In my previous post, Overview of the Federal Reserve System (Linked here), I went over the entities that comprise the system rather superficially. I would like to go much more in depth with this one. Basically, there are three entities that are fundamental to the Fed: The Board of Governors, the Reserve Banks, and the Federal Open Market Committee. Now, there are other entities as well, but they are more of participants than constituent of the system itself. These include depository institutions and advisory councils, which we will explore later in this post.
The Board of Governors
As the governing body of the Fed, the Board of Governors consists of seven members that are nominated by the President and confirmed by the Senate. Their main purpose is to guide the operation of the system in order to promote their congressionally defined goals and responsibilities. Also, all members of the Board also serve on the Federal Open Market Committee (FOMC).
Each Governor can serve 14-year terms that are staggered to end on January 31st of every even numbered year. The Chair and Vice Chair of the Board are appointed by the President and confirmed by the Senate and must already be on the Board of Governors. Once appointed to the position of Chair or Vice Chair, they can serve 4-year terms. Since the terms are so long (14-years) for Board membership, the governors cannot be re-appointed to the board once they serve a full term, however if they are replaced or step down without serving a full term, they can be reappointed to fulfill the 14-year max.
As we know the Board is the governing body of the Fed, they oversee operations of each of the 12 Reserve banks. They also share responsibility for supervising and regulating certain financial institutions and financial activities. This includes approving each Reserve Bank’s budget. In terms of the population, the Board also attempts to become aware of the concerns of communities and consumers by conducting multiple types of consumer-focused research and promoting a “fair and transparent” consumer financial services market.
Reserve Banks
The Reserve Banks of the Fed are the entity I find most interesting, at least in their structure. There are 12 Reserve Banks that are spread out into 12 different regions of the United States. The boundary lines are based off of prevailing trade regions that were present in 1913. These 12 banks and their 24 branches are the operating entities of the Fed.
One of the largest responsibilities of the Reserve banks is to gather information about the businesses and the needs of their communities in their respective region. This research is compiled and given to the FOMC to influence monetary policy. As an example, if you ever see me or someone else use a FRED (Federal Reserve Economic Data) chart, this is economic data that was compiled by the St. Louis Fed. Below is an example of a FRED chart, this is the real GDP of the United States from 1947 to the present.
Now, for the fun part of the Reserve banks, their leadership. Each Reserve bank has a Board of Directors that is responsible for overseeing their Bank’s administration, reviewing the bank’s budget, their overall performance, their audit process, and developing strategic goals for the Bank. This is a lot like a private company, however, unlike a private company, the reserve banks are supposed to be operated with the public’s interests in mind, not their shareholders. Every year, the Board of Governors (this is the board that is national scope) elect one chair and deputy chair for each Reserve bank from among its class C directors.
To reiterate, the Board of Governors is a separate entity of the Fed from the Reserve banks and is national in scope. Whereas the Bank’s Board of Directors is a board of a specific Reserve Bank. I just wanted to make this clarification because it tripped me up a few times when I first read about it because there are so many boards. Also, there are more. Each branch of the Reserve banks has their OWN Board of directors. I’ll refer to these as Branch directors in an attempt to remain clear. Each Board of Branch Directors has five or seven members that are appointed, and they are NOT divided into different classes. The Board of Bank Directors is divided into 3 classes (A, B, and C), but the board of Branch Directors is not divided into classes.
Finally, at least in terms of reserve bank leadership, we have the Reserve Banks Presidents. They essentially act as CEOs of their bank, so nothing out of the ordinary except that they also serve on the FOMC on a rotating basis, which we will discuss more about below.
Above is a diagram of the composition of the Reserve bank’s board of directors. There are three classes, Class A, Class B, and Class C, each with three directors. Class A directors represent the depository institutions of their district, and they are elected by those institutions. Class B directors represent the public interest and are also elected by the depository institutions within the Reserve bank’s regional jurisdiction. Finally, Class C directors also represent the public, but they are appointed by the Federal Reserve’s Board of Governors. The presidents of the reserve banks are nominated from classes B and C, the ones who represent the public, and are approved by the Board of Governors. Also, the chair and deputy chair of the bank are chosen by the board of governors and are chosen from among the Class C directors.
So, as you can imagine with all this leadership and different Classes and such, there must be some responsibilities that come along with this non-superficial leadership structure. Think of each Reserve bank as a Bank for the banks. The regional reserve bank is literally just a bank for their depository institutions (commercial banks and others) within their region. The reserve banks are responsible for supervising those depository institutions and other entities that are deemed “systematically important under authority delegated to them by the board”, words from the Federal Reserve themselves. Take that how you will. The Reserve banks are also responsible for lending to their depository institutions to ensure that the financial system maintains liquidity. Meaning money continuously flows around the system with velocity. If that money stops flowing, there will be major negative consequences, not just nationally, but globally.
Furthermore, as a Bank for banks, the reserve banks provide financial services to their member banks and institutions, this includes services that underlay the nation’s payment system (ACH, Fed-Wire, etc.). As a part of their services and oversight, they also have the ability to enforce compliance of regulations, especially for federal consumer protection laws.
FOMC
The Federal Open Market Committee is the entity of the Federal Reserve system that sets national monetary policy in order to guide the economy towards its congressionally mandated goals of price stability and maximum unemployment. They are sometimes deemed to be some extremely powerful entity that can do whatever they want, well, they may be powerful, but they can pretty much only change the fed funds rate (rate that depository institutions lend to one another) or adjust the size and composition of their balance sheet (buy or sell treasuries or Mortgage-Backed Securities MBS). Other than that, the FOMC uses forward guidance a lot to try to influence the financial system. Forward guidance is basically the Fed telling markets what they are going to do multiple times before they actually do anything. Now, this is all domestically, as the central bank of the United States, the Fed, operates in foreign exchange markets and authorizes currency swap and other programs with foreign central banks. These operations are also directed by the FOMC.
The FOMC has 12 voting members: the seven from the Board of Governors, the president of the Fed in New York, and the remaining four positions from the eleven remaining reserve bank presidents who serve one-year terms on a rotating basis. All 12 reserve bank presidents attend the FOMC meetings, however, only the ones on the current committee may vote. Now, the FOMC can determine its own internal structure, but as a tradition, the FOMC elects the chair of the Board of Governors as its own chair and the president of the New York Fed as its vice chair.
Depository institutions
Depository institutions are your commercial banks and other financial entities that hold deposits at the Reserve bank overseeing their region. The institution offers checking accounts to the public as well as having their own checking account at the Fed. These are the institutions that have bank reserves if you have heard the term. These bank reserves are held in their account at their reserve bank, where they can receive interest on those reserves or transfer them to other institutions to back up their customer’s transactions to other banks.
As a side not, the money you have in your checking account is a liability of your bank, they owe it to you. So, if you transfer that money to another bank, say by paying someone else who banks at a different bank, then your bank cannot send ONLY the liabilities. They must also send an offsetting asset; one example could be bank reserves. If a bank only received liabilities, they would go bankrupt rather quickly, at least in our current system, so this is one remedy. Further clarification on this note will be the subject of future posts.
Advisory councils
With all this power and influence with something as important as the world’s reserve currency, multiple advisory councils are used so that policy goals and decisions are made with as good of information as possible. These councils are listed as follows: Federal Advisory Council (FAC), Community Depository Institutions Advisory Council (CDIAC), Model Validation Council, Community Advisory Council (CAC), Insurance Policy Advisory Committee (IPAC). These are just the advisory councils for the FOMC, the Reserve Banks have their own as well.
Final words
The Federal Reserve system can be rather complex, especially when you dive into their actions and history. I have delved a little bit into their history, and it made my skin crawl, which is one reason why I am so interested in learning about it. Even if you are not interested in its history, understanding the monetary system as a whole will give you an extremely advantageous edge in your investing. Also, in a time where government entities are attempting to regulate areas in life where they have no jurisdiction (i.e., CDC and their eviction moratorium), it is helpful to understand the responsibilities and abilities of those entities beforehand.
To your wealth and future,
James Forsythe
For more on the Banking System
https://jamesdforsythe.com/category/finance/banking-system/
