Federal Reserve System ; Banks and banking, Central

Verle B. Johnston

English

Research Papers in Economics

FRBSF
February 8, 1985 WEEKLY LETTER
The Structure of Our Nation's Central Bank
As our nation's central bank, the Federal Reserve
System is responsiblefordeterminingand carrying
out monetary policy. In addition, the System has
majorresponsibilities forsupervising and examin~
ing state chartered banks that are members ofthe
Federal Reserve System, regulating all bank hold-
ing companies, writing regulations to implement
numerous consumer protection laws (such as
Truth-in-Lending), and contributingto a smoothly
functioning national payments system by provid-
ing wholesale banking services, including
currency and coin, and check collection.
The Federal Reserve is uniqueamongthe world's
central banks in that it is nota single entity but a
"System" involving a blend ofpublic and private,
as well as national and regional, elements. The
Board ofGovernors-called the "capstone" of
the System byWoodrow Wilson, who signed into
lawthe actcreatingthe Federal Reserve in 1913-
is an agency ofthe United States government
consisting ofseven members appointed by the
President with the advice and consent ofthe
Senate. These members, called Governors, serve
staggered 14-yearterms butcan be removed by
the Presidentforcause. Board members (including
the Chairman and Vice Chairman, who are
appointed to these particular posts for four-year
terms) are representative of"thefinancial, agricul-
tural, industrial and commercial interests and
geographical divisionsofthecountry" and cannot
be officers, directors or stockholders in any bank-
ing institution. Nomorethan oneGovernorcan be
selected from each oftwelve Reserve Districts.
Each District is served by a Reserve Bank with its
own president and board ofdirectors and Reserve
Bank branches with theirown boards ofdirectors.
Role of the Board of Governors
The Board ofGovernors exercises the major
responsibility for formulating monetary policy as
its seven members constitute a majorityofthe
twelve-member policy-making body, the Federal
Open MarketCommittee (FOMC). Reserve Bank
presidents fill the remaining five voting spots on a
rotating basis. Theexception is the presidentofthe
Federal Reserve Bank of New York, who is a
permanent voting member because the New York
Fed acts as agent for the FOMC and all twelve
Reserve Banks in carrying outthe FOMC's direc-
tives. Presidents notserving in a voting capacity
nevertheless contribute their views on issues of
monetary policy.
To protectthe Fed from the sometimes fierce
short-term partisan political pressures towhich
both the Congress and the Executive branch
naturallyare subject, theCongress overthe years
has endeavored to providethe System with a
substantial degree of "independence,"or insula-
tion, in itsday-to-dayconductofmonetarypolicy.
In addition to the provision for long and staggered
terms for the members ofthe Board ofGovernors,
this insulation includes exemption from the
Congressional appropriations process. (However,
in addition to internally conducted audits, the
System is subject to financial audit by a nationally
recognized, independent audit firm, as well as to
financial and operational, but notpolicy audit, by
the GAO.)
Because the Congress believed that the Federal
Reserve was attimes subjecttoexcessive pressure
from the Executive branch ofgovernment, it re~
moved theTreasury Secretary and theComptroller
ofthe Currency from membership on the Board of
Governors in 1935, positions whichthey had held
since the Fed's inception in 1914. Senator Glass,
an architectofthe original Federal Reserve Act
and Secretary ofthe Treasury, had cited his own
actions as well as those ofother Treasury secre-
taries in exertingenormous influenceon the Board,
oftentimestreating itas "abureau oftheTreasury"
and the System as "a doormatofthe Treasury."
The rationale behindthe Fed's substantial degree
of independence reflects a tacit recognition-
one underscored by historical experience-that
it is not desirable to place directcontrol overthe
powerto create money in the hands ofthose (the
Congress and the Treasury) who develop spend-
ing programs and who pay the government's bills.
Congress expected this insulation to place those
charged with managing the nation's money and
credit(in this case, the Fed) in a better position to
frame their policies in relation to whatthey
perceive as the nation's best long-term interest,
even though such policies could be painful in the
short-run.FRBSF
The decision to grantthe Fed a substantial degree
of independence also reflects a recognition bythe
Congress that a large deliberative bodysuch as
itselfsimply is notwell-equipped todeal with the
complexities of monetary management on a day-
to-day basis. This consideration is especially true
in today's rapidly changing financial environment.
Nevertheless, by law and practice, the System
remains fully accountableto the Congress, which
exercises a thorough (and frequently critical)
oversight and broad "policy audit" ofthe System,
and which can changethe ground rules and con-
straints underwhich the System operates when-
ever itchooses. Congress has, in fact, done so on
numerous occasions although, on balance, ithas
strengthened System "independence" materially
overtheyears and has madethe System both more
effective and more accountable.
The vastly expanded reporting requirements and
hearings on monetary policy pursuant to the
Humphrey-Hawkins "Balanced Growth and Full
EmploymentActof1978" is oneexample. These
requirements include the formalized targeting
proceduresforthe monetaryand creditaggregates
and their relation to projections ofnational
income, employmentand changes in the price
level. Another is the substantially broadened di-
rector representation on the boards ofthe Reserve
Banks mandated bythe Federal Reserve Reform
Act in 1977. Most recently, the Monetary Control
Actof 1980 demonstrated the Congress' abiIityto
alter the Federal Reserve's operations in a funda-
mental way. Itcalled for sweeping changes that
included provisions for mandatory reserves and
open access to System services to all depository
institutions (member or non-member, bankor
thrift). The Act also required thatthese services
be priced to users on a basis which, overthe
long-run, would cover all directand indirect
costs, includingthe imputed cost oftaxes and a
return on capital comparable to thatofprivate
competitors.
In addition to its monetary policy responsibilities,
the Board ofGovernors exercises supervisory
authority over the operations ofthe Reserve Banks.
It must formally approve the selection ofReserve
Bank presidents (who first are appointed bythe
Reserve Bank boards ofdirectors) and it selects
three ofthe nine directors ofa Reserve Bank,
includingthechairman and deputychairman. The
Board ofGovernors also has the powerto remove
any Reserve Bank director, officer, or president.
The Board also must approve any change in the
discount rate proposed by a Reserve Bank's direc-
tors, and setthe rules underwhich aReserve Bank
may lend to depository institutions. Italso
approves Reserve Bank budgets and levies assess-
ments on the Banks tocover itsownexpenditures.
Role of the Reserve Banks
Technically, the Reserve Banks are organized in
the form ofprivate corporations whose stock is
subscribed to by the member banks in their
respective districts. The provision for member
banksubscription to Reserve Bank stock was
designed in partto letthe Treasury avoid paying
the costs ofsetting upthe new system in }913.
Stock ownership in Reserve Banks does notcon-
vey the usual. proprietary interest and control
associated with holdingstock in private firms.
Member banks are limited by lawto an annual
dividend of6 percent and must surrender their
stock when they withdraw from the System. The
public nature ofthe Reserve Banks (and ofthe
entire System) is evident in the fact that after de-
ducting operating expenses and payment ofthe
small statutory dividend, all ofthe System's net
earnings are paid to the Treasury. In 1984, these
payments (mostly earnings from its portfolio of
government and other securities and from its
lendingto depository institutions) amounted to
$16.1 biIIion and represented 87 percent ofthe
System's gross income.
Members have the rightto elect six ofa Reserve
Bank's nine directors. However, onlythree of
these directors can be bankers, one each repre-
senting large, medium and small sized banks.
The otherthree directors elected by member
banks must represent the public "withoutdis-
crimination as to race, creed, color, sex, or
national origin, and with due but notexclusive
consideration to the interests ofagriculture,
commerce, industry, service, laborand con-
sumers." They cannot be officers, directors or
employees ofany banking institution. The same
is true ofthe final set ofthree directors that serve
on a Reserve Bank's board, although they must
meetthe additional stipulation thatthey cannot
hold bank stock. The final three directors are
appointed by the Board ofGovernors rather than
elected by member banks. The Board ofGover-
nors also designates the chairman and deputychairman ofa Reserve Bank's board ofdirectors
from among this set ofpublic directors.
The same constraints applyto directorsofReserve
Bank branches, fourofwhom are appointed bythe
directorsofa Bank's headquartersofficeand three
(includingthe branch board's chairman) bythe
Board ofGovernors in Washington, D.C. Cur-
rently, there are 25 branch boards in the System.
Reserve Bank directors are responsible by lawto
the Board ofGovernors for the general adminis-
tration and managementofthe Reserve Banks. In
addition, they appoint Reserve Bank presidents
and first vice presidents (subjectto the approval
ofthe Board ofGovernors) as well as otherofficers
and the District's representative to the Federal
AdvisoryCouncil. The last meets periodicallywith
the Board ofGovernors to discuss the business
situation and to make recommendations on
various issues affecting the System.
With their very wide array of backgrounds and
expertise, the directors bring to the Reserve Banks
a broad range of managerial experience. In addi-
tion, they offer valuable inputto the formulation
of monetary policy by providing a "grass roots"
information network abouteconomic conditions
in their business communities.
Theydothis in connection withtwo related func-
tions, the first beingthe requirement(by law) that
theyset thediscount rate-the rate at which the
Reserve Banks lend to borrowing depository insti-
tutions. In carrying outtheirdiscount-rate
responsibilities, they must meet at least every 14
days. In so doing, they normally exchange views
with the Reserve Bank president and the Bank's
research staff before they set the rate, which is
subjectto "review and determination" by the
Board ofGovernors.
The second monetary policy function performed
bydirectors involves the perspectives they pro-
videthe Reserve Bank presidentin his capacityas
a memberofthe FOMC With their grass roots
connections and differingbackgrounds, the
directors act as achannel through which the
particular problems and concerns ofthe various
regions and sectors ofthe economy find consider-
ation in the policymaking process. Even in an era
ofsubstantial "homogenization," majordiffer-
ences still exist in the structure andoperations of
the various regions ofthe country, differences that
cannot always be detected in data that are national
or"aggregate" in character. Underthesecircum-
stances, there is no substitute for having ready
access to timely, firsthand knowledge ofpoten-
tiallysignificantdevelopments. Directorsare ina
unique position to providethis knowledge as a
complement to the internal economic data-
gathering and research activitiesofthe staffatthe
Reserve Banks and the Board ofGovernors.
Summary
As Chairman Volckerhas noted, "fromthe begin-
ning, the Federal Reserve System has been based
on acombination ofcentral and regional ele-
ments...in ordertoassure aproperconsideration
ofviewpoints and needs from all sections ofthe
country. The premise was that all wisdom does
not reside in Washington and that some furtl1er
insulation'lfrom short-term and partisan political
pressure would come from giving an important
role to the Reserve Banks."
Verle B. Johnston
Opinionsexpressed in this newsletterdo not necessarily reflect theviews ofthe managementofthe Federal Reserve Bank ofSan
Francisco, orofthe Board ofGovernorsofthe Federal Reserve System.
Editorialcommentsmay beaddressedtotheeditor(GregoryTong) ortotheauthor....Freecopiesof Federal Reserve publications
can be obtainedfrom the Public Information Department, Federal Reserve Bank ofSan Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.uo~6U!4S0m 4o~n U060JO OpOll0U
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Change from 01/25/84
Dollar Percent?
Change
from
Amount
Outstanding
01 /23/85 01/16/85
Loans, Leases and Investments] 2 187,199 - 807 13,233 7.6
Loans and Leases] 6 169,089 - 808 15,261 9.0
Commercial and Industrial 51,981 - 244 6,131 13.4
Real estate 61,997 102 2,654 4.5
Loans to Individuals 32,368 6 5,611 20.9
Leases 5,269 3 229 4.5
U.S. Treasury and Agency Securities2 11,014 - 13 - 1,157 - 9.5
Other Securities2 7,095 13 - 869 - 10.9
Total Deposits 191,743 -3,592 9,732 5.3
Demand Deposits 43,311 -2,762 2,439 5.9
Demand Deposits Adjusted3 28,575 -1,193 437 1.5
OtherTransaction Balances4 12,542 - 521 837 7.1
Total Non-Transaction Balances6 135,890 - 309 6,456 4.9
MoneyMarket Deposit
Accounts-Total 42,965 62 3,276 8.2
Time Deposits in Amounts of
$100,000 or more 39,623 - 188 1,067 2.7
Other Liabilities for Borrowed Monevs 20,707 - 693 1,536 8.0
BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Two Week Averages
of Daily Fi2ures
Period ended
01/14/85
Period ended
12/31/84
Reserve Position, All Reporting Banks
Excess Reserves (+)/Deficiency(-)
Borrowings
Netfree reserves (+)/Netborrowed(-)
21
22
o
74
30
44
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading account securities
3 Excludes U.s. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
5 Includes borrowingviaFRB, IT&L notes, Fed Funds, RPs and other sources
6 Includes items notshown separately
7 Annualized percentchange

The structure of our nation's central bank

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The structure of our nation's central bank

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