Structure and Functions of the
Federal Reserve System
Pauline Smale
Analyst in Financial Economics
May 4, 2010
Congressional Research Service
7-5700
www.crs.gov
RS20826
CRS Report for Congress
P
repared for Members and Committees of Congress
Structure and Functions of the Federal Reserve System
Summary
In 1913, Congress created the Federal Reserve System to serve as the central bank for the United
States. The Federal Reserve formulates the nation’s monetary policy, supervises and regulates
banks, and provides a variety of financial services to depository financial institutions and the
federal government. The System comprises three major components, the Board of Governors, a
network of 12 Federal Reserve Banks, and member banks.
Congress created the Federal Reserve as an independent agency to enable the central bank to
carry out its responsibilities protected from excessive political and private pressures. At the same
time, by law and practice, the Federal Reserve is accountable to Congress. The seven members of
the board are appointed by the President with the advice and consent of the Senate. Congress
routinely monitors the Federal Reserve System through formal and informal oversight activities.
This report examines the structure and operations of the major components of the Federal Reserve
System and provides an overview of congressional oversight activities. In addition, the report
discusses the provisions of one of the pending pieces of legislation (S. 3217, the Restoring
American Financial Stability Act of 2010) that would affect the structure and operations of the
System. This report will be updated as events warrant.
Congressional Research Service
Structure and Functions of the Federal Reserve System
Contents
Background ................................................................................................................................ 1
Board of Governors..................................................................................................................... 1
Monetary Policy.................................................................................................................... 2
Supervision and Regulation................................................................................................... 3
Federal Reserve Banks ................................................................................................................ 3
Member Banks............................................................................................................................ 4
Congressional Oversight ............................................................................................................. 5
Reports and Hearings ............................................................................................................ 5
Current Legislation ..................................................................................................................... 6
Contacts
Author Contact Information ........................................................................................................ 7
Congressional Research Service
Structure and Functions of the Federal Reserve System
Background
The U.S. central banking system was established in 1913 by the Federal Reserve Act (P.L. 63-43).
Congress created the Federal Reserve (popularly known as the “Fed”) as an independent entity to
attend to the nation’s credit and monetary needs without undue influence from political pressures.
Today, the Fed’s monetary policy operations are intended to promote stability in the nation’s
economy; its supervisory and regulatory functions are intended to provide a safer, more flexible
banking system; and its work as fiscal agent for the government and clearinghouse for private
sector financial transactions promotes efficiency in the overall banking system.1 In keeping with
its independence within the federal government, the System operates without appropriations from
Congress. Its income derives primarily from interest on government securities acquired through
monetary policy operations, and fees for banking services, with any excess income returned to the
Treasury.
The current structure of the System has three major components established by the original act.
First, a Board of Governors oversees the whole System and has responsibility for monetary
policy. Second, there are 12 regional Federal Reserve Banks, which carry out supervision and
examination of commercial banks that are Fed members. The member banks, all national banks
and all state-chartered banks that choose to be members of the System, make up the third
component.
Board of Governors
The Board of Governors of the Federal Reserve System was established as a federal government
agency. The Administration and Congress can have a significant influence on the Fed through
control over appointments to the seven-member board. Each of the seven governors is appointed
by the President, with the advice and consent of the Senate. The full term of service for a board
seat is 14 years and governors may be named to a vacant seat at any point during the term. The
appointments are staggered with one term expiring every two years. Governors serving a full term
may not be reappointed. Two members hold the leadership positions of chairman and vice
chairman of the board. They are designated by the President, with the advice and consent of the
Senate. The term of service for both leadership offices is four years; an office holder may be
reappointed. These terms do not coincide with that of the President or each other. While the board
chairman is considered quite powerful, each governor has one vote on the board.
When selecting a governor, the President is required by law to give due regard to a fair
representation of financial, agricultural, industrial, and commercial interests, and geographical
divisions of the country. No more than one governor can be selected from any one Federal
Reserve district. The members of the Board of Governors cannot hold any office, position, or
employment in any member bank during the time they are in office and for two years after.
At present, there are five governors, two positions are vacant. The board chairman is Ben S.
Bernanke, whose term as chairman ends in 2014 and whose term as governor expires in 2020.
1 For an examination of the policy actions initiated by the Federal Reserve to manage and contain the current financial
crisis and further financial stability, see CRS Report RL34427, Financial Turmoil: Federal Reserve Policy Responses,
by Marc Labonte.
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Structure and Functions of the Federal Reserve System
The vice chairman is Donald L. Kohn, whose term as vice chairman expires in June 2010 and
whose term as governor ends in 2016. Governor Elizabeth A. Duke is serving in a term that ends
in 2012. Governor Kevin M. Warsh is serving in a term that ends in 2018. Governor Daniel K.
Tarullo is serving in a term that ends in 2022. On March 1, 2010, Vice Chairman Kohn
announced his intent to resign on June 23, 2010.2 On April 29, 2010, President Obama nominated
three new board members Janet Yellon (to be vice chairman), Peter Diamond, and Sara Bloom
Rashkin.
Monetary Policy
A central responsibility of the Board of Governors of the Federal Reserve System is the
formulation of monetary policy. In broad terms, monetary policy involves “ ... influencing the
monetary and credit conditions in the economy in pursuit of maximum employment, stable prices,
and moderate long-term interest rates.”3 In addition, when the Federal Reserve was established, it
was given the role of “lender of last resort” to the nation’s financial system.
The Federal Open Market Committee (FOMC) is the policy making body for open market
operations—the principal means through which monetary policy is conducted. The seven board
members plus five of the 12 Federal Reserve Bank presidents make up the FOMC. The president
of the Federal Reserve Bank of New York (New York Fed) is a permanent member because the
New York Fed executes the Federal Reserve’s monetary policy decisions through open market
operations. The remaining four seats are filled by the other 11 presidents on a rotating basis for
one-year terms. All of the presidents participate in the FOMC meetings and contribute their
views, but only the five members vote. The committee elects a chairman and vice chairman.
Traditionally, the chairman of the Board of Governors is elected chairman of the FOMC and the
New York Fed’s president is elected vice chairman.
Open market operations involve the purchase and sale of government securities in the secondary
market by the Federal Reserve. The operations are conducted to keep the federal funds rate close
to a target rate that is set by the FOMC. The Federal Reserve System’s portfolio is composed of
U.S. Treasury securities, federal agency securities, and bankers acceptances. The Federal Reserve
Bank of New York holds the portfolio and through its trading desk conducts open market
operations pursuant to directives of the FOMC.
Two less often used monetary policy instruments may be employed by the Federal Reserve—
legal reserve requirements and the discount window. Depository financial institutions are required
by law to set aside reserves in certain proportions against demand deposits. What is held in
reserve affects the availability of loanable funds. An increase in the requirement would mean
banks and thrifts would have less money to lend and would tend to restrain credit conditions.
Alternatively, lowering the requirement would increase the proportion of deposits that could be
lent and would tend to ease credit conditions. Reserve requirements are rarely changed because as
a monetary policy tool they are considered too blunt an instrument.
2 Board of Governors of the Federal Reserve System press release, see http://www.federalreserve.gov/newsevents/
press/other/20100301a.htm.
3 Board of Governors of the Federal Reserve System, The Federal Reserve System: Purposes and Functions, p. 1,
available at http://www.federalreserve.gov/pf/pdf/pf_1.pdf.
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The discount window is the Federal Reserve facility for lending to eligible depository institutions.
An institution may borrow funds for short periods from a Federal Reserve Bank to augment its
reserve balances for interbank transactions. The discount rate is the interest rate charged for this
short-term loan. The rate is set by each Bank subject to approval by the Board of Governors; over
time, it has become common practice for the rate to be uniform for all 12 Reserve Banks. A
higher rate discourages borrowing and in turn lending by banks and thrifts. Currently, the
discount window serves mainly a signaling function that acts as a complement to open market
operations.4.
Supervision and Regulation
The Board of Governors has a broad range of supervisory and regulatory responsibilities that
affect the entire U.S. banking system. The board seeks to promote safety and soundness, ensure
compliance with laws and regulation, and foster the fair and efficient delivery of services to
customers of financial institutions. Federal Reserve Board regulations implement policies set by
Congress that are defined in legislation and referred to the Federal Reserve for enforcement. For
example, the Fed has implementation and enforcement responsibilities for the Truth in Lending
Act, the Electronic Funds Transfer Act, and the Fair Housing Act. The board coordinates its
activities with other federal and state regulatory agencies. The board has the power to examine all
member banks and their affiliates and to require periodic reports from them.
The board has the primary responsibility for supervising and regulating bank holding companies
and state-chartered banks that are members of the Federal Reserve System. In addition, the board
supervises corporations through which U.S. banks conduct operations abroad, and the U.S.
operations of foreign banks. The board delegates many supervisory duties to the 12 Reserve
Banks subject to the board’s policy and oversight. An example is the task of conducting bank
examinations.
The Board of Governors has broad oversight and supervisory authority over the operations and
activities of the Federal Reserve Banks. The board appoints three of the nine directors of each
Bank. The board conducts annual financial examinations of the Reserve Banks. Major
expenditures, such as building construction, must be approved by the board. The salaries of
Reserve Bank presidents and first vice presidents are subject to board approval.
Federal Reserve Banks
The 12 Federal Reserve Banks carry out the day-to-day operations of the Federal Reserve
System. Within each geographic district a city was designated as the location of the Reserve
Bank. The act also provided for branch offices to support the operations of the Federal Reserve
Banks. The 12 Banks are located in Boston, New York, Philadelphia, Cleveland, Richmond,
Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. The Board of
Governors has established 25 branches over the years.
4 For more information on monetary policy, see CRS Report RL30354, Monetary Policy and the Federal Reserve:
Current Policy and Conditions, by Marc Labonte.
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Structure and Functions of the Federal Reserve System
Each Federal Reserve Bank is managed by a nine-member board of directors that is divided into
three classes: A, B, and C. They serve three-year terms on a staggered basis. The three Class A
and Class B directors are elected by the member banks in each district. Three Class C directors
are appointed by the Board of Governors. The three Class A directors represent the interests of the
member banks. The remaining six directors represent the general public and are selected with due
consideration to the interests of agriculture, commerce, industry, services, labor, and consumers.
Class B and C directors cannot be officers, directors or employees of any banking institution. In
addition, Class C directors cannot hold stock in a bank or bank holding company. The board
designates one Class C director as chairman and another as deputy chairman. Each Reserve Bank
is headed by a president appointed by the nine directors with the approval of the Board of
Governors.
The District Banks are the principal medium through which the general supervisory powers of the
Fed are executed. Federal Reserve Banks conduct on-site examinations of state member banks
and inspections of bank holding companies and their nonbank subsidiaries.
The Federal Reserve Banks provide fiscal agency and depository services to the federal
government. For example, as fiscal agents they issue, transfer, exchange and redeem government
securities and savings bonds. As depositories, they provide transaction accounts for the Treasury
and they collect and disburse funds on behalf of the federal government.
The 12 Reserve Banks provide banking services to depository financial institutions. The Banks
maintain reserve and clearing accounts for banks and thrifts. The Banks play a major role in the
nation’s payment system. Reserve Banks move coin and currency into and out of circulation.
They also participate in the collection and processing of millions of checks daily. The Banks are
an integral part of electronic funds transfer systems, clearing and settling electronically originated
credits and debits.
The income of the Federal Reserve Banks is primarily generated from interest on government
securities acquired through open market operations. In addition, the Monetary Control Act of
1980 requires the Federal Reserve to charge fees for various services. From their earnings the
Reserve Banks pay their operating and other expenses. The Banks are assessed semiannually by
the Board of Governors for the board’s costs and expenditures. The residual earnings are turned
over to the U.S. Treasury. Payments to the Treasury in 2009 totaled $47.4 billion.5
Member Banks
The Federal Reserve Act requires all national banks to be members of the Federal Reserve
System. National banks are banks chartered by the federal government. Membership by state-
chartered banks is optional. If state-chartered banks elect to become members they must meet
standards set by the Board of Governors. As of June 30, 2008, there were 1,582 national banks
and 863 state-chartered Federal Reserve member banks. While these member banks represented
only about 34% of all federally insured U.S. banks, they held about 79% of all insured bank
assets.6 The 12 Reserve Banks are “owned” by their member banks. The stock of the Federal
5 Federal Reserve Board press release, see http://www.federalreserve.gov/newsevents/press/other/20100421b.htm.
6 U.S. Federal Reserve System, 2008 Annual Report of the Board of Governors of the Federal Reserve System, June
2009, p.414.
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Structure and Functions of the Federal Reserve System
Reserve Banks is held entirely by the member banks in their respective districts. Ownership of
this stock does not carry the usual rights of control and financial interest ordinarily associated
with being a shareholder in a corporation operated for the purpose of making a profit. Each
member bank buys stock in its district Reserve Bank equal to 6% of its own capital and surplus.
Of this amount, 3% must be paid-in and 3% is subject to call by the Board of Governors. The
stock may not be sold or pledged as security for loans. Dividends are set by law at the rate of 6%
per year on paid-in stock.
Congressional Oversight
Throughout the history of the Federal Reserve System, Congress has been concerned with
achieving a balance between assuring independence for the System’s operations and making the
agency accountable for its actions. Attention to Federal Reserve accountability has resulted in
increased disclosure by the Fed and dialogue between the Fed and Congress on monetary policy
and the agency’s operations overall. Avenues of communication and oversight, both formal and
informal, have developed over time.
Aside from its appointment role, Congress exercises oversight in a variety of ways. The Federal
Banking Agency Audit Act (P.L. 95-320) was enacted in 1978 to enhance congressional oversight
responsibilities. The law gave the General Accounting Office (GAO; now the Government
Accountability Office) the authority to audit the Board of Governors, the Reserve Banks and
branches. Such audits are limited, however, as GAO is prohibited from auditing monetary policy
operations, foreign transactions, and the FOMC operations. Congressional oversight on these
matters is exercised through the requirement for reports and through semi-annual monetary policy
hearings. The Federal Reserve’s recent policy responses to the ongoing financial turmoil could
result in additional oversight hearings during the current Congress.
Reports and Hearings
The Federal Reserve publishes numerous reports during the year which are important to the
oversight work of Congress. The Board of Governors publishes an annual report of activities
which includes the minutes of the FOMC meetings. The board is required by law to report
annually on compliance with its consumer regulations. The Federal Reserve issues reports and
surveys on a variety of subjects, for example an annual survey of bank fees and services and a
report on the profitability of credit card operations.
The Fed is frequently called upon to testify on a wide range of issues affecting the economy and
the banking industry. In addition, a monetary policy reporting system, accomplished through
hearings, was made a matter of legislative mandate in the Federal Reserve Reform Act of 1977
(P.L. 95-188). The process was modified by provisions embodied in P.L. 95-523, the Humphrey-
Hawkins Act of 1978. The provisions are designed to enhance the dialogue on monetary policy
between Congress and the Federal Reserve through a more detailed reporting and evaluation
process than existed earlier. Further, the provisions are intended to contribute to the ability of
Congress to take a coordinated look at government economic policies. The two goals are sought
through a system of regularly scheduled oversight hearings at which the Federal Reserve reports
to the banking committees on its policy intention. The banking committees in turn report to their
respective houses.
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Structure and Functions of the Federal Reserve System
The statutory requirements for semi-annual monetary policy reporting, the board’s annual report
and several other reports would have been discontinued by provisions of the 1995 Federal
Reports Elimination and Sunset Act (P.L. 104-66). Provisions contained in P.L. 106-569, enacted
on December 27, 2000, reinstated these requirements.
Current Legislation
On March 22, 2010, the Senate Committee on Banking, Housing, and Urban Affairs approved a
financial regulatory reform bill, the Restoring American Financial Stability Act, S. 3217,7
containing provisions that would change the supervisory authority of the Federal Reserve Board
and affect the operations and structure of Federal Reserve Board and the 12 Reserve Banks.
These proposals are not part of the House reform bill H.R. 4173 (the Wall Street Reform and
Consumer Protection Act of 2009).
Currently, the Federal Reserve Board has the primary responsibility for supervising and
regulating bank holding companies and state-chartered banks that are members of the Federal
Reserve System. Under the provisions of S. 3217, the Federal Reserve would supervise all bank
and thrift holding companies with assets greater than $50 billion and their non-depository
subsidiaries and “systemically important” nonbank financial firms. The Office of the Comptroller
of the Currency (OCC) would supervise holding companies with assets less than $50 billion and
their non-depository subsidiaries (if the majority of assets held by their depository institution
subsidiaries are held by federally chartered depository institutions). The Federal Deposit
Insurance Corporation (FDIC) would supervise all state-chartered banks and thrifts (both member
and nonmember institutions). In addition, the FDIC would supervise holding companies with
assets less than $50 billion and their non-depository subsidiaries (if the majority of assets held by
their depository institution subsidiaries are held by state chartered depository institutions).
S. 3217 would establish a second vice chairman position for the Board of Governors. A member
of the board would serve as vice chairman for supervision and would be designated by the
President, with the advice and consent of the Senate. The duties of this vice chairman would
include developing policy recommendations regarding supervision and regulation for the board.
The vice chairman of supervision would be required to appear before the House Financial
Services and the Senate Banking committees semiannually to testify on the objectives and efforts
of the board with respect to the conduct of supervision and regulation. In addition, S. 3217 would
amend the Federal Reserve Act to prohibit the board from delegating to a Federal Reserve Bank
its functions for establishing the supervisory and regulatory policy for financial firms.
S. 3217 would make changes to the procedures for choosing the Federal Reserve Bank directors.
Each Federal Reserve Bank is managed by a nine-member board of directors that is divided into
three classes: A, B, and C. Currently, Class A and Class B directors are elected by the member
banks in each district. S. 3217 would amend the Federal Reserve Act to state that no company, or
subsidiary or affiliate of a company, that is supervised by the Board of Governors can vote for
7 Chairman Christopher Dodd of the Senate Banking, Housing, and Urban Affairs Committee issued a single
comprehensive committee print on November 16, 2009, the Restoring American Financial Stability Act (RAFSA) of
2009. This proposal was revised over the following months and a committee print of RAFSA of 2010 was issued on
March 15, 2010. RAFSA of 2010 was amended in committee on March 22, 2010, and reported to the Senate floor as S.
3217.
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Structure and Functions of the Federal Reserve System
Federal Reserve Bank directors. Currently, Class B and Class C directors cannot be officers,
directors, or employees of any banking institution. S. 3217 would amend the Federal Reserve Act
to state that officers, directors, and employees of companies, or subsidiaries or affiliates of a
company, that is supervised by the Board of Governors are restricted from serving as directors
period. Finally, S. 3217 would require that the president of the Federal Reserve Bank of New
York (currently appointed by the Bank’s directors), be appointed by the President, with the advice
and consent of the Senate.
Author Contact Information
Pauline Smale
Analyst in Financial Economics
psmale@crs.loc.gov, 7-7832
Congressional Research Service
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