Economic Research section of the Federal Reserve Board’s website,
https://www.federalreserve.gov/econres/scfindex.htm).
114 The Fed Explained: What the Central Bank Does
• writing and reviewing regulations that implement consumer protection and community reinvest-
ment laws, taking into account, when appropriate, institutions’ business models and asset size;
• conducting rigorous research, analysis, and data collection to identify and assess consumer
and community development issues to understand emerging opportunities and risks when mak-
ing policy decisions; and
• engaging, convening, and informing key stakeholders to identify emerging issues and policies
and practices to advance effective community reinvestment and consumer protection.
Consumer Protection Supervision and Examination
Various consumer protection, fair lending, fair housing, and community reinvestment laws apply to
how financial institutions interact with their customers and their communities. A primary Federal
Reserve responsibility to consumers is to ensure that the financial institutions under its jurisdic-
tion comply with applicable laws established by Congress and regulations implemented by the
federal regulatory agencies.
Who the Federal Reserve Supervises for Consumer Protection Laws
and Regulations
The Federal Reserve conducts tailored, risk-focused supervision of state member banks for com-
pliance with consumer- and community- oriented laws commensurate with their size and risk profile
based on their products and services (for a full discussion of state member banks, see section
5, “Supervising and Regulating Financial Institutions and Activities,” on page 62). The Federal
Reserve evaluates
• performance under the Community Reinvestment Act (CRA) for all state member banks, regard-
less of size;
• compliance by all state member banks, regardless of size, and their affiliates with the Fair
Housing Act, the Servicemembers Civil Relief Act, the National Flood Insurance Act, prohibitions
on unfair or deceptive acts or practices (UDAP) under the Federal Trade Commission Act, and
certain other federal consumer financial protection laws not specifically under the Consumer
Financial Protection Bureau’s authority; and
• compliance by state member banks with total assets of $10 billion or less with all federal
consumer financial protection laws and regulations. (See figure 7.2 for an overview of federal
consumer financial protection laws and regulations that apply to banks.)
In addition, the Federal Reserve serves as the consolidated supervisor for all bank holding compa-
nies and ensures that assessments of consumer compliance risk are appropriately incorporated
Promoting Consumer Protection and Community Development 115
into a holding company’s consolidated supervision rating. The Federal Reserve has additional
supervisory responsibility as the federal supervisor for savings and loan holding companies and
the consolidated supervisor for foreign banking organizations and nonbank financial companies
designated by the Financial Stability Oversight Council for supervision by the Federal Reserve un-
der the Dodd-Frank Wall Street Reform and Consumer Protection Act. (For more details on entities
the Federal Reserve supervises, see section 5, “Supervising and Regulating Financial Institutions
and Activities,” on page 62.)
How the Federal Reserve Supervises for Consumer Protection Laws
and Regulations
The Federal Reserve Board of Governors (Board of Governors), and the 12 Federal Reserve Banks
(Reserve Banks) under delegated authority, have responsibilities for consumer compliance supervi-
sion of organizations under the Federal Reserve’s jurisdiction. The Board’s Division of Consumer
and Community Affairs (DCCA) supports the Board in carrying out its consumer protection activi-
ties.
The Board develops consumer compliance supervisory policies and identifies emerging issues;
provides continuous examiner training; and assists with the enforcement of fair lending, UDAP, and
flood insurance violations. Further, the Board evaluates applications involving bank or thrift hold-
ing companies or state member banks that present CRA or consumer compliance issues, or that
receive adverse comments from external parties. The Board also works with other agencies to
promote consistency in examination principles, standards, and processes.
A Regional Approach to Supervision
The Federal Reserve employs a regionalized approach to supervision. The Board has delegated its
examination authority to the 12 Reserve Banks, which maintain consumer compliance supervisory
programs that evaluate institutions for their level of compliance with applicable consumer protec-
tion laws, using policies set by the Board that are tailored to account for risk profiles and asset
size. Each Reserve Bank has a staff of examiners who conduct periodic compliance examinations
at financial institutions under the Federal Reserve’s supervisory authority, including state member
banks and bank holding companies. Consumer compliance examiners review the policies and
practices that pertain to consumer products and services offered at each of these institutions.
Staff in DCCA oversee these Reserve Bank programs and routinely evaluate their effectiveness.
The network of Reserve Banks across the United States is integral to the implementation of the
Federal Reserve’s supervisory policy and helps inform the Board’s understanding of consumer
financial services trends and issues that may be specific to some regions of the country.
116 The Fed Explained: What the Central Bank Does
Figure 7.2. Federal consumer financial protection laws and regulations applicable to banks
Financial institutions must comply with a variety of laws and regulations that protect consumers. The Federal
Reserve Banks, using policies set by and under delegated authority from the Board of Governors, maintain
consumer compliance supervisory programs that evaluate institutions for their level of compliance with applicable
consumer protection laws.
(continued on next page)
General banking
Federal Trade Commission Act Prohibits unfair or deceptive acts or practices in any aspect of banking transactions.
Gramm-Leach-Bliley Act (title V, subpart A), Disclo-
sure of Nonpublic Personal Information*
Describes the conditions under which a financial institution may disclose nonpublic personal
information about consumers to nonaffiliated third parties, provides a method for consumers to
opt out of information sharing with nonaffiliated third parties, and requires a financial institution
to notify consumers about its privacy policies and practices.
Depository accounts
Electronic Fund Transfer Act/
Regulation E*
Requires disclosure of the terms and conditions of electronic fund transfers. Protects consumers
against unauthorized transfers and establishes procedures for resolving errors and disputes.
Expedited Funds Availability Act/
Regulation CC
Limits hold periods on deposits made to depository institutions and requires appropriate
consumer disclosures.
Truth in Savings Act/
Regulation DD*
Requires uniform disclosure of terms and conditions regarding interest rates and fees associated
with deposit accounts. Prohibits misleading and inaccurate advertisements.
Credit/general lending
Truth in Lending Act/
Regulation Z*
Requires lenders to clearly disclose lending terms and costs to borrowers, and incorporates the
provisions of the Credit Card Accountability Responsibility and Disclosure Act, Fair Credit Billing
Act, Fair Credit and Charge Card Disclosure Act, Home Equity Loan Consumer Protection Act, and
Home Ownership and Equity Protection Act.
Fair Credit Reporting Act/
Regulation V*
Protects consumers from unfair credit reporting practices and requires credit-reporting agencies
to allow credit applicants to correct inaccurate credit reports.
Equal Credit Opportunity Act/
Regulation B*
Prohibits creditors from discriminating on the basis of race, color, national origin, religion, sex,
marital status, age, receipt of public assistance, and exercise of rights under the Consumer
Credit Protection Act.
Community Reinvestment Act/
Regulation BB
Encourages financial institutions to help meet the credit needs of their entire communities,
including low- and moderate-income neighborhoods.
Promoting Consumer Protection and Community Development 117
Figure 7.2. Federal consumer financial protection laws and regulations applicable to banks
(continued)
Disclosure and Reporting of
CRA-Related Agreements/
Regulation G
Requires banks and their affiliates and other parties to make public certain agreements that
are in fulfillment of the Community Reinvestment Act, and to file annual reports concerning the
agreements with the appropriate agency.
Fair and Accurate Credit
Transactions Act*
Amends the Fair Credit Reporting Act. Enhances consumers’ ability to combat identity theft,
increases the accuracy of consumer reports, allows consumers to exercise greater control over
the type and amount of marketing solicitations they receive, restricts the use and disclosure of
sensitive medical information, and establishes uniform national standards in the regulation of
consumer reporting.
Servicemembers Civil Relief Act and Military
Lending Act
Provides members of the military certain financial protections while on active duty.
Mortgage lending
Fair Housing Act Prohibits discrimination in the sale, rental, and financing of dwellings and housing-related trans-
actions on the basis of race, color, national origin, religion, sex, handicap, or familial status.
Real Estate Settlement
Procedures Act/
Regulation X*
Requires that the nature and costs of real estate settlements be disclosed to borrowers. Also
protects borrowers against abusive practices, such as kickbacks, and regulates the use of escrow
accounts.
Home Mortgage Disclosure Act/
Regulation C*
Requires mortgage lenders to annually disclose to the public data on the geographic distribution
of applications and loans for originations, purchases, home-improvement, and refinancings.
Requires lenders to report data on the ethnicity, race, sex, income of applicants and borrowers,
and other data. Also directs the Federal Financial Institutions Examination Council, of which the
Federal Reserve is a member, to make summaries of the data available to the public.
Other financial topics
Flood Disaster Protection Act/
Regulation H
Requires flood insurance in connection with loans secured by property located in a flood hazard
area designated under the National Flood Insurance Program.
Consumer Leasing Act/
Regulation M*
Requires disclosure of information about the costs and terms of consumer leases for vehicles
and other personal property.
* The Federal Reserve System does not examine for these laws and regulations for depository institutions with total assets in
excess of $10 billion.
118 The Fed Explained: What the Central Bank Does
Insights and examination findings from the Reserve Banks support the Federal Reserve’s efforts
to ensure that banking institutions effectively serve consumers and communities and treat con-
sumers fairly in their credit and financial transactions.
Risk-Focused Consumer Compliance Supervision
The Federal Reserve applies a risk-focused approach to consumer compliance supervision, tailor-
ing examination focus most intensely on those areas involving the greatest compliance risk. This
approach is designed to promote strong compliance risk-management practices at financial institu-
tions and to enhance the efficacy of the Federal Reserve’s supervision program while reducing
supervisory burden on the institutions under the Federal Reserve’s jurisdiction.
Under the Federal Reserve’s risk-focused
consumer compliance supervision program,
consumer compliance examiners follow pro-
cedures for assessing an individual financial
institution’s risk profile, including its consumer
compliance culture and how effectively it iden-
tifies and manages consumer compliance risk,
to tailor the scope and resources needed to conduct an examination. The risk-focused supervision
program also incorporates ongoing supervision to support institutions in their compliance efforts
by helping to identify and, if necessary, address areas of risk in the institution’s compliance risk-
management program or in the level of consumer compliance risk present, as well as to ensure
that supervisory information is up to date.
The Federal Reserve also maintains a risk-focused program for assessing consumer compliance
risk at bank holding companies in the System, to ensure that consumer compliance risk is effec-
tively integrated into the holding company rating.
Supervisory Policies and Guidance
The Federal Reserve communicates consumer-related policy and supervisory expectations and
priorities through Consumer Affairs (CA) supervisory letters, as well as in joint Supervision and
Regulation (SR) letters, when appropriate. The Federal Reserve often works closely with other
supervisors in crafting policy statements and guidance that articulates the agencies’ general
views regarding appropriate practices for a given topic, including compliance with mortgage-related
transactions and data reporting, privacy of consumer financial information, special legal protec-
tions for service members’ credit transactions, and examination procedures for various consumer
protection laws and regulations and the CRA.
Consumer Affairs (CA) letters
To see the wide range of consumer issues addressed
by the Federal Reserve through CA letters, visit the
Consumers & Communities section of the Board’s
website at https://www.federalreserve.gov/supervi-
sionreg/caletters/caletters.htm.
Promoting Consumer Protection and Community Development 119
Interagency Initiatives
Through its participation on the Federal Financial Institutions Examination Council (FFIEC), the
Federal Reserve collaborates with other federal and state banking agencies on consumer financial
supervisory guidance. The FFIEC works to develop uniform principles, standards, and report forms
for the federal examinations of financial institutions. These efforts promote the goal of supervi-
sory consistency and uniformity across the banking industry.
The Board’s FFIEC representative is advised by DCCA staff regarding policy, procedures, and guid-
ance related to consumer compliance supervision. For more information on interagency supervi-
sory initiatives, see “Other Federal Authorities and Entities” on page 69.
Box 7.1. Supporting Compliance with Consumer Laws and
Regulations
The Federal Reserve’s consumer compliance supervision program is founded on the principle that
consumer compliance risk management is an integral part of an institution’s corporate-wide risk
management.
The Federal Reserve’s goal is to support each institution in its efforts to comply with federal consumer
protection laws and regulations and by reviewing its processes and programs to keep up with new or
revised compliance requirements that may arise as laws, regulations, and bank products and services
change. Examiners review various indicators of effective consumer compliance risk management:
• Board of directors and senior management oversight. Directors understand they have
ultimate responsibility for the risk taken by their institutions. Examiners seek to ensure that senior
management is implementing strategies that effectively identify and control for consumer compli-
ance risk.
• Policies and procedures. An effective compliance management program includes documented
policies, procedures, and processes for monitoring and controlling compliance risks.
• Risk monitoring. Robust and timely information management systems should be in place to
provide timely reports to support management in monitoring an institution’s financial condition,
operating performance, and risk exposure.
• Internal controls. An institution’s internal control structure allows it to effectively manage its
consumer compliance risk, and creates effective lines of authority and responsibility.
• Training. An institution should provide its personnel with training regarding rules, regulations, poli-
cies, and procedures that impact the institution’s business lines.
The Federal Reserve conducts outreach and training to financial institutions through webinars, newslet-
ters, and other means to support their understanding of updates and supervisory information. For
more details on these efforts, see the “Consumer and Community Affairs” section of the Board’s
Annual Report (https://www.federalreserve.gov/publications/annual-report.htm).
120 The Fed Explained: What the Central Bank Does
How the Federal Reserve Enforces Consumer Protection
Laws and Rules
After a consumer compliance examination, examiners issue a confidential report of examination,
which includes a consumer compliance program rating that reflects the institution’s performance
with regard to consumer compliance. When an examination reveals that an institution’s policies or
practices do not comply with consumer protection rules and regulations, examiners cite violations
in the report of examination and require management to correct the violations and address any
program deficiencies. The Federal Reserve also has additional supervisory tools to ensure that
bank management addresses consumer compliance program weaknesses, including informal and
formal enforcement actions.
Formal enforcement actions include
• executing a written agreement between the Federal Reserve and the financial institution’s board
of directors or its management that requires the institution to take specified corrective action;
• issuing cease-and-desist orders to halt practices in violation;
• assessing civil money penalties, when appropriate, depending on the nature, severity, and de-
gree of harm to consumers as a result of deficient practices; and
• ordering remedies or restitution to consumers affected by an institution’s violations.
Evaluating Performance under the Community Reinvestment Act
The CRA encourages depository institutions to help meet the credit needs of their local com-
munities, including low- and moderate-income neighborhoods, consistent with safe and sound
operations. The CRA requires the Federal Reserve to evaluate each state member bank’s CRA
performance and assign one of four CRA ratings—Outstanding, Satisfactory, Needs to Improve, or
Substantial Noncompliance. The CRA rating and conclusions, as well as the facts, data, and analy-
sis that support the bank’s rating, are summarized in a publicly available performance evaluation.
CRA examiners assess a bank’s performance using examination procedures tailored to the bank’s
size and the type of business it does. Performance is evaluated in the context of the institution
and the communities within which it operates. That means examiners consider information about
the bank’s business strategy, product offerings, capacity, and constraints, as well as the economic
conditions, lending, investment, and service needs and opportunities in the bank’s communities.
The public can also play a role in the CRA examination process by offering comments on an institu-
tion’s CRA performance, which the financial institution must make accessible to the public. Examin-
ers review these comments and consider them when evaluating a bank’s overall CRA performance.
Promoting Consumer Protection and Community Development 121
An institution’s CRA rating and comments
from the public are also considered when the
institution applies to open additional branches
or to engage in a merger or acquisition. The
public has the opportunity to submit written
comments on an application. These comments
are considered by the Board when it evaluates
the application.
For more information on the Federal Reserve’s
role with the CRA, how banks are evaluated,
and exam schedules, see the Community Re-
investment Act section of the Board’s website
(https://www.federalreserve.gov/consumer-
scommunities/cra_about.htm).
Responding to Consumer Feedback
In addition to tailored, risk-focused examiner reviews of financial institutions, Federal Reserve
staff identify and investigate possible violations of consumer protection laws through the Federal
Reserve System’s consumer complaint and consumer inquiry programs. Through these programs,
staff answer consumers’ questions, explain consumer rights under federal law, investigate com-
plaints against entities supervised by the Federal Reserve, and refer complaints about other enti-
ties to the appropriate agency. Consumer complaints are a critical component of the risk-focused
supervision program. The Federal Reserve uses data on consumer complaint activity in its super-
visory processes when monitoring financial institutions, scoping and conducting examinations,
and analyzing applications. Information about consumer complaints is also reported in the Federal
Reserve Board’s Annual Report to Congress (available at https://www.federalreserve.gov/publica-
tions/annual-report.htm).
Handling Complaints
The Federal Reserve has uniform policies and procedures for investigating and responding to
consumer complaints, which are implemented by staff at the 12 Reserve Banks and the Federal
Reserve Consumer Help (FRCH) Center. The FRCH is a centralized consumer complaint and inquiry
processing center, which allows consumers to contact the Federal Reserve online or by telephone,
fax, mail, or email.
When a consumer files a complaint with the FRCH, the first step is to determine which Reserve
Bank or other banking agency has responsibility for investigating that complaint. If the complaint
involves an entity that is not supervised by the Federal Reserve, the FRCH forwards the complaint
CRA history, public input, and resources
The Community Reinvestment Act(CRA), enacted in
1977 amid concerns over redlining (discrimination in
lending based on a community’s racial composition),
codifies that banks have a continuing and affirma-
tive obligation to help meet the credit needs of their
local communities, including low- and moderate-
income neighborhoods. Federal banking regulators
each publish CRA regulations that detail how the law
is implemented and encourage public input in their
assessment of banks’ CRA performance to inform
supervision and decisions about a bank’s applica-
tion to open more branches or complete a merger or
acquisition. For CRA resources and more on submit-
ting comments, see https://www.federalreserve.gov/
consumerscommunities/cra_about.htm.
122 The Fed Explained: What the Central Bank Does
to the appropriate agency and then tells the consumer how to contact that agency. If a complaint
involves an institution supervised by the Federal Reserve System, the FRCH forwards it to the
Reserve Bank that examines the institution in question to conduct an investigation. The FRCH typi-
cally responds to consumers within 15 business days of the complaint submission.
After receiving the complaint from the FRCH, the Reserve Bank forwards the consumer complaint
to the institution to obtain a written response. During the complaint investigation, the Reserve
Bank analyzes the documentation provided by the consumer and the institution to determine if the
institution violated a law, handled the situation correctly, or corrected an error. The Reserve Bank
communicates the outcome of the investigation to the consumer in writing.
Addressing Inquiries and Potential Financial Scams
The FRCH receives thousands of consumer inquiries on a wide range of topics each year. FRCH
staff strive to provide consumers with information about their rights to enable an understanding of
financial products and services, which may be useful in future financial decisionmaking. The FRCH
website offers information about many of these topics—credit cards, checking accounts, electronic
Box 7.2. Federal Reserve Consumer Help: Responding to
Consumer Complaints and Inquiries
Federal Reserve Consumer Help (FRCH), a centralized consumer complaint and inquiry processing cen-
ter, allows consumers to contact the Federal Reserve online or by telephone, fax, mail, or email.
The FRCH website (https://www.federalreserveconsumerhelp.gov) is a resource for consumers to learn
about financial products and services and provides instructions on how to file a consumer complaint
with the Federal Reserve.
Promoting Consumer Protection and Community Development 123
banking, mortgages, and foreclosures. Consumers are directed to resources offered by federal
agencies and trusted organizations to get accurate and straightforward information to answer their
questions.
The FRCH also empowers consumers to recognize and report potential scams. The FRCH web-
site contains information alerting consumers to characteristics of a scam and provides a link for
reporting the information on a product or service they suspect is a scam.
Administering Consumer Laws and Drafting Regulations
The Federal Reserve Board has rulemaking responsibility under specific statutory provisions of the
consumer financial services laws. The Board issues regulations to implement those laws and also
issues (directly or through staff) official interpretations and compliance guidance for the financial
industry and for the Reserve Banks’ examination staff. The Board also regularly works with other
federal financial regulatory agencies in proposing rules and procedures to implement new laws
and amendments to existing laws and considers, where appropriate, the impact and burden on
institutions of various size and business models. These joint efforts aim to ensure that consumer
protections mandated by Congress are enforced effectively across all institutions.
Research and Analysis of Emerging Consumer Issues
Research and analysis about consumers, their financial experiences, and the communities in
which they live inform Federal Reserve policymaking.
The Board and the Reserve Banks collaborate to identify trends and emerging issues that impact
the financial livelihood and well-being of consumers and communities. This effort relies on a vari-
ety of resources, including a wealth of data collected through surveys and independent research.
Findings from compliance examinations and trends in consumer complaints also help to shed light
on emerging issues. Sources of data and information continually evolve as information resources
and technology provide better insights into the financial services and community development is-
sues of consumers and neighborhoods.
To inform its research efforts, the Federal Reserve engages with consumer and community groups,
academic and policy organizations, and conducts consumer surveys to gain insight into trends in
consumer financial services, community economic development, and policy matters. This informa-
tion and data contribute to the Federal Reserve’s work and provide the consumer perspective for
other Federal Reserve System functions.
124 The Fed Explained: What the Central Bank Does
The results of the Federal Reserve’s research and policy analysis inform its policymaking in various
ways. Tracking and studying emerging issues allows the Federal Reserve to evaluate the impact
that financial services and market trends may have on consumers and communities. Results are
often published and disseminated to inform and foster discussion among regulators, industry
groups, consumer and community advocates, and academic and policy organizations.
The Federal Reserve produces consumer- and community-focused research and analysis that looks
at consumer and household issues broadly, as well as a number of specialized topics, including
• unemployment and workforce development,
• community investment and stabilization,
• household economics and decisionmaking,
• economic conditions and opportunities for rural communities, and
• economic and credit conditions in low- and moderate-income populations and neighborhoods.
In particular, the Board’s Survey of Household Economics and Decisionmaking (SHED), conducted
annually, measures the economic well-being of U.S. households and identifies potential risks to
their finances. See figure 7.3 for more details on the SHED, or go to https://www.federalreserve.
gov/consumerscommunities/shed.htm.
Figure 7.3. Federal Reserve research examines trends and issues affecting consumers and
households
The Federal Reserve Board conducts the annual Survey of Household Economics and Decisionmaking (SHED), a
nationally representative survey that evaluates the economic well-being of U.S. households and identifies potential
risks to their financial stability. The survey includes modules on a range of topics of current relevance to financial
well-being, including economic fragility, employment, banking and credit access, housing, education, student loans,
and retirement.
Handling Unexpected Expenses
Faced with an unexpected $400 expense…
In 2019:
63% would pay using cash or its equivalent
25% would borrow or sell something
12% could not pay
Versus 2013:
50% would pay using cash or its equivalent
32% would borrow or sell something
18% could not pay
2019201820172016201520142013
Percent
50
53
54
56
59
61
63
Would pay unexpected $400 expense with cash or its
equivalent, 2013−19
Note: “Cash or its equivalent” means cash, savings, or a credit card paid off at the next statement.
Source: Report on the Economic Well-Being of U.S. Households in 2019, Featuring Supplemental Data from April 2020 (published May
2020), available at https://www.federalreserve.gov/consumerscommunities/shed.htm.
Promoting Consumer Protection and Community Development 125
For additional Federal Reserve research on consumer topics, visit the Consumers & Communities
section of the Federal Reserve Board’s website at https://www.federalreserve.gov/consumer-
scommunities.htm.
Community Economic Development Activities
The Federal Reserve supports the growth of a strong, stable, and inclusive economy. Increasing
economic opportunity is good for individuals and communities, and it is vital to the overall econo-
my. That’s why community development staff at the Federal Reserve Board and at each of the
Reserve Banks work to foster economically resilient communities all across the country, bring
people together to help remove barriers to upward mobility in underserved communities, and en-
sure that people have access to the information and resources that help them thrive.
Federal Reserve community development staff engage in a wide variety of activities, focused on
such issues as affordable housing, access to financial services, and community development
finance. Although activities vary throughout the System, they aim to advance goals in four key
areas:
• Policy and practice: Promoting the well-being of economically vulnerable communities by
enhancing the scale, sustainability, and impact of community development finance, workforce
development, and affordable housing solutions.
• Financial capability: Helping to sustain and promote policies that improve access to financial
services, financial stability, and economic mobility of lower-income communities and individuals.
• Community revitalization: Engaging in “place-based” efforts to revitalize underserved communi-
ties in both rural and urban areas by advancing comprehensive community development efforts
that are responsive to local and regional needs.
• Small business: Working with intermediaries to support small businesses and microenterprises
in order to help increase the capacity of funding and technical assistance providers; enhancing
the availability of credit and capital for small businesses; and building a deeper understanding
of small business trends and conditions.
The CD function of the Federal Reserve System is made up of dedicated community develop-
ment departments at each of the 12 Reserve Banks, as well as at the Board, that collaborate to
advance effective community development policies and practices through a range of activities,
including
• Convening stakeholders: The function brings together practitioners from financial institutions,
nonprofits, governmental agencies, and the philanthropic and private sectors to collaborate on
126 The Fed Explained: What the Central Bank Does
community and economic development initiatives and to identify both key challenges and prom-
ising practices to address them.
• Conducting and sharing research: The function provides policymakers and practitioners with
objective analysis on the economic challenges facing lower-income communities and related
policy and program implications. CD research is shared in blogs, articles, and working papers
as well as in small group settings and at larger scale conferences.
• Identifying emerging issues: The function gathers and analyzes current information on econom-
ic and financial conditions to identify emerging issues affecting lower-income communities and
individuals. For example, staff regularly conduct web-based polls or surveys of individuals and
organizations to help track perceptions and provide market intelligence and sentiments around
a wide range of CD issues.
The CD function supports the implementation of the CRA through a wide range of activities, includ-
ing assessing community economic development and credit needs, fostering conditions support-
ive of investment, lending and banking services in low- and moderate-income communities, and
Figure 7.4. Federal Reserve community development efforts engage at the national and
local levels
The Federal Reserve has dedicated community development staff in each of its offices throughout the country who
work collaboratively to engage stakeholders; to understand issues and challenges in low- and moderate-income
communities; and to provide research, policy insights, and technical assistance to support community and economic
development programs.
Seattle
Portland
Helena
Salt Lake City
Los Angeles
San Francisco
Minneapolis
Kansas City
Chicago
Dallas
Atlanta
Cleveland
Richmond
Boston
Philadelphia
New York
St. Louis
Denver
Omaha
Oklahoma
City
Detroit
El Paso
San Antonio
Houston
Little
Rock
Memphis
Louisville
Nashville
Birmingham
Jacksonville
Miami
Charlotte
Cincinnati
Baltimore
Pittsburgh
New Orleans
Districts
Bank cities
Branch cities
Promoting Consumer Protection and Community Development 127
sharing information on lending and investment opportunities. CD also seeks to mobilize ideas,
networks, and approaches that address a wide range of community and economic development
challenges. The function leverages its capacity by working with intermediaries that offer financial,
real estate development, advisory, and human services, rather than working directly with consum-
ers or providing direct funding.
Working at the National Level
The community development program at the Board of Governors serves as the Federal Reserve’s
primary liaison to national community organizations and financial intermediaries on interagency
projects and task forces. This effort convenes local and national stakeholders to discuss potential
solutions to issues faced by communities throughout the country (figure 7.4).
In 2015, the Board established its Community Advisory Council (CAC) to provide insights on the
economic circumstances and financial services needs of consumers and communities, with a
particular focus on the concerns of low- and moderate-income consumers and communities. The
members of the CAC represent a diverse group of experts and representatives of consumer and
community development organizations and interests, including from such fields as affordable hous-
ing, community and economic development, small business, and asset and wealth building. This
council complements the Board’s other advisory councils—the Community Depository Institutions
Advisory Council and the Federal Advisory Council (see pages 13–14 in section 2, “The Three Key
System Entities,” for more information on Board advisory councils).
In addition to the CAC, the Board seeks perspectives directly from community organizations,
with community development staff collaborating with a wide range of private and public entities,
including NeighborWorks America, the Department of Housing and Urban Development, the Small
Business Administration, the Department of the Treasury, the Department of Agriculture, and the
Bureau of Indian Affairs.
The Board’s community development staff also promote and coordinate Systemwide, high-priority
efforts. Initiatives have included close coordination with community development staff at the
Federal Reserve Banks to study the impact of foreclosed properties on communities and consum-
ers as well as the credit needs of small businesses. Such initiatives result in collaborations with
a broad range of government agencies at the federal, state, and local levels, and conferences
and other events that brought together community organizations, lenders, academics, and govern-
ment officials. These efforts also have resulted in publications and reports that share promising
practices and policy solutions, as well as research and ongoing projects to address the challenges
confronting lower-income communities and individuals.
128 The Fed Explained: What the Central Bank Does
Engaging at the Local Level
The community development issues faced by different regions of the country are often unique to
each area because of differing market influences and trends. In recognition of this dynamic, the
Reserve Banks develop their programs to target the most pressing community and economic de-
velopment needs and issues in their Districts.
Box 7.3. Community Development: Targeting the Challenges and
Concerns on Main Street
The Federal Reserve leverages a network of regional Federal Reserve Bank staff to support community
development by targeting the specific, unique challenges faced by different communities throughout
the country.
• Community development website: The Federal Reserve’s work in community development is
captured in a central portal at https://fedcommunities.org. The site links the System’s community
development resources and research by topic and region.
• Support for employment and workforce development: The Federal Reserve recognizes the challeng-
es facing populations with historically higher unemployment rates, such as youth, the less-educated,
and minorities, and works to help identify effective policies and practices that address obstacles to
employment.
• Support for small businesses and entrepreneurship: Viable small businesses and small-business
owners are key to vibrant local economies. The Federal Reserve works to help identify opportunities
to improve access to capital and credit for small-business development.
• Support for neighborhood revitalization: The Federal Reserve supports efforts to align communi-
ties’ development needs with available resources and advocates the strategic use of data and
other tools to achieve this goal.
Federal Reserve staff and officials routinely convene conferences and events focused on community development issues. In May
2019, Chair Powell gave opening remarks at a System biennial community development research conference, “Renewing the
Promise of the Middle Class” (speech available at https://www.federalreserve.gov/newsevents/speech/powell20190509a.htm).
Promoting Consumer Protection and Community Development 129
Much of this work involves promoting mutually beneficial relationships between local governments,
financial institutions, nonprofit organizations, and the communities those entities serve. The
Reserve Banks sponsor forums and conferences to provide research and policy insights on com-
munity development issues and offer the opportunity for stakeholders to engage face-to-face. In
addition to bringing these stakeholders together, community development staff provide them with
the information and technical assistance needed to develop and implement effective community
and economic development programs.
The Fed Explained: What the Central Bank Does 131
Find other Federal Reserve Board publications (www.federalreserve.gov/publications/default.htm) or order
those offered in print (www.federalreserve.gov/files/orderform.pdf) on our website. Also visit the site for more
information about the Board and to learn how to stay connected with us on social media.
www.federalreserve.gov
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