United States Banking System

1
United States Banking System

• An FLDC Presentation

2
What is A Banking System?

• A network of commercial, savings, and specialized
  banks that provide financial services, including
  accepting deposits and providing loans and
  credit, money transmission, and investment
  facilities.

3
Origins of the Federal Reserve System

• The United States Banking System is also known as
  the Federal Reserve System.
• Before 1863, banks issued notes that functioned
  like our present day currency, except they were
  the duty of individual banks.
• The money that was in circulation fluctuated with
  the business cycle, possibly exaggerating them.

4
Origins of the Federal Reserve System (Continued)

• Banks were subject to liquidity problems and the
  economy suffered several crashes which led to the
  crash of 1907.
• It was then that the Federal Reserve Act was
  created in 1913.

5
The Feds Initial Purposes

• Serve as a leader of last resort
• Provide an elastic currency (money supply
  control).
• Provide for a sounder banking system
• Improving how transactions were processed (check
  clearing and promoting payments system
  technology).

6
The Purpose of the Federal Reserve System In
Present Day

• Conducting the Nations monetary policy by
  influencing monetary and conditions in the
  economy, in pursuit of employment, stable prices,
  and moderate long-term interest rates.
• Supervising and regulating banking institutions
  to ensure the safety of the banking system and to
  protect credit rights of consumers.
• Providing financial services to depository
  institutions, the U.S government and other
  foreign institutions.
• They also make loans to commercial banks, and are
  authorized to issue Federal Reserve Notes.

7
Non-Monetary Functions of the Federal Reserve
System

• Regulation Q They establish the maximum rate
  that depository institutions could pay on deposit
  accounts.
• Securities Credit Regulation Establishes
  borrowing limit for buyers on securities margins.
• Supervision Examination of State Member Banks by
  Feds.

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Non-Monetary Powers of the Federal Reserve System
(Cont.)

• Regulation of Bank and Financial holding
  companies.
• Regulation of payment system.
• Control of International Banking actions.
• Consumer Credit Regulation
• Being a Fiscal Agent for the U.S Treasury

9
Cracking the Federal Reserve System

• Seven Members make up the Board of Governors.
• 12 Regional Federal Reserve Banks.
• Thousands of Member Commercial Banks
• Federal Open Market Committee( FOTC)
• The FOTC consists of the Board of Governors and
  the 5 Presidents from the district banks.

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Cracking the Federal Reserve (Cont)
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The Feds Balance SheetEx. From 2000
12
The Federal Reserve Systems Balance Sheet

• The Assets of the Federal Reserve System include
• U.S Government and Agency Securities (Primary).
• Net loan of reserves of extended.
• Treasury coin.
• Loans to member banks.
• Gold Certificates and SDRs.

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Three Tools of the Federal Reserve Monetary Policy
1. Establishing reserve requirements, the minimum
proportion (percentage) of bank deposits they
must keep on deposit at the Fed. Increasing
reserve requirements () increases the percentage
of bank deposits kept in noninterest bearing
deposits at the Fed and limits bank lending.
Decreasing reserve requirements () reduces the
percentage of bank deposits kept in the Fed and
provides the banking system with excess reserves.
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Three Tools of Federal Reserve Monetary Policy
(cont.)

• Bank deposits (reserves) in the Fed are needed
  to clear checks and to satisfy reserve
  requirements.
• Actual reserves (AR) are balances needed to
  meet check clearing and legal reserve
  requirements including
• -vault cash.
• -noninterest bearing bank deposits in Federal
  Reserve banks.

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Three Tools of Federal Reserve Monetary Policy
(cont.)

• Excess Reserves equals actual minus the required
  reserves.
• Excess Reserves may loaned to customers or sold
  to other banks (federal funds market) by an
  individual bank.
• If the level of the banking system's Federal
  Reserve borrowed reserves (BR) (Fed loan credited
  to reserve accounts) exceeds the level of excess
  reserves in a period, the banking system is in a
  net borrowed reserve position, is less likely to
  promote lending activities, and interest rates
  are most likely to be increasing.

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Three Tools of Federal Reserve Monetary Policy
(continued)

• If the level of level of excess reserves exceeds
  Fed borrowing, the banking system is in a
  net-free reserve position, credit is easier and
  interest rates are generally lower.
• Many analysts prefer to examine banks net-free
  reserves (Excess Reserves - Borrowed Reserves).

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Three Tools of Federal Reserve Monetary Policy
(continued)

• 2. Open market operations affect the level of
  member bank reserves and the monetary base.
• Buying government securities from the private
  sector, the Fed eventually credits member bank
  deposits, thus increasing the level of bank
  reserves and the banks' ability to make loans and
  expand the money supply.
• Selling securities (could be any asset) to
  private security dealers or banks, the Fed is
  paid with a bank check which reduces the level of
  member bank actual reserves.

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Three Tools of Federal Reserve Monetary Policy
(continued)

• The Federal Reserve usually expands or contracts
  its liabilities by engaging in Open Market
  Operations.
• When they buy securities, they write a check on
  themselves.
• The Federal Reserve increases the monetary base
  via the banks reserve accounts whenever it
  acquires more assets

19
Three Tools of Federal Reserve Monetary Policy
(concluded)

• Discount Rate Policy -- The rate of interest
  depository institutions pay for borrowing from
  the Fed.
• Raising the discount rate increases the cost of
  borrowing for needed reserve balances.
• Lowering the discount rate lowers the cost of
  bank liquidity and encourages lending and money
  supply expansion
• Rarely used as a tool of monetary policy now.

20
Monetary Base

• Changes in the assets and liabilities of the
  Federal Reserve System largely determine the
  nations Monetary Base
• The Monetary Base equals currency in circulation
  plus financial institution deposits at the
  Federal Reserve.
• The Federal Reserve increases the monetary base
  via the banks reserve account whenever it
  acquires more assets. It decreases the monetary
  base when it sells assets.

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Impacts of FederalReserve Policy

• Expansionary monetary policy
• Open market operations -- purchase securities --
  increase bank excess reserves and the monetary
  base.
• Reserve requirements -- reduce reserve
  requirements -- increase excess reserves and
  increase the deposit expansion multiplier.
• Discount rate -- reduce the rate -- reduce the
  cost of borrowing reserves.
• Expands the money supply reduces interest rates.

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Impacts of FederalReserve Policy (cont.)

• Restrictive monetary policy
• Open market operations -- sell securities, reduce
  bank reserves and the monetary base.
• Reserve requirements -- increase reserve
  requirements, reduces excess reserves and the
  deposit expansion multiplier.
• Discount rate -- increase the discount rate and
  the cost of borrowing reserve deficiencies.
• Reduce the money supply or its growth rate
  increase interest rates.

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Other Tools of Federal Reserve Monetary Policy

• Moral Suasion - Chairman of the Federal Reserve
  System makes a speech or testifies before
  Congress
• Regulation of Banks
• International Activities arising from acting as
  the Agent of the United States Government in
  International Finance

24
The Federal Reserve System and Interest Rates

• The Federal Reserve has ultimate power in
  influencing interest rates.
• During a period of time when interest rates are
  low, capital is easy to acquire and this spurs
  development because the more cash a consumer has,
  the more items they buy.
• In contrast, if interest rates are too high, the
  result can be a recession and in extreme cases
  even deflation.

25
The Federal Reserve System and Interest Rates
(Cont.)

• There are two ways that the Federal Reserve can
  influence the interest rates.
• 1- The Federal Reserve can either increase or
  decrease the discount rate.
• 2- By indirectly influencing direction of the
  Federal Funds Rate.