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Updated January 6, 2020
Introduction to Financial Services: The Federal Reserve
Structure of the Federal Reserve
dividends of 6% for banks with less than $10 billion in
The Federal Reserve Act (12 U.S.C. 221 et seq.) created the
assets and the lower of 6% or the 10-year Treasury yield for
Federal Reserved (Fed) as the nation’s central bank in 1913.
banks with more than $10 billion in assets. Stockholders
The Fed is composed of 12 regional Federal Reserve banks
choose two-thirds of the board at the regional Fed banks.
overseen by a Board of Governors in Washington, DC.
Figure 1 illustrates the city in which each bank is
Responsibilities of the Federal Reserve
headquartered and the area of each bank’s jurisdiction. The
The Fed’s responsibilities fall into four main categories:
board is composed of seven governors nominated by the
monetary policy, lender of last resort, prudential
President and confirmed by the Senate. The President
supervision of certain banks and other financial firms, and
selects (and the Senate confirms) a chair and two vice
provision and oversight of payment systems.
chairs from among the governors; one vice chair is
responsible for supervision. The governors serve
Monetary Policy. The Fed’s primary monetary policy
nonrenewable 14-year terms, but the chair and vice chairs
instrument is the federal funds rate (the overnight bank
serve renewable 4-year terms. Jerome Powell’s term as
lending rate). The Fed influences interest rates to affect
chair began February 5, 2018. Board members are chosen
interest-sensitive spending on capital investment, consumer
without regard to political affiliation. Regional bank
durables, and housing. Interest rates also indirectly
presidents are chosen by their boards, not by the President,
influence the value of the dollar and, therefore, spending on
with the approval of the Board of Governors.
exports and imports. The Fed reduces rates to stimulate
economic activity and raises rates to slow activity.
Figure 1. Federal Reserve Districts
Monetary policy is considered a blunt instrument that
cannot be targeted to affect specific regions, certain
industries, or the income distribution.
The Fed targets the federal funds rate through open market
operations—the purchase and sale of U.S. Treasury
securities, mainly from primary dealers (who specialize in
trading government securities), in the secondary market.
Often, these transactions are made on a temporary basis
using repurchase agreements, known as repos. The Fed sets
reserve requirements and the interest rate it pays banks to
hold reserves. In addition, monetary policy can involve
foreign exchange operations, although these are rare. Open
market and foreign exchange operations are conducted by
Source: Federal Reserve.
the New York Fed per the FOMC’s directives. The Fed
influences the money supply through its control over bank
reserves and currency in circulation.
In general, policy is formulated by the board and carried out
by the regional banks. Monetary policy decisions, however,
During the 2007-2009 financial crisis, the Fed reduced the
are made by the Federal Open Market Committee (FOMC),
federal funds rate to zero and conducted large-scale asset
which is composed of the seven governors, the president of
purchases of Treasury- and mortgage-backed securities
the New York Fed, and four other regional bank presidents.
from 2008 to 2014—known as quantitative easing—that
Representation for these four seats rotates among the other
increased the size of its balance sheet. The Fed then began
11 regional banks. The FOMC meets at least every six
to normalize monetary policy. From 2015 to 2018, the Fed
weeks to review the stance of monetary policy.
initiated a series of increases in the federal funds rate. From
The Fed’s budget is not subject to congressional
2017 to 2019, the Fed gradually reduced the size of its
balance sheet. However, an economic slowdown in 2019
appropriations or authorizations. The Fed is funded by fees
prompted the Fed to cut rates and repo market instability
and the income generated by securities it owns. Its income
prompted the Fed to begin expanding its balance sheet
exceeds its expenses, and it remits most of its net income to
again in October. A large balance sheet has boosted the
the Treasury, where it is used to reduce the federal debt.
Fed’s remittances to the Treasury in recent years.
The Fed’s capital consists of stock and a surplus. The Fed’s
Lender of Last Resort. Despite their name, Federal
surplus is capped at $6.825 billion by law. Private banks
Reserve banks do not carry out any banking activities, with
regulated by the Fed buy stock in the Fed to become
one limited exception. The Fed traditionally acts as lender
member banks. Membership is mandatory for national
of last resort by making short-term, collateralized loans to
banks, but optional for state banks. The stock pays
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Introduction to Financial Services: The Federal Reserve
banks through its discount window. The Fed generally sets
confidential information. The Dodd-Frank Act (P.L. 111-
the discount rate charged for these loans above market
203) required the Fed to release information with a lag on
rates. In normal market conditions, the Fed’s lending
the identities of all borrowers and the terms of borrowing.
operations are minimal. In the financial crisis, it created a
number of temporary facilities to provide extensive
Balance Sheet. Congress has conducted oversight of the
assistance to banks and nonbank financial firms using
Fed’s balance sheet. The Fed has decided to continue using
emergency authority.
a new method for targeting interest rates that relies on
maintaining a balance sheet more than four times larger
Regulation. The Fed regulates bank holding companies
than before the financial crisis and paying banks interest on
(including the largest banks), some foreign banks, and some
the reserves they hold at the Fed. The Fed enlarged its
state banks. The Fed’s regulatory responsibilities overlap
balance sheet in 2019 and may take additional steps to
with those of other bank regulators—the Consumer
stabilize the repo market. Congress has reduced the Fed’s
Financial Protection Bureau (CFPB), the Federal Deposit
financial surplus as a budgetary “pay for” in P.L. 114-94,
Insurance Corporation (FDIC), and the Office of the
P.L. 115-123, and P.L. 115-174, and would do so again in
Comptroller of the Currency (OCC). The Fed shares
multiple bills passed by the House in the 116th Congress.
responsibility for maintaining financial stability with the
Financial Stability Oversight Council (FSOC) and its
Regulation. The Fed has recently been implementing
members. FSOC is a council of regulators, including the
regulatory relief for large and small banks on its own
Fed, headed by the Treasury Secretary. The Fed participates
initiative and as required by P.L. 115-174. Finding the
in intergovernmental fora, such as the Financial Stability
optimal trade-off between the benefits and costs of financial
Board and the Basel Committee on Banking Supervision,
regulation continues to be debated. Congress has also been
with other U.S. agencies.
concerned about whether the Fed is susceptible to
regulatory capture, the concept that regulated entities have
Payment Systems. The Fed operates key payment systems,
undue influence over regulation.
including those for check clearing and interbank transfers,
and oversees private-sector payment systems. It also acts as
Governance and Diversity. Congress has debated changes
the federal government’s fiscal agent—federal receipts and
to the Fed’s governance structure. Proposals include
payments flow through Treasury’s accounts at the Fed.
changing the voting balance between Fed governors and
presidents on the FOMC; making the New York Fed
Policy Issues
president a presidential appointee; and changing how the
Congressional Oversight. Congress has delegated
regional bank directors and presidents are selected. Some
monetary policy to the Fed but conducts oversight to ensure
Members of Congress have also expressed concern over a
the Fed meets its statutory mandate of “maximum
lack of diversity at the Fed. The Dodd-Frank Act created
employment, stable prices, and moderate long-term interest
Offices of Minority and Women Inclusion for the Federal
rates.” The Fed has defined stable prices as a longer-run
Reserve System. H.R. 281 would require diverse candidates
goal of 2% inflation. The Fed is expected to complete a
to be interviewed when selecting Federal Reserve bank
review of its monetary policy strategy, tools, and
presidents. H.R. 974 would require the vice chair for
communications in 2020.
supervision to provide written testimony and would require
the chair to testify if the vice chair position is vacant.
The Fed is more independent from Congress and the
Administration than most agencies. Economists have
Real Time Payments (RTP). In 2019, the Fed announced
justified the Fed’s independence on the grounds that
that it would create a RTP system to expedite bank-to-bank
monetary policy decisions that are insulated from short-
payment settlement. This system would compete with an
term political pressures result in better economic outcomes.
existing RTP system owned by a group of large banks.
There is an inherent trade-off between independence and
Competition in RTP between the Fed and the private sector
accountability, however.
raises issues about cost to users, ubiquity, equity,
innovation, interoperability, and security.
Nevertheless, the Fed’s independence has limits. Contrary
to popular belief, the Government Accountability Office
CRS Resources
already audits the Fed upon congressional request, but it is
CRS Report RL30354, Monetary Policy and the Federal
prohibited by law from conducting economic analyses of
Reserve: Current Policy and Conditions, by Marc Labonte
monetary or lender-of-last-resort activities. The Fed is
statutorily required to testify semiannually before and
CRS Report R42079, Federal Reserve: Oversight and
present a written report to the House Financial Services
Disclosure Issues, by Marc Labonte
Committee and the Senate Banking, Housing, and Urban
Affairs Committee. Congress has debated whether the Fed
CRS Report R45927, U.S. Payment System Policy Issues:
should report to it more frequently and in more detail.
Faster Payments and Innovation, by Cheryl R. Cooper,
Congress has also debated what types of information the
Marc Labonte, and David W. Perkins
Fed should publicly disclose. Disclosure helps Congress
Marc Labonte, Specialist in Macroeconomic Policy
and the public to better understand the Fed’s actions. Up to
a point, this makes monetary and regulatory policy more
IF10054
effective, but too much disclosure could make both less
effective because they rely on market-sensitive and
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Introduction to Financial Services: The Federal Reserve
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