Banking Types of banks Central bank Advising bank Commercial bank Community development bank Credit union Custodian bank Depository bank Export credit agency Investment bank Industrial bank Islamic banking Merchant bank Mutual bank Mutual savings bank National bank Offshore bank Postal savings system Private bank Retail Bank Savings and loan association Savings bank Universal bank Deposit accounts Savings account Transactional account Money market account Time deposit ATM card Debit card Credit card Electronic funds transfer Automated Clearing House Electronic bill payment Giro Wire transfer Bank From Wikipedia, the free encyclopedia A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities: A central bank circulates money on behalf of a government and acts as its monetary authority by implementing monetary policy, which regulates the money supply. A commercial bank accepts deposits and pools those funds to provide credit, either directly by lending, or indirectly by investing through the capital markets. Within the global financial markets, these institutions connect market participants with capital deficits (borrowers) to market participants with capital surpluses (investors and lenders) by transferring funds from those parties who have surplus funds to invest (financial assets) to those parties who borrow funds to invest in real assets. A savings bank (known as a "building society" in the United Kingdom) is similar to a savings and loan association (S&L). They can either be stockholder owned or mutually owned, in which case they are permitted to only borrow from members of the financial cooperative. The asset structure of savings banks and savings and loan associations is similar, with residential mortgage loans providing the principal assets of the institution's portfolio. Because of the important role depository institutions play in the financial system, the banking industry is highly regulated, and government restrictions on financial activities by banks have varied over time and by location. Current global bank capital requirements are referred to as Basel II. In some countries, such as Germany, banks have historically owned major stakes in industrial companies, while in other countries, such as the United States, banks have traditionally been prohibited from owning non-financial companies. In Japan, banks are usually the nexus of a cross-share holding entity known as the "keiretsu". In Iceland, banks followed international standards of regulation prior to the recent global financial crisis that began in 2007. The oldest bank still in existence is Monte dei Paschi di Siena, headquartered in Siena, Italy, which has been operating continuously since 1472.[1] Contents 1 History 1.1 Origin of the word 2 Definition 3 Banking 3.1 Standard activities Wire transfer Banking terms Anonymous banking Automatic teller machine Loan Money creation Cheque List of banks Finance series Financial market Financial market participants Corporate finance Personal finance Public finance Banks and Banking Financial regulation Finance Bond market Stock market (equity market) Foreign exchange market Derivatives market Commodity market Money market Spot market (cash market) Over the counter Real estate Private equity Financial market participants: Investor and speculator Institutional and retail Cash: Deposit Option (call or put) Loans Security Derivative Stock Time deposit or certificate of deposit Futures contract Exotic option 3.2 Channels 3.3 Business model 3.4 Products 3.4.1 Retail 3.4.2 Wholesale 4 Risk and capital 5 Banks in the economy 5.1 Economic functions 5.2 Bank crisis 5.3 Size of global banking industry 6 Regulation 7 Types of banks 7.1 Types of retail banks 7.2 Types of investment banks 7.3 Both combined 7.4 Other types of banks 8 Challenges within the banking industry 8.1 United States 8.2 Competition for loanable funds 9 Accounting for bank accounts 9.1 Brokered deposits 10 Banking by country 11 See also 12 References 13 External links History Main article: History of banking Banking in the modern sense of the word can be traced to medieval and early Renaissance Italy, to the rich cities in the north like Florence, Venice and Genoa. The Bardi and Peruzzi families dominated banking in 14th century Florence, establishing branches in many other parts of Europe.[2] Perhaps the most famous Italian bank was the Medici bank, set up by Giovanni Medici in 1397.[3] The earliest known state deposit bank, Banco di San Giorgio (Bank of St. George), was founded in 1407 at Genoa, Italy.[4] Origin of the word The word bank was borrowed in Middle English from Middle French banque, from Old Italian banca, from Old High German banc, bank Financial markets Financial instruments Structured finance Capital budgeting Financial risk management Mergers and acquisitions Accountancy Financial statement Audit Credit rating agency Leveraged buyout Venture capital Credit and debt Student financial aid Employment contract Retirement Financial planning Government spending: Transfer payment (Redistribution) Government operations Government final consumption expenditure Government revenue: Taxation Non-tax revenue Government budget Government debt Surplus and deficit deficit spending Warrant (of payment) Fractional-reserve banking Central Bank List of banks Deposits Loan Money supply Finance designations Accounting scandals ISO 31000 "bench, counter". Benches were used as desks or exchange counters during the Renaissance by Florentine bankers, who used to make their transactions atop desks covered by green tablecloths.[5] The earliest evidence of money-changing activity is depicted on a silver Greek drachm coin from ancient Hellenic colony Trapezus on the Black Sea, modern Trabzon, c. 350–325 BC, presented in the British Museum in London. The coin shows a banker's table (trapeza) laden with coins, a pun on the name of the city. In fact, even today in Modern Greek the word Trapeza (...pe.a) means both a table and a bank. Definition The definition of a bank varies from country to country. See the relevant country page (below) for more information. Under English common law, a banker is defined as a person who carries on the business of banking, which is specified as:[6] conducting current accounts for his customers paying cheques drawn on him, and collecting cheques for his customers. In most common law jurisdictions there is a Bills of Exchange Act that codifies the law in relation to negotiable instruments, including cheques, and this Act contains a statutory definition of the term banker: banker includes a body of persons, whether incorporated or not, who carry on the business of banking' (Section 2, Interpretation). Although this definition seems circular, it is actually functional, because it ensures that the legal basis for bank transactions such as cheques does not depend on how the bank is organised or regulated. The business of banking is in many English common law countries not defined by statute but by common law, the definition above. In other English common law jurisdictions there are statutory definitions of the business of banking or banking business. When looking at these definitions it is important to keep in mind that they are defining the business of banking for the purposes of the legislation, and not necessarily in general. In particular, most of the definitions are from legislation that has the purposes of entry regulating and supervising banks rather than regulating the actual business of banking. However, in many cases the statutory definition closely mirrors the common law one. Examples of statutory definitions: "banking business" means the business of receiving money on current or deposit account, paying and collecting cheques drawn by or paid in by customers, the making of advances to Corporate finance Personal finance Public finance Banks and banking Financial regulation Standards International Financial Reporting Stock market bubble Recession Stock market crash History of private equity Banco de Venezuela in Coro. Large door to an old bank vault. customers, and includes such other business as the Authority may prescribe for the purposes of this Act; (Banking Act (Singapore), Section 2, Interpretation). "banking business" means the business of either or both of the following: 1. receiving from the general public money on current, deposit, savings or other similar account repayable on demand or within less than [3 months] ... or with a period of call or notice of less than that period; 2. paying or collecting cheques drawn by or paid in by customers[7] Since the advent of EFTPOS (Electronic Funds Transfer at Point Of Sale), direct credit, direct debit and internet banking, the cheque has lost its primacy in most banking systems as a payment instrument. This has led legal theorists to suggest that the cheque based definition should be broadened to include financial institutions that conduct current accounts for customers and enable customers to pay and be paid by third parties, even if they do not pay and collect cheques.[8] Banking Standard activities Banks act as payment agents by conducting checking or current accounts for customers, paying cheques drawn by customers on the bank, and collecting cheques deposited to customers' current accounts. Banks also enable customer payments via other payment methods such as telegraphic transfer, EFTPOS, and automated teller machine (ATM). Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending. Banks provide almost all payment services, and a bank account is considered indispensable by most businesses, individuals and governments. Non-banks that provide payment services such as remittance companies are not normally considered an adequate substitute for having a bank account. Banks borrow most funds from households and non-financial businesses, and lend most funds to households and non-financial businesses, but non-bank lenders provide a significant and in many cases adequate substitute for bank Economic history loans, and money market funds, cash management trusts and other non-bank financial institutions in many cases provide an adequate substitute to banks for lending savings too. Channels Banks offer many different channels to access their banking and other services: ATM is a machine that dispenses cash and sometimes takes deposits without the need for a human bank teller. Some ATMs provide additional services. A branch is a retail location Call center Mail: most banks accept check deposits via mail and use mail to communicate to their customers, e.g. by sending out statements Mobile banking is a method of using one's mobile phone to conduct banking transactions Online banking is a term used for performing transactions, payments etc. over the Internet Relationship Managers, mostly for private banking or business banking, often visiting customers at their homes or businesses Telephone banking is a service which allows its customers to perform transactions over the telephone without speaking to a human Video banking is a term used for performing banking transactions or professional banking consultations via a remote video and audio connection. Video banking can be performed via purpose built banking transaction machines (similar to an Automated teller machine), or via a videoconference enabled bank branch.clarification Business model A bank can generate revenue in a variety of different ways including interest, transaction fees and financial advice. The main method is via charging interest on the capital it lends out to customers[citation needed]. The bank profits from the differential between the level of interest it pays for deposits and other sources of funds, and the level of interest it charges in its lending activities. This difference is referred to as the spread between the cost of funds and the loan interest rate. Historically, profitability from lending activities has been cyclical and dependent on the needs and strengths of loan customers and the stage of the economic cycle. Fees and financial advice constitute a more stable revenue stream and banks have therefore placed more emphasis on these revenue lines to smooth their financial performance. In the past 20 years American banks have taken many measures to ensure that they remain profitable while responding to increasingly changing market conditions. First, this includes the Gramm-Leach-Bliley Act, which allows banks again to merge with investment and insurance houses. Merging banking, investment, and insurance functions allows traditional banks to respond to increasing consumer demands for "one-stop shopping" by enabling cross-selling of products (which, the banks hope, will also increase profitability). Second, they have expanded the use of risk-based pricing from business lending to consumer lending, which means charging higher interest rates to those customers that are considered to be a higher credit risk and thus increased chance of default on loans. This helps to offset the losses from bad loans, lowers the price of loans to those who have better credit histories, and offers credit products to high risk customers who would otherwise be denied credit. A former building society, now a modern retail bank in Leeds, West Yorkshire. An interior of a branch of National Westminster Bank on Castle Street, Liverpool Third, they have sought to increase the methods of payment processing available to the general public and business clients. These products include debit cards, prepaid cards, smart cards, and credit cards. They make it easier for consumers to conveniently make transactions and smooth their consumption over time (in some countries with underdeveloped financial systems, it is still common to deal strictly in cash, including carrying suitcases filled with cash to purchase a home). However, with convenience of easy credit, there is also increased risk that consumers will mismanage their financial resources and accumulate excessive debt. Banks make money from card products through interest payments and fees charged to consumers and transaction fees to companies that accept the credit- debit - cards. This helps in making profit and facilitates economic development as a whole.[citation needed] Products Retail Business loan Cheque account Credit card Home loan Insurance advisor Mutual fund Personal loan Savings account Wholesale Capital raising (Equity / Debt / Hybrids) Mezzanine finance Project finance Revolving credit Risk management (FX, interest rates, commodities, derivatives) Term loan Risk and capital Banks face a number of risks in order to conduct their business, and how well these risks are managed and understood is a key driver behind profitability, and how much capital a bank is required to hold. Some of the main risks faced by banks include: Credit risk: risk of loss[citation needed] arising from a borrower who does not make payments as promised. Liquidity risk: risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). Market risk: risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. Operational risk: risk arising from execution of a company's business functions. The capital requirement is a bank regulation, which sets a framework on how banks and depository institutions must handle their capital. The categorization of assets and capital is highly standardized so that it can be risk weighted (see risk-weighted asset). Banks in the economy See also: Financial system Economic functions The economic functions of banks include: 1. Issue of money, in the form of banknotes and current accounts subject to cheque or payment at the customer's order. These claims on banks can act as money because they are negotiable or repayable on demand, and hence valued at par. They are effectively transferable by mere delivery, in the case of banknotes, or by drawing a cheque that the payee may bank or cash. 2. Netting and settlement of payments – banks act as both collection and paying agents for customers, participating in interbank clearing and settlement systems to collect, present, be presented with, and pay payment instruments. This enables banks to economise on reserves held for settlement of payments, since inward and outward payments offset each other. It also enables the offsetting of payment flows between geographical areas, reducing the cost of settlement between them. 3. Credit intermediation – banks borrow and lend back-to-back on their own account as middle men. 4. Credit quality improvement – banks lend money to ordinary commercial and personal borrowers (ordinary credit quality), but are high quality borrowers. The improvement comes from diversification of the bank's assets and capital which provides a buffer to absorb losses without defaulting on its obligations. However, banknotes and deposits are generally unsecured; if the bank gets into difficulty and pledges assets as security, to raise the funding it needs to continue to operate, this puts the note holders and depositors in an economically subordinated position. 5. Maturity transformation – banks borrow more on demand debt and short term debt, but provide more long term loans. In other words, they borrow short and lend long. With a stronger credit quality than most other borrowers, banks can do this by aggregating issues (e.g. accepting deposits and issuing banknotes) and redemptions (e.g. withdrawals and redemptions of banknotes), maintaining reserves of cash, investing in marketable securities that can be readily converted to cash if needed, and raising replacement funding as needed from various sources (e.g. wholesale cash markets and securities markets). Bank crisis Banks are susceptible to many forms of risk which have triggered occasional systemic crises. These include liquidity risk (where many depositors may request withdrawals in excess of available funds), credit risk (the chance that those who owe money to the bank will not repay it), and interest rate risk (the possibility that the bank will become unprofitable, if rising interest rates force it to pay relatively more on its deposits than it receives on its loans). Banking crises have developed many times throughout history, when one or more risks have materialized for a banking sector as a whole. Prominent examples include the bank run that occurred during the Great Depression, the U.S. Savings and Loan crisis in the 1980s and early 1990s, the Japanese banking crisis during the 1990s, and the subprime mortgage crisis in the 2000s. Size of global banking industry Assets of the largest 1,000 banks in the world grew by 6.8% in the 2008/2009 financial year to a record $96.4 trillion while profits declined by 85% to $115bn. Growth in assets in adverse market conditions was largely a result of recapitalisation. EU banks held the largest share of the total, 56% in 2008/2009, down from 61% in the previous year. Asian banks' share increased from 12% to 14% during the year, while the share of US banks increased from 11% to 13%. Fee revenue generated by global investment banking totalled $66.3bn in 2009, up 12% on the previous year.[9] The United States has the most banks in the world in terms of institutions (7,085 at the end of 2008) and possibly branches (82,000).[citation needed] This is an indicator of the geography and regulatory structure of the USA, resulting in a large number of small to medium-sized institutions in its banking system. As of Nov 2009, China's top 4 banks have in excess of 67,000 branches (ICBC:18000+, BOC:12000+, CCB:13000+, ABC:24000+) with an additional 140 smaller banks with an undetermined number of branches. Japan had 129 banks and 12,000 branches. In 2004, Germany, France, and Italy each had more than 30,000 branches—more than double the 15,000 branches in the UK.[9] Regulation Main article: Banking regulation See also: Basel II Currently in most jurisdictions commercial banks are regulated by government entities and require a special bank licence to operate. Usually the definition of the business of banking for the purposes of regulation is extended to include acceptance of deposits, even if they are not repayable to the customer's order—although money lending, by itself, is generally not included in the definition. Unlike most other regulated industries, the regulator is typically also a participant in the market, being either a publicly or privately governed central bank. Central banks also typically have a monopoly on the business of issuing banknotes. However, in some countries this is not the case. In the UK, for example, the Financial Services Authority licences banks, and some commercial banks (such as the Bank of Scotland) issue their own banknotes in addition to those issued by the Bank of England, the UK government's central bank. Banking law is based on a contractual analysis of the relationship between the bank (defined above) and the customer—defined as any entity for which the bank agrees to conduct an account. The law implies rights and obligations into this relationship as follows: 1. The bank account balance is the financial position between the bank and the customer: when the account is in credit, the bank owes the balance to the customer; when the account is overdrawn, the customer owes the balance to the bank. 2. The bank agrees to pay the customer's cheques up to the amount standing to the credit of the customer's account, plus any agreed overdraft limit. 3. The bank may not pay from the customer's account without a mandate from the customer, e.g. a cheque drawn by the customer. National Bank of the Republic, Salt Lake City 1908 4. The bank agrees to promptly collect the cheques deposited to the customer's account as the customer's agent, and to credit the proceeds to the customer's account. 5. The bank has a right to combine the customer's accounts, since each account is just an aspect of the same credit relationship. 6. The bank has a lien on cheques deposited to the customer's account, to the extent that the customer is indebted to the bank. 7. The bank must not disclose details of transactions through the customer's account—unless the customer consents, there is a public duty to disclose, the bank's interests require it, or the law demands it. 8. The bank must not close a customer's account without reasonable notice, since cheques are outstanding in the ordinary course of business for several days. These implied contractual terms may be modified by express agreement between the customer and the bank. The statutes and regulations in force within a particular jurisdiction may also modify the above terms and/or create new rights, obligations or limitations relevant to the bank-customer relationship. Some types of financial institution, such as building societies and credit unions, may be partly or wholly exempt from bank licence requirements, and therefore regulated under separate rules. The requirements for the issue of a bank licence vary between jurisdictions but typically include: 1. Minimum capital 2. Minimum capital ratio 3. 'Fit and Proper' requirements for the bank's controllers, owners, directors, or senior officers 4. Approval of the bank's business plan as being sufficiently prudent and plausible. Types of banks Banks' activities can be divided into retail banking, dealing directly with individuals and small businesses; business banking, providing services to mid-market business; corporate banking, directed at large business entities; private banking, providing wealth management services to high net worth individuals and families; and investment banking, relating to activities on the financial markets. Most banks are profit-making, private enterprises. However, some are owned by government, or are non-profit organizations. Types of retail banks Commercial bank: the term used for a normal bank to distinguish it from an investment bank. After the Great Depression, the U.S. Congress required that banks only engage in banking activities, whereas investment banks were limited to capital market activities. Since the two no longer have to be under separate ownership, some use the term "commercial bank" to refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses. Community banks: locally operated financial institutions that empower employees to make local decisions to serve their customers and the partners. Community development banks: regulated banks that provide ATM Al-Rajhi Bank National Copper Bank, Salt Lake City 1911 Community development banks: regulated banks that provide financial services and credit to under-served markets or populations. Credit unions: not-for-profit cooperatives owned by the depositors and often offering rates more favorable than for-profit banks. Typically, membership is restricted to employees of a particular company, residents of a defined neighborhood, members of a certain labor union or religious organizations, and their immediate families. Postal savings banks: savings banks associated with national postal systems. Private banks: banks that manage the assets of high net worth individuals. Historically a minimum of USD 1 million was required to open an account, however, over the last years many private banks have lowered their entry hurdles to USD 250,000 for private investors.[citation needed] Offshore banks: banks located in jurisdictions with low taxation and regulation. Many offshore banks are essentially private banks. Savings bank: in Europe, savings banks took their roots in the 19th or sometimes even in the 18th century. Their original objective was to provide easily accessible savings products to all strata of the population. In some countries, savings banks were created on public initiative; in others, socially committed individuals created foundations to put in place the necessary infrastructure. Nowadays, European savings banks have kept their focus on retail banking: payments, savings products, credits and insurances for individuals or small and medium-sized enterprises. Apart from this retail focus, they also differ from commercial banks by their broadly decentralised distribution network, providing local and regional outreach—and by their socially responsible approach to business and society. Building societies and Landesbanks: institutions that conduct retail banking. Ethical banks: banks that prioritize the transparency of all operations and make only what they consider to be socially-responsible investments. A Direct or Internet-Only bank is a banking operation without any physical bank branches, conceived and implemented wholly with networked computers. Types of investment banks Investment banks "underwrite" (guarantee the sale of) stock and bond issues, trade for their own accounts, make markets, and advise corporations on capital market activities such as mergers and acquisitions. Merchant banks were traditionally banks which engaged in trade finance. The modern definition, however, refers to banks which provide capital to firms in the form of shares rather than loans. Unlike venture capital firms, they tend not to invest in new companies. Both combined Universal banks, more commonly known as financial services companies, engage in several of these activities. These big banks are very diversified groups that, among other services, also distribute insurance— hence the term bancassurance, a portmanteau word combining "banque or bank" and "assurance", signifying that both banking and insurance are provided by the same corporate entity. Other types of banks Central banks are normally government-owned and charged with quasi-regulatory responsibilities, such as supervising commercial banks, or controlling the cash interest rate. They generally provide liquidity to the banking system and act as the lender of last resort in event of a crisis. Islamic banks adhere to the concepts of Islamic law. This form of banking revolves around several wellestablished principles based on Islamic canons. All banking activities must avoid interest, a concept that is forbidden in Islam. Instead, the bank earns profit (markup) and fees on the financing facilities that it extends to customers. Challenges within the banking industry United States Main article: Banking in the United States In the United States, the banking industry is a highly regulated industry with detailed and focused regulators. All banks with FDIC-insured deposits have the Federal Deposit Insurance Corporation (FDIC) as a regulator; however, for examinations, the Federal Reserve is the primary federal regulator for Fed-member state banks; the Office of the Comptroller of the Currency (OCC) is the primary federal regulator for national banks; and the Office of Thrift Supervision, or OTS, is the primary federal regulator for thrifts. State non-member banks are examined by the state agencies as well as the FDIC. National banks have one primary regulator—the OCC. Qualified Intermediaries & Exchange Accommodators are regulated by MAIC. Each regulatory agency has their own set of rules and regulations to which banks and thrifts must adhere. The Federal Financial Institutions Examination Council (FFIEC) was established in 1979 as a formal interagency body empowered to prescribe uniform principles, standards, and report forms for the federal examination of financial institutions. Although the FFIEC has resulted in a greater degree of regulatory consistency between the agencies, the rules and regulations are constantly changing. In addition to changing regulations, changes in the industry have led to consolidations within the Federal Reserve, FDIC, OTS, MAIC and OCC. Offices have been closed, supervisory regions have been merged, staff levels have been reduced and budgets have been cut. The remaining regulators face an increased burden with increased workload and more banks per regulator. While banks struggle to keep up with the changes in the regulatory environment, regulators struggle to manage their workload and effectively regulate their banks. The impact of these changes is that banks are receiving less hands-on assessment by the regulators, less time spent with each institution, and the potential for more problems slipping through the cracks, potentially resulting in an overall increase in bank failures across the United States. The changing economic environment has a significant impact on banks and thrifts as they struggle to effectively manage their interest rate spread in the face of low rates on loans, rate competition for deposits and the general market changes, industry trends and economic fluctuations. It has been a challenge for banks to effectively set their growth strategies with the recent economic market. A rising interest rate environment may seem to help financial institutions, but the effect of the changes on consumers and businesses is not predictable and the challenge remains for banks to grow and effectively manage the spread to generate a return to their shareholders. The management of the banks’ asset portfolios also remains a challenge in today’s economic environment. Loans are a bank’s primary asset category and when loan quality becomes suspect, the foundation of a bank is shaken to the core. While always an issue for banks, declining asset quality has become a big problem for financial institutions. There are several reasons for this, one of which is the lax attitude some banks have adopted because of the years of “good times.” The potential for this is exacerbated by the reduction in the regulatory oversight of banks and in some cases depth of management. Problems are more likely to go undetected, resulting in a significant impact on the bank when they are recognized. In addition, banks, like any business, struggle to cut costs and have consequently eliminated certain expenses, such as adequate employee training programs. Banks also face a host of other challenges such as aging ownership groups. Across the country, many banks’ management teams and board of directors are aging. Banks also face ongoing pressure by shareholders, both public and private, to achieve earnings and growth projections. Regulators place added pressure on banks to manage the various categories of risk. Banking is also an extremely competitive industry. Competing in the financial services industry has become tougher with the entrance of such players as insurance agencies, credit unions, check cashing services, credit card companies, etc. As a reaction, banks have developed their activities in financial instruments, through financial market operations such as brokerage and MAIC trust & Securities Clearing services trading and become big players in such activities. Competition for loanable funds To be able to provide homebuyers and builders with the funds needed, banks must compete for deposits. The phenomenon of disintermediation had to dollars moving from savings accounts and into direct market instruments such as U.S. Treasury obligations, agency securities, and corporate debt. One of the greatest factors in recent years in the movement of deposits was the tremendous growth of money market funds whose higher interest rates attracted consumer deposits.[10] To compete for deposits, US savings institutions offer many different types of plans:[10] Passbook or ordinary deposit accounts — permit any amount to be added to or withdrawn from the account at any time. NOW and Super NOW accounts — function like checking accounts but earn interest. A minimum balance may be required on Super NOW accounts. Money market accounts — carry a monthly limit of preauthorized transfers to other accounts or persons and may require a minimum or average balance. Certificate accounts — subject to loss of some or all interest on withdrawals before maturity. Notice accounts — the equivalent of certificate accounts with an indefinite term. Savers agree to notify the institution a specified time before withdrawal. Individual retirement accounts (IRAs) and Keogh plans — a form of retirement savings in which the funds deposited and interest earned are exempt from income tax until after withdrawal. Checking accounts — offered by some institutions under definite restrictions. All withdrawals and deposits are completely the sole decision and responsibility of the account owner unless the parent or guardian is required to do otherwise for legal reasons. Club accounts and other savings accounts — designed to help people save regularly to meet certain goals. Suburban bank branch Club accounts and other savings accounts — designed to help people save regularly to meet certain goals. Accounting for bank accounts Bank statements are accounting records produced by banks under the various accounting standards of the world. Under GAAP and MAIC there are two kinds of accounts: debit and credit. Credit accounts are Revenue, Equity and Liabilities. Debit Accounts are Assets and Expenses. This means you credit a credit account to increase its balance, and you debit a credit account to decrease its balance.[11] This also means you credit your savings account every time you deposit money into it (and the account is normally in credit), while you debit your credit card account every time you spend money from it (and the account is normally in debit). However, if you read your bank statement, it will say the opposite—that you credit your account when you deposit money, and you debit it when you withdraw funds. If you have cash in your account, you have a positive (or credit) balance; if you are overdrawn, you have a negative (or deficit) balance. Where bank transactions, balances, credits and debits are discussed below, they are done so from the viewpoint of the account holder—which is traditionally what most people are used to seeing. Brokered deposits One source of deposits for banks is brokers who deposit large sums of money on the behalf of investors through MAIC or other trust corporations. This money will generally go to the banks which offer the most favorable terms, often better than those offered local depositors. It is possible for a bank to be engaged in business with no local deposits at all, all funds being brokered deposits. Accepting a significant quantity of such deposits, or "hot money" as it is sometimes called, puts a bank in a difficult and sometimes risky position, as the funds must be lent or invested in a way that yields a return sufficient to pay the high interest being paid on the brokered deposits. This may result in risky decisions and even in eventual failure of the bank. Banks which failed during 2008 and 2009 in the United States during the global financial crisis had, on average, four times more brokered deposits as a percent of their deposits than the average bank. Such deposits, combined with risky real estate investments, factored into the Savings and loan crisis of the 1980s. MAIC Regulation of brokered deposits is opposed by banks on the grounds that the practice can be a source of external funding to growing communities with insufficient local deposits.[12] Banking by country Banking in Australia Banking in Austria Banking in Bangladesh Banking in Canada Banking in China Banking in France Banking in Germany Banking in Greece Banking in Iran Banking in Iran Banking in India Banking in Israel Banking in Italy Banking in Pakistan Banking in Russia Banking in Singapore Banking in Switzerland Banks of the United Kingdom Banking in the United States See also Types of institutions: Bankers' bank Building Society Cooperative bank Credit union Ethical bank Industrial loan company Islamic banking Mortgage bank Mutual savings bank Offshore banking Person-to-person lending Savings and loan association Savings bank Sparebank Terms and concepts: Bank regulation Bankers' bonuses Call Report Cheque Electronic funds transfer Factoring (finance) Finance Fractional-reserve banking Hedge fund IBAN Internet banking Investment banking Mobile banking Money Crime: Bank fraud Bank robbery Cheque fraud Mortgage fraud Lists: List of accounting topics List of bank mergers in United States List of banks List of economics topics List of finance topics List of largest U.S. bank failures List of stock exchanges Money Money laundering Narrow banking Overdraft Overdraft protection Piggy bank Pigmy Deposit Scheme Private Banking Stock broker Substitute check SWIFT Tax haven Venture capital Wealth Management Wire transfer List of stock exchanges Federal Reserve System Seal Federal Reserve System headquarters (Eccles Building) Headquarters Washington, D.C. Chairman Ben Bernanke Central bank of United States Currency United States dollar ISO 4217 Code USD Base borrowing rate 0%–0.25%[1] Website federalreserve.gov (http://www.federalreserve.gov/) Public Finance A series on Government Economic policy Fiscal policy · Monetary policy Trade policy · Investment policy Agricultural policy · Industrial policy Energy policy · Social policy Policy mix Tax policy · Budgetary policy Revenue · Spending · Budget Deficit or Surplus · Deficit spending Debt (External · Internal) Finance ministry · Fiscal union Money supply · Interest rate Monetary base · Discount window Reserve requirements Bank reserves · Gold reserves Central bank · Monetary union Tariff · Non-tariff barrier Balance of trade · Gains from trade Trade creation · Trade diversion Protectionism · Free trade Commerce ministry · Trade bloc Tax revenue · Non-tax revenue Mandatory spending Discretionary spending Balanced budget (Fiscal) Price stability (Monetary) Growth (Trade and Investment) Banking in the United States Federal Reserve System From Wikipedia, the free encyclopedia The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) is the central banking system of the United States. It was created in 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907.[2][3][4] Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure has evolved.[3][5] Events such as the Great Depression were major factors leading to changes in the system.[6] Its duties today, according to official Federal Reserve documentation, are to conduct the nation's monetary policy, supervise and regulate banking institutions, maintain the stability of the financial system and provide financial services to depository institutions, the U.S. government, and foreign official institutions.[7] The Federal Reserve System's structure is composed of the presidentially appointed Board of Governors (or Federal Reserve Board), the Federal Open Market Committee (FOMC), twelve regional Federal Reserve Banks located in major cities throughout the nation, numerous privately owned U.S. member banks and various advisory councils.[8][9][10] The FOMC is the committee responsible for setting monetary policy and consists of all seven members of the Board of Governors and the twelve regional bank presidents, though only five bank presidents vote at any given time. The Federal Reserve System has both private and public components, and was designed to serve the interests of both the general public and private bankers. The result is a structure that is considered unique among central banks. It is also unusual in that an entity outside of the central bank, namely the United States Department of the Treasury, creates the currency used.[11] According to the Board of Governors, the Federal Reserve is independent within government in that "its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government." However, its authority is derived from the U.S. Congress and is subject to congressional oversight. Additionally, the members of the Board of Governors, including its chairman and vice-chairman, are chosen by the President and confirmed by Congress. The government also exercises some control over the Federal Reserve by appointing and setting the salaries of the system's highest-level employees. Thus the Federal Reserve has both private and public aspects.[12][13][14][15] The U.S. Government receives all of the system's annual profits, after a statutory dividend of 6% on member banks' capital investment is paid, and an account surplus is maintained. In 2010, the Federal Reserve made a profit of $82 billion and transferred $79 billion to the U.S. Treasury.[16] Contents 1 History 1.1 Central banking in the United States 1.1.1 Timeline of central banking in the United States 1.1.2 Creation of First and Second Central Bank 1.1.3 Creation of Third Central Bank 1.1.3.1 Federal Reserve Act 1.2 Key laws 2 Purpose 2.1 Addressing the problem of bank panics 2.1.1 Elastic currency 2.1.2 Check Clearing System 2.1.3 Lender of last resort 2.1.3.1 Emergencies 2.1.3.2 Fluctuations 2.2 Central bank 2.2.1 Federal funds 2.3 Balance between private banks and responsibility of governments 2.3.1 Government regulation and supervision 2.3.1.1 Preventing asset bubbles 2.4 National payments system 3 Structure 3.1 Board of Governors 3.1.1 List of members of the Board of Governors 3.2 Federal Open Market Committee 3.3 Federal Reserve Banks 3.3.1 Legal status of regional Federal Reserve Banks 4 Monetary policy 4.1 Interbank lending is the basis of policy 4.2 Tools 4.2.1 Federal funds rate and open market operations 4.2.1.1 Repurchase agreements 4.2.2 Discount rate 4.2.3 Reserve requirements 4.2.4 New facilities 4.2.4.1 Term auction facility Policies Fiscal policy Monetary policy Trade policy Revenue and Spending Optimum Monetary policy The Federal Reserve System Regulation Lending Credit card Deposit accounts Savings account Checking account Money market account Certificate of deposit Deposit account insurance FDIC and NCUA Electronic funds transfer (EFT) ATM card Debit card ACH Bill payment EBT Wire transfer Check Clearing System Checks Substitute checks • Check 21 Act Types of bank charter Credit union Federal savings bank Federal savings association National bank 4.2.4.2 Term securities lending facility 4.2.4.3 Primary dealer credit facility 4.2.4.4 Interest on reserves 4.2.4.5 Term deposit facility 4.2.4.6 Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility 4.2.4.7 Commercial Paper Funding Facility 4.2.5 Quantitative policy 4.2.6 Quantitative easing 5 Measurement of economic variables 5.1 Net worth of households and nonprofit organizations 5.2 Money supply 5.3 Personal consumption expenditures price index 5.3.1 Inflation and the economy 5.4 Unemployment rate 6 Budget 7 Net worth 7.1 Balance sheet 8 Criticism 8.1 Influence on economics researchers 8.2 Accountability 8.3 Role in business cycles and inflation 9 See also 10 References 11 Bibliography 11.1 Recent 11.2 Historical 12 External links 12.1 Official Federal Reserve websites and information 12.1.1 Open Market operations 12.1.2 Repurchase agreements 12.1.3 Discount window 12.1.4 Economic indicators 12.1.5 Federal Reserve publications 12.2 Other websites describing the Federal Reserve 12.3 Sites critical of the Federal Reserve History Central banking in the United States Main article: History of central banking in the United States In 1690, the Massachusetts Bay Colony became the first in the United States to issue paper money, but soon others began printing their own money as well. The demand for currency in the colonies was due to the scarcity of coins, which had been the primary means of trade.[17] Colonies' paper currencies were used to pay for their expenses, as well as a means to lend money to the colonies' citizens. Paper money quickly became the primary means of exchange within each colony, and it even began to be used in financial transactions with other colonies.[18] However, some of the currencies were not redeemable in gold or silver, which caused them to depreciate.[17] The first attempt at a national currency was during the American Revolutionary war. In 1775 the Continental Congress began issuing its own paper currency, calling their bills "Continentals". The Continentals were backed only by future tax revenue, and were used to help finance the Revolutionary War. As a result, the value of a Continental diminished quickly. The experience led the United States to be skeptical of unbacked currencies, which were not issued again until the Civil War.[17] In 1791, which was after the U.S. Constitution was ratified, the government granted the First Bank of the United States a charter to operate as the U.S. central bank until 1811.[17] Unlike the prior attempt at a centralized currency, the increase in the federal government's power, granted to it by the constitution, allowed national central banks to possess a monopoly on the minting of U.S currency.[19] Nonetheless, the First Bank of the United States came to an end under President Madison because Congress refused to renew its charter. The Second Bank of the United States was established in 1816, and lost its authority to be the central bank of the U.S. twenty years later under President Jackson when its charter expired. Both banks were based upon the Bank of England.[20] Ultimately, a third national bank, known as the Federal Reserve, was established in 1913 and still exists to this day. Timeline of central banking in the United States 1791–1811: First Bank of the United States 1811–1816: No central bank 1816–1836: Second Bank of the United States 1837–1862: Free Bank Era 1846–1921: Independent Treasury System 1863–1913: National Banks 1913–Present: Federal Reserve System Sources: "Remarks by Chairman Alan Greenspan – "Our banking history"" (http://www.federalreserve.gov/BoardDocs/Speeches/1998/19980502.htm) . May 2, 1998. http://www.federalreserve.gov/BoardDocs/Speeches/1998/19980502.htm., "History of the Federal Reserve" Newspaper clipping, December 24, 1913 (http://www.federalreserveeducation.org/about%2Dthe%2Dfed/history) . http://www.federalreserveeducation.org/about%2Dthe%2Dfed/history., "Historical Beginnings...The Federal Reserve" (http://www.bos.frb.org/about/pubs/begin.pdf) (pdf). 1999. http://www.bos.frb.org/about/pubs/begin.pdf., Chapter 1 Creation of First and Second Central Bank The first U.S. institution with central banking responsibilities was the First Bank of the United States, chartered by Congress and signed into law by President George Washington on February 25, 1791 at the urging of Alexander Hamilton. This was done despite strong opposition from Thomas Jefferson and James Madison, among numerous others. The charter was for twenty years and expired in 1811 under President Madison, because Congress refused to renew it.[21] In 1816, however, Madison revived it in the form of the Second Bank of the United States. Years later, early renewal of the bank's charter became the primary issue in the reelection of President Andrew Jackson. After Jackson, who was opposed to the central bank, was reelected, he pulled the government's funds out of the bank. Nicholas Biddle, President of the Second Bank of the United States, responded by contracting the money supply to pressure Jackson to renew the bank's charter forcing the country into a recession, which the bank blamed on Jackson's policies. Interestingly, Jackson is the only President to completely pay off the national debt (http://online.wsj.com/article/SB123491373049303821.html) . The bank's charter was not renewed in 1836. From 1837 to 1862, in the Free Banking Era there was no formal central bank. From 1862 to 1913, a system of national banks was instituted by the 1863 National Banking Act. A series of bank panics, in 1873, 1893, and 1907, provided strong demand for the creation of a centralized banking system. Creation of Third Central Bank Main article: History of the Federal Reserve System The main motivation for the third central banking system came from the Panic of 1907, which caused renewed demands for banking and currency reform.[22] During the last quarter of the 19th century and the beginning of the 20th century the United States economy went through a series of financial panics.[23] According to many economists, the previous national banking system had two main weaknesses: an inelastic currency and a lack of liquidity.[23] In 1908, Congress enacted the Aldrich-Vreeland Act, which provided for an emergency currency and established the National Monetary Commission to study banking and currency reform.[24] The National Monetary Commission returned with recommendations which later became the basis of the Federal Reserve Act, passed in 1913. Federal Reserve Act Main article: Federal Reserve Act The head of the bipartisan National Monetary Commission was financial expert and Senate Republican leader Nelson Aldrich. Aldrich set up two commissions—one to study the American monetary system in depth and the other, headed by Aldrich himself, to study the European central banking systems and report on them.[24] Aldrich went to Europe opposed to centralized banking, but after viewing Germany's monetary system he came away believing that a centralized bank was better than the government-issued bond system that he had previously supported. In early November 1910, Aldrich met with five well known members of the New York banking community to devise a central banking bill. Paul Warburg, an attendee of the meeting and long time advocate of central banking in the U.S., later wrote that Aldrich was "bewildered at all that he had absorbed abroad and he was faced with the difficult task of writing a highly technical bill while being harassed by the daily grind of his parliamentary duties."[25] After ten days of deliberation, the bill, which would later be referred to as the "Aldrich Plan", was agreed upon. It had several key components including: a central bank with a Washington-based headquarters and fifteen branches located throughout the U.S. in geographically strategic locations, and a uniform elastic currency based on gold and commercial paper. Aldrich believed a central banking system with no political involvement was best, but was convinced by Warburg that a plan with no public control was not politically feasible.[25] The compromise involved representation of the public sector on the Board of Directors.[26] Aldrich's bill was met with much opposition from politicians. Critics were suspicious of a central bank, and charged Aldrich of being biased due to his close ties to wealthy bankers such as J. P. Morgan and John D. Rockefeller, Jr., Aldrich's son-in-law. Most Republicans favored the Aldrich Plan,[26] but it lacked enough support in Congress to pass because rural and western states viewed it as favoring the "eastern establishment".[2] In contrast, progressive Democrats favored a reserve system owned and operated by the government; they believed that public ownership of the central bank would end Wall Street's control of the American currency supply.[26] Conservative Democrats fought for a privately owned, yet decentralized, reserve system, which would still be free of Wall Street's control.[26] The original Aldrich Plan was dealt a fatal blow in 1912, when Democrats won the White House and Congress.[25] Nonetheless, President Woodrow Wilson believed that the Aldrich plan would suffice with a few modifications. The plan became the basis for the Federal Reserve Act, which was proposed by Senator Robert Owen in May 1913. The primary difference between the two bills was the transfer of control of the Board of Directors (called the Federal Open Market Committee in the Federal Reserve Act) to the government.[2][21] The bill passed Congress in late 1913[27][28] on a mostly partisan basis, with most Democrats voting "yea" and most Republicans voting "nay".[21] Key laws Key laws affecting the Federal Reserve have been:[29] Federal Reserve Act Federal Income Tax Glass–Steagall Act Banking Act of 1935 Employment Act of 1946 Federal Reserve-Treasury Department Accord of 1951 Bank Holding Company Act of 1956 and the amendments of 1970 Federal Reserve Reform Act of 1977 International Banking Act of 1978 Full Employment and Balanced Growth Act (1978) Depository Institutions Deregulation and Monetary Control Act (1980) The monthly changes in the currency component of the U.S. money supply show currency being added into (% change greater than zero) and removed from circulation (% change less than zero). The most noticeable changes occur around the Christmas holiday shopping season as new currency is created so people can make withdrawals at banks, and then removed from circulation afterwards, when less cash is demanded. Financial Institutions Reform, Recovery and Enforcement Act of 1989 Federal Deposit Insurance Corporation Improvement Act of 1991 Gramm-Leach-Bliley Act (1999) Financial Services Regulatory Relief Act (2006) Emergency Economic Stabilization Act (2008) Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) Purpose The primary motivation for creating the Federal Reserve System was to address banking panics.[3] Other purposes are stated in the Federal Reserve Act, such as "to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes".[30] Before the founding of the Federal Reserve, the United States underwent several financial crises. A particularly severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913. Today the Fed has broader responsibilities than only ensuring the stability of the financial system.[31] Current functions of the Federal Reserve System include:[7][31] To address the problem of banking panics To serve as the central bank for the United States To strike a balance between private interests of banks and the centralized responsibility of government To supervise and regulate banking institutions To protect the credit rights of consumers To manage the nation's money supply through monetary policy to achieve the sometimes-conflicting goals of maximum employment stable prices, including prevention of either inflation or deflation[32] moderate long-term interest rates To maintain the stability of the financial system and contain systemic risk in financial markets To provide financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system To facilitate the exchange of payments among regions To respond to local liquidity needs To strengthen U.S. standing in the world economy Addressing the problem of bank panics Further information: bank run and fractional-reserve banking Bank runs occur because banking institutions in the United States are only required to hold a fraction of their depositors' money in reserve. This practice is called fractional-reserve banking. As a result, most banks invest the majority of their depositors' money. On rare occasion, too many of the bank's customers will withdraw their savings and the bank will need help from another institution to continue operating. Bank runs can lead to a multitude of social and economic problems. The Federal Reserve was designed as an attempt to prevent or minimize the occurrence of bank runs, and possibly act as a lender of last resort if a bank run does occur. Many economists, following Milton Friedman, believe that the Federal Reserve inappropriately refused to lend money to small banks during the bank runs of 1929.[33] Elastic currency One way to prevent bank runs is to have a money supply that can expand when money is needed. The term "elastic currency" in the Federal Reserve Act does not just mean the ability to expand the money supply, but also to contract it. Some economic theories have been developed that support the idea of expanding or shrinking a money supply as economic conditions warrant. Elastic currency is defined by the Federal Reserve as:[34] Currency that can, by the actions of the central monetary authority, expand or contract in amount warranted by economic conditions. Monetary policy of the Federal Reserve System is based partially on the theory that it is best overall to expand or contract the money supply as economic conditions change. Check Clearing System Because some banks refused to clear checks from certain others during times of economic uncertainty, a check-clearing system was created in the Federal Reserve system. It is briefly described in The Federal Reserve System—Purposes and Functions as follows:[35] By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907. During that episode, payments were disrupted throughout the country because many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that contributed to the failure of otherwise solvent banks. To address these problems, Congress gave the Federal Reserve System the authority to establish a nationwide check-clearing system. The System, then, was to provide not only an elastic currency—that is, a currency that would expand or shrink in amount as economic conditions warranted—but also an efficient and equitable check-collection system. Lender of last resort Further information: Lender of last resort Emergencies Ben Bernanke (lower-right), Chairman of the Federal Reserve Board of Governors, at a House Financial Services Committee hearing on February 10, 2009. Members of the Board frequently testify before congressional committees such as this one. The Senate equivalent of the House Financial Services Committee is the Senate Committee on Banking, According to the Federal Reserve Bank of Minneapolis, "the Federal Reserve has the authority and financial resources to act as 'lender of last resort' by extending credit to depository institutions or to other entities in unusual circumstances involving a national or regional emergency, where failure to obtain credit would have a severe adverse impact on the economy."[36] The Federal Reserve System's role as lender of last resort has been criticized because it shifts the risk and responsibility away from lenders and borrowers and places it on others in the form of inflation.[37] Fluctuations Through its discount and credit operations, Reserve Banks provide liquidity to banks to meet short-term needs stemming from seasonal fluctuations in deposits or unexpected withdrawals. Longer term liquidity may also be provided in exceptional circumstances. The rate the Fed charges banks for these loans is the discount rate (officially the primary credit rate). By making these loans, the Fed serves as a buffer against unexpected day-to-day fluctuations in reserve demand and supply. This contributes to the effective functioning of the banking system, alleviates pressure in the reserves market and reduces the extent of unexpected movements in the interest rates.[38] For example, on September 16, 2008, the Federal Reserve Board authorized an $85 billion loan to stave off the bankruptcy of international insurance giant American International Group (AIG).[39][40] Central bank Further information: Central bank In its role as the central bank of the United States, the Fed serves as a banker's bank and as the government's bank. As the banker's bank, it helps to assure the safety and efficiency of the payments system. As the government's bank, or fiscal agent, the Fed processes a variety of financial transactions involving trillions of dollars. Just as an individual might keep an account at a bank, the U.S. Treasury keeps a checking account with the Federal Reserve, through which incoming federal tax deposits and outgoing government payments are handled. As part of this service relationship, the Fed sells and redeems U.S. government securities such as savings bonds and Treasury bills, notes and bonds. It also issues the nation's coin and paper currency. The U.S. Treasury, through its Bureau of the Mint and Bureau of Engraving and Printing, actually produces the nation's cash supply and, in effect, sells the paper currency to the Federal Reserve Banks at manufacturing cost, and the coins at face value. The Federal Reserve Banks then distribute it to other financial institutions in various ways.[41] During the Fiscal Year 2008, the Bureau of Engraving and Printing delivered 7.7 billion notes at an average cost of 6.4 cents per note.[42] Federal funds Main article: Federal funds Federal funds are the reserve balances (also called federal reserve accounts) that private banks keep at their local Federal Reserve Bank.[43][44] These balances are the namesake reserves of the Federal Reserve System. The purpose of keeping funds at a Federal Reserve Bank is to have a mechanism for private banks to lend funds to one another. This market for funds plays an important role in the Federal Reserve System as it is what inspired the name of the system and it is what is used as the basis for monetary policy. Monetary policy works by influencing how much interest the private banks charge each other for the lending of these funds. Federal reserve accounts contain federal reserve credit, which can be converted into federal reserve notes. Private banks maintain their bank reserves in federal reserve accounts. Balance between private banks and responsibility of governments The system was designed out of a compromise between the competing philosophies of privatization and government regulation. In 2006 Donald L. Kohn, vice chairman of the Board of Governors, summarized the history of this compromise:[45] Agrarian and progressive interests, led by William Jennings Bryan, favored a central bank under public, rather than banker, control. But the vast majority of the nation's bankers, concerned about government intervention in the banking business, opposed a central bank structure directed by political appointees. The legislation that Congress ultimately adopted in 1913 reflected a hard-fought battle to balance these two competing views and created the hybrid public-private, centralized-decentralized structure that we have today. In the current system, private banks are for-profit businesses but government regulation places restrictions on what they can do. The Federal Reserve System is a part of government that regulates the private banks. The balance between privatization and government involvement is also seen in the structure of the system. Private banks elect members of the board of directors at their regional Federal Reserve Bank while the members of the Board of Governors are selected by the President of the United States and confirmed by the Senate. The private banks give input to the government officials about their economic situation and these government officials use this input in Federal Reserve policy decisions. In the end, private banking businesses are able to run a profitable business while the U.S. government, through the Federal Reserve System, oversees and regulates the activities of the private banks. Government regulation and supervision Federal Banking Agency Audit Act enacted in 1978 as Public Law 95-320 and Section 31 USC 714 of U.S. Code establish that the Federal Reserve may be audited by the Government Accountability Office (GAO).[46] The GAO has authority to audit check-processing, currency storage and shipments, and some regulatory and bank examination functions, however there are restrictions to what the GAO may in fact audit. Audits of the Reserve Board and Federal Reserve banks may not include: 1. transactions for or with a foreign central bank or government, or nonprivate international financing organization; 2. deliberations, decisions, or actions on monetary policy matters; 3. transactions made under the direction of the Federal Open Market Committee; or 4. a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to items (1), (2), or (3).[47][48] The financial crisis which began in 2007, corporate bailouts, and concerns over the Fed's secrecy have brought renewed concern regarding ability of the Fed to effectively manage the national monetary system.[49] A July 2009 Gallup Poll found only 30% Americans thought the Fed was doing a good or excellent job, a rating even lower than that for the Internal Revenue Service, which drew praise from 40%.[50] The Federal Reserve Transparency Act was introduced by congressman Ron Paul in order to obtain a more detailed audit of the Fed. The Fed has since hired Linda Robertson who headed the Washington lobbying office of Enron Corp. and was adviser to all three of the Clinton administration's Treasury secretaries.[51][52][53][54] The Board of Governors in the Federal Reserve System has a number of supervisory and regulatory responsibilities in the U.S. banking system, Housing, but not complete responsibility. A general description of the types of regulation and supervision involved in the U.S. banking system is given by and Urban Affairs. the Federal Reserve:[55] The Board also plays a major role in the supervision and regulation of the U.S. banking system. It has supervisory responsibilities for state-chartered banks (http://www.state.ar.us/bank/benefits.html) that are members of the Federal Reserve System, bank holding companies (companies that control banks), the foreign activities of member banks, the U.S. activities of foreign banks, and Edge Act and agreement corporations (limited-purpose institutions that engage in a foreign banking business). The Board and, under delegated authority, the Federal Reserve Banks, supervise approximately 900 state member banks and 5,000 bank holding companies. Other federal agencies also serve as the primary federal supervisors of commercial banks; the Office of the Comptroller of the Currency supervises national banks, and the Federal Deposit Insurance Corporation supervises state banks that are not members of the Federal Reserve System. Some regulations issued by the Board apply to the entire banking industry, whereas others apply only to member banks, that is, state banks that have chosen to join the Federal Reserve System and national banks, which by law must be members of the System. The Board also issues regulations to carry out major federal laws governing consumer credit protection, such as the Truth in Lending, Equal Credit Opportunity, and Home Mortgage Disclosure Acts. Many of these consumer protection regulations apply to various lenders outside the banking industry as well as to banks. Members of the Board of Governors are in continual contact with other policy makers in government. They frequently testify before congressional committees on the economy, monetary policy, banking supervision and regulation, consumer credit protection, financial markets, and other matters. The Board has regular contact with members of the President's Council of Economic Advisers and other key economic officials. The Chairman also meets from time to time with the President of the United States and has regular meetings with the Secretary of the Treasury. The Chairman has formal responsibilities in the international arena as well. Preventing asset bubbles The board of directors of each Federal Reserve Bank District also has regulatory and supervisory responsibilities. For example, a member bank (private bank) is not permitted to give out too many loans to people who cannot pay them back. This is because too many defaults on loans will lead to a bank run. If the board of directors has judged that a member bank is performing or behaving poorly, it will report this to the Board of Governors. This policy is described in United States Code:[56] Each Federal reserve bank shall keep itself informed of the general character and amount of the loans and investments of its member banks with a view to ascertaining whether undue use is being made of bank credit for the speculative carrying of or trading in securities, real estate, or commodities, or for any other purpose inconsistent with the maintenance of sound credit conditions; and, in determining whether to grant or refuse advances, rediscounts, or other credit accommodations, the Federal reserve bank shall give consideration to such information. The chairman of the Federal reserve bank shall report to the Board of Governors of the Federal Reserve System any such undue use of bank credit by any member bank, together with his recommendation. Whenever, in the judgment of the Board of Governors of the Federal Reserve System, any member bank is making such undue use of bank credit, the Board may, in its discretion, after reasonable notice and an opportunity for a hearing, suspend such bank from the use of the credit facilities of the Federal Reserve System and may terminate such suspension or may renew it from time to time. The punishment for making false statements or reports that overvalue an asset is also stated in the U.S. Code:[57] Whoever knowingly makes any false statement or report, or willfully overvalues any land, property or security, for the purpose of influencing in any way...shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both. These aspects of the Federal Reserve System are the parts intended to prevent or minimize speculative asset bubbles, which ultimately lead to severe market corrections. The recent bubbles and corrections in energies, grains, equity and debt products and real estate cast doubt on the efficacy of these controls. National payments system The Federal Reserve plays an important role in the U.S. payments system. The twelve Federal Reserve Banks provide banking services to depository institutions and to the federal government. For depository institutions, they maintain accounts and provide various payment services, including collecting checks, electronically transferring funds, and distributing and receiving currency and coin. For the federal government, the Reserve Banks act as fiscal agents, paying Treasury checks; processing electronic payments; and issuing, transferring, and redeeming U.S. government securities.[58] In passing the Depository Institutions Deregulation and Monetary Control Act of 1980, Congress reaffirmed its intention that the Federal Reserve should promote an efficient nationwide payments system. The act subjects all depository institutions, not just member commercial banks, to reserve requirements and grants them equal access to Reserve Bank payment services. It also encourages competition between the Reserve Banks and private-sector providers of payment services by requiring the Reserve Banks to charge fees for certain payments services listed in the act and to recover the costs of providing these services over the long run. The Federal Reserve plays a vital role in both the nation's retail and wholesale payments systems, providing a variety of financial services to depository institutions. Retail payments are generally for relatively small-dollar amounts and often involve a depository institution's retail clients—individuals and smaller businesses. The Reserve Banks' retail services include distributing currency and coin, collecting checks, and electronically transferring funds through the automated clearinghouse system. By contrast, wholesale payments are generally for large-dollar amounts and often involve a depository institution's large corporate customers or counterparties, including other financial institutions. The Reserve Banks' wholesale services include electronically transferring funds through the Fedwire Funds Service and transferring securities issued by the U.S. government, its agencies, and certain other entities through the Fedwire Securities Service. Because of the large amounts of funds that move through the Reserve Banks every day, the System has policies and procedures to limit the risk to the Reserve Banks from a depository institution's failure to make or settle its payments. The Federal Reserve Banks began a multi-year restructuring of their check operations in 2003 as part of a long-term strategy to respond to the declining use of checks by consumers and businesses and the greater use of electronics in check processing. The Reserve Banks will have reduced the number of full-service check processing locations from 45 in 2003 to 4 by early 2011.[59] Structure Main article: Structure of the Federal Reserve System The Federal Reserve System has both private and public components, and can make decisions without the permission of Congress or the President of the U.S.[60] The System does not require public funding, and derives its authority and purpose from the Federal Reserve Act passed by Congress in 1913. The two main aspects of the Federal Reserve System are the Federal Open Market Committee and regional Federal Reserve Banks located throughout the country. Board of Governors Organization of the Federal Reserve System Federal Reserve Districts The seven-member Board of Governors is a federal agency and is the main governing body of the Federal Reserve System. It is charged with the overseeing of the 12 District Reserve Banks and setting national monetary policy. It also supervises and regulates the U.S. banking system in general.[61] Governors are appointed by the President of the United States and confirmed by the Senate for staggered 14-year terms.[38] The Board is required to make an annual report of operations to the Speaker of the U.S. House of Representatives. The Chairman and Vice Chairman of the Board of Governors are appointed by the President from among the sitting Governors. They both serve a four year term and they can be renominated as many times as the President chooses, until their terms on the Board of Governors expire.[62] List of members of the Board of Governors The current members of the Board of Governors are as follows:[63] Commissioner Entered office[64] Term expires Ben Bernanke (Chairman) February 1, 2006 January 31, 2020 January 31, 2014 (as Chairman) Janet Yellen (Vice Chairman) October 4, 2010 January 31, 2024 October 4, 2014 (as Vice Chairman) Vacant —— Elizabeth A. Duke August 5, 2008 January 31, 2012 Daniel Tarullo January 28, 2009 January 31, 2022 Sarah Bloom Raskin October 4, 2010 January 31, 2016 Vacant —— Federal Open Market Committee Main article: Federal Open Market Committee The Federal Open Market Committee (FOMC) consists of 12 members, seven from the Board of Governors and 5 of the regional Federal Reserve Bank presidents. The FOMC oversees open market operations, the principal tool of national monetary policy. These operations affect the amount of Federal Reserve balances available to depository institutions, thereby influencing overall monetary and credit conditions. The FOMC also directs operations undertaken by the Federal Reserve in foreign exchange markets. The president of the Federal Reserve Bank of New York, is a permanent member of the FOMC, while the rest of the bank presidents rotate at two- and three-year intervals. All Regional Reserve Bank presidents contribute to the committee's assessment of the economy and of policy options, but only the five presidents who are then members of the FOMC vote on policy decisions. The FOMC determines its own internal organization and, by tradition, elects the Chairman of the Board of Governors as its chairman and the president of the Federal Reserve Bank of New York as its vice chairman. It is informal policy, within the FOMC, for the Board of Governors and the New York Federal Reserve Bank president to vote with the Chairman of the FOMC. Additionally, anyone who is not an expert on monetary policy traditionally votes with the chairman as well. In any vote, no more than two FOMC members can dissent.[65] Formal meetings typically are held eight times each year in Washington, D.C. Nonvoting Reserve Bank presidents also participate in Committee deliberations and discussion. The FOMC generally meets eight times a year in telephone consultations and other meetings are held when needed.[66] Federal Reserve Banks Main article: Federal Reserve Bank There are 12 Federal Reserve Banks, and they are located in the following cities: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St Louis, Minneapolis, Kansas City, Dallas, and San Francisco. Each reserve Bank is responsible for member banks located in its district. The size of each district was set based upon the population distribution of the United States when the Federal Reserve Act was passed. Each regional Bank has a president, who is the chief executive officer of their Bank. Each regional Reserve Bank's president is nominated by their Bank's board of directors, but the nomination is contingent upon approval by the Board of Governors. Presidents serve five year terms and may be reappointed.[67] Each regional Bank's board consists of nine members. Members are broken down into three classes: A, B, and C. There are three board members in each class. Class A members are chosen by the regional Bank's shareholders, and are intended to represent member banks' interests. Member banks are divided into three categories large, medium, and small. Each category elects one of the three class A board members. Class B board members are also nominated by the region's member banks, but class B board members are supposed to represent the interests of the public. Lastly, class C board members are nominated by the Board of Governors, and are also intended to represent the interests of the public.[68] A member bank is a private institution and owns stock in its regional Federal Reserve Bank. All nationally chartered banks hold stock in one of the Federal Reserve Banks. State chartered banks may choose to be members (and hold stock in their regional Federal Reserve bank), upon meeting certain standards. About 38% of U.S. banks are members of their regional Federal Reserve Bank.[69] The amount of stock a member bank must own is equal to 3% of its combined capital and surplus.[70][71] However, holding stock in a Federal Reserve bank is not like owning stock in a publicly traded company. These stocks cannot be sold or traded, and member banks do not control the Federal Reserve Bank as a result of owning this stock. The charter and organization of each Federal Reserve Bank is established by law and cannot be altered by the member banks. Member banks, do however, elect six of the nine members of the Federal Reserve Banks' boards of directors.[38][72] From the profits of the Regional Bank of which it is a member, a member bank receives a dividend equal to 6% of their purchased stock.[60] The remainder of the regional Federal Reserve Banks' profits is given over to the United States Treasury Department. In 2009, the Federal Reserve Banks distributed $1.4 billion in dividends to member banks and returned $47 billion to the U.S. Treasury.[73] Legal status of regional Federal Reserve Banks The effective federal funds rate charted over more than fifty years. The Federal Reserve Banks have an intermediate legal status, with some features of private corporations and some features of public federal agencies. The United States has an interest in the Federal Reserve Banks as tax-exempt federally-created instrumentalities whose profits belong to the federal government, but this interest is not proprietary.[74] In Lewis v. United States,[75] the United States Court of Appeals for the Ninth Circuit stated that: "The Reserve Banks are not federal instrumentalities for purposes of the FTCA [the Federal Tort Claims Act], but are independent, privately owned and locally controlled corporations." The opinion went on to say, however, that: "The Reserve Banks have properly been held to be federal instrumentalities for some purposes." Another relevant decision is Scott v. Federal Reserve Bank of Kansas City,[74] in which the distinction is made between Federal Reserve Banks, which are federally-created instrumentalities, and the Board of Governors, which is a federal agency. Monetary policy Further information: Monetary policy of the United States The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. What happens to money and credit affects interest rates (the cost of credit) and the performance of an economy. The Federal Reserve Act of 1913 gave the Federal Reserve authority to set monetary policy in the United States.[76][77] Interbank lending is the basis of policy The Federal Reserve sets monetary policy by influencing the Federal funds rate, which is the rate of interbank lending of excess reserves. The rate that banks charge each other for these loans is determined in the interbank market but the Federal Reserve influences this rate through the three "tools" of monetary policy described in the Tools section below. The Federal Funds rate is a short-term interest rate the FOMC focuses on directly. This rate ultimately affects the longer-term interest rates throughout the economy. A summary of the basis and implementation of monetary policy is stated by the Federal Reserve: The Federal Reserve implements U.S. monetary policy by affecting conditions in the market for balances that depository institutions hold at the Federal Reserve Banks...By conducting open market operations, imposing reserve requirements, permitting depository institutions to hold contractual clearing balances, and extending credit through its discount window facility, the Federal Reserve exercises considerable control over the demand for and supply of Federal Reserve balances and the federal funds rate. Through its control of the federal funds rate, the Federal Reserve is able to foster financial and monetary conditions consistent with its monetary policy objectives.[78] This influences the economy through its effect on the quantity of reserves that banks use to make loans. Policy actions that add reserves to the banking system encourage lending at lower interest rates thus stimulating growth in money, credit, and the economy. Policy actions that absorb reserves work in the opposite direction. The Fed's task is to supply enough reserves to support an adequate amount of money and credit, avoiding the excesses that result in inflation and the shortages that stifle economic growth.[79] Tools There are three main tools of monetary policy that the Federal Reserve uses to influence the amount of reserves in private banks:[76] Tool Description Open market operations Purchases and sales of U.S. Treasury and federal agency securities—the Federal Reserve's principal tool for implementing monetary policy. The Federal Reserve's objective for open market operations has varied over the years. During the 1980s, the focus gradually shifted toward attaining a specified level of the federal funds rate (the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed), a process that was largely complete by the end of the decade.[80] Discount rate The interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility—the discount window.[81] Reserve requirements The amount of funds that a depository institution must hold in reserve against specified deposit liabilities.[82] Federal funds rate and open market operations Further information: open market operations, money creation, and federal funds rate The Federal Reserve System implements monetary policy largely by targeting the federal funds rate. This is the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed. This rate is actually determined by the market and is not explicitly mandated by the Fed. The Fed therefore tries to align the effective federal funds rate with the targeted rate by adding or subtracting from the money supply through open market operations. The Federal Reserve System usually adjusts the federal funds rate target by 0.25% or 0.50% at a time. Open market operations allow the Federal Reserve to increase or decrease the amount of money in the banking system as necessary to balance the Federal Reserve's dual mandates. Open market operations are done through the sale and purchase of United States Treasury security, sometimes called "Treasury bills" or more informally "T-bills" or "Treasuries". The Federal Reserve buys Treasury bills from its primary dealers. The purchase of these securities affects the federal funds rate, because primary dealers have accounts at depository institutions.[83] The Federal Reserve education website describes open market operations as follows:[77] Open market operations involve the buying and selling of U.S. government securities (federal agency and mortgage-backed). The term 'open market' means that the Fed doesn't decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an 'open market' in which the various securities dealers that the Fed does business with—the primary dealers—compete on the basis of price. Open market operations are flexible and thus, the most frequently used tool of monetary policy. Open market operations are the primary tool used to regulate the supply of bank reserves. This tool consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the U.S. Treasury, Federal agencies and government-sponsored enterprises. Open market operations are carried out by the Domestic Trading Desk of the Federal Reserve Bank of New York under direction from the FOMC. The transactions are undertaken with primary dealers. The Fed's goal in trading the securities is to affect the federal funds rate, the rate at which banks borrow reserves from each other. When the Fed wants to increase reserves, it buys securities and pays for them by making a deposit to the account maintained at the Fed by the primary dealer's bank. When the Fed wants to reduce reserves, it sells securities and collects from those accounts. Most days, the Fed does not want to increase or decrease reserves permanently so it usually engages in transactions reversed within a day or two. That means that a reserve injection today could be withdrawn tomorrow morning, only to be renewed at some level several hours later. These short-term transactions are called repurchase agreements (repos) – the dealer sells the Fed a security and agrees to buy it back at a later date. Repurchase agreements Further information: repurchase agreement To smooth temporary or cyclical changes in the money supply, the desk engages in repurchase agreements (repos) with its primary dealers. Repos are essentially secured, short-term lending by the Fed. On the day of the transaction, the Fed deposits money in a primary dealer's reserve account, and receives the promised securities as collateral. When the transaction matures, the process unwinds: the Fed returns the collateral and charges the primary dealer's reserve account for the principal and accrued interest. The term of the repo (the time between settlement and maturity) can vary from 1 day (called an overnight repo) to 65 days.[84] Discount rate Further information: discount window The Federal Reserve System also directly sets the "discount rate", which is the interest rate for "discount window lending", overnight loans that member banks borrow directly from the Fed. This rate is generally set at a rate close to 100 basis points above the target federal funds rate. The idea is to encourage banks to seek alternative funding before using the "discount rate" option.[85] The equivalent operation by the European Central Bank is referred to as the "marginal lending facility".[86] Both the discount rate and the federal funds rate influence the prime rate, which is usually about 3 percent higher than the federal funds rate. Reserve requirements Another instrument of monetary policy adjustment employed by the Federal Reserve System is the fractional reserve requirement, also known as the required reserve ratio.[87] The required reserve ratio sets the balance that the Federal Reserve System requires a depository institution to hold in the Federal Reserve Banks,[78] which depository institutions trade in the federal funds market discussed above.[88] The required reserve ratio is set by the Board of Governors of the Federal Reserve System.[89] The reserve requirements have changed over time and some of the history of these changes is published by the Federal Reserve.[90] Reserve Requirements in the U.S. Federal Reserve System[82] Liability Type Requirement Percentage of liabilities Effective date Net transaction accounts $0 to $10.7 million 0 12/30/10 More than $10.7 million to $58.8 million 3 12/30/10 More than $58.8 million 10 12/30/10 Nonpersonal time deposits 0 12/27/90 Eurocurrency liabilities 0 12/27/90 As a response to the financial crisis of 2008, the Federal Reserve now makes interest payments on depository institutions' required and excess reserve balances. The payment of interest on excess reserves gives the central bank greater opportunity to address credit market conditions while maintaining the federal funds rate close to the target rate set by the FOMC.[91] New facilities In order to address problems related to the subprime mortgage crisis and United States housing bubble, several new tools have been created. The first new tool, called the Term Auction Facility, was added on December 12, 2007. It was first announced as a temporary tool[92] but there have been suggestions that this new tool may remain in place for a prolonged period of time.[93] Creation of the second new tool, called the Term Securities Lending Facility, was announced on March 11, 2008.[94] The main difference between these two facilities is that the Term Auction Facility is used to inject cash into the banking system whereas the Term Securities Lending Facility is used to inject treasury securities into the banking system.[95] Creation of the third tool, called the Primary Dealer Credit Facility (PDCF), was announced on March 16, 2008.[96] The PDCF was a fundamental change in Federal Reserve policy because now the Fed is able to lend directly to primary dealers, which was previously against Fed policy.[97] The differences between these 3 new facilities is described by the Federal Reserve:[98] The Term Auction Facility program offers term funding to depository institutions via a bi-weekly auction, for fixed amounts of credit. The Term Securities Lending Facility will be an auction for a fixed amount of lending of Treasury general collateral in exchange for OMO-eligible and AAA/Aaa rated private-label residential mortgage-backed securities. The Primary Dealer Credit Facility now allows eligible primary dealers to borrow at the existing Discount Rate for up to 120 days. Some of the measures taken by the Federal Reserve to address this mortgage crisis have not been used since The Great Depression.[99] The Federal Reserve gives a brief summary of these new facilities:[100] As the economy has slowed in the last nine months and credit markets have become unstable, the Federal Reserve has taken a number of steps to help address the situation. These steps have included the use of traditional monetary policy tools at the macroeconomic level as well as measures at the level of specific markets to provide additional liquidity. The Federal Reserve's response has continued to evolve since pressure on credit markets began to surface last summer, but all these measures derive from the Fed's traditional open market operations and discount window tools by extending the term of transactions, the type of collateral, or eligible borrowers. A fourth facility, the Term Deposit Facility, was announced December 9, 2009, and approved April 30, 2010, with an effective date of Jun 4, 2010.[101] The Term Deposit Facility allows Reserve Banks to offer term deposits to institutions that are eligible to receive earnings on their balances at Reserve Banks. Term deposits are intended to facilitate the implementation of monetary policy by providing a tool by which the Federal Reserve can manage the aggregate quantity of reserve balances held by depository institutions. Funds placed in term deposits are removed from the accounts of participating institutions for the life of the term deposit and thus drain reserve balances from the banking system. Term auction facility Further information: Term auction facility The Term Auction Facility is a program in which the Federal Reserve auctions term funds to depository institutions.[92] The creation of this facility was announced by the Federal Reserve on December 12, 2007 and was done in conjunction with the Bank of Canada, the Bank of England, the European Central Bank, and the Swiss National Bank to address elevated pressures in short-term funding markets.[102] The reason it was created is because banks were not lending funds to one another and banks in need of funds were refusing to go to the discount window. Banks were not lending money to each other because there was a fear that the loans would not be paid back. Banks refused to go to the discount window because it is usually associated with the stigma of bank failure.[103][104][105][106] Under the Term Auction Facility, the identity of the banks in need of funds is protected in order to avoid the stigma of bank failure.[107] Foreign exchange swap lines with the European Central Bank and Swiss National Bank were opened so the banks in Europe could have access to U.S. dollars.[107] Federal Reserve Chairman Ben Bernanke briefly described this facility to the U.S. House of Representatives on January 17, 2008: the Federal Reserve recently unveiled a term auction facility, or TAF, through which prespecified amounts of discount window credit can be auctioned to eligible borrowers. The goal of the TAF is to reduce the incentive for banks to hoard cash and increase their willingness to provide credit to households and firms...TAF auctions will continue as long as necessary to address elevated pressures in short-term funding markets, and we will continue to work closely and cooperatively with other central banks to address market strains that could hamper the achievement of our broader economic objectives.[108] It is also described in the Term Auction Facility FAQ[92] The TAF is a credit facility that allows a depository institution to place a bid for an advance from its local Federal Reserve Bank at an interest rate that is determined as the result of an auction. By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help ensure that liquidity provisions can be disseminated efficiently even when the unsecured interbank markets are under stress. In short, the TAF will auction term funds of approximately one-month maturity. All depository institutions that are judged to be in sound financial condition by their local Reserve Bank and that are eligible to borrow at the discount window are also eligible to participate in TAF auctions. All TAF credit must be fully collateralized. Depositories may pledge the broad range of collateral that is accepted for other Federal Reserve lending programs to secure TAF credit. The same collateral values and margins applicable for other Federal Reserve lending programs will also apply for the TAF. Term securities lending facility The Term Securities Lending Facility is a 28-day facility that will offer Treasury general collateral to the Federal Reserve Bank of New York's primary dealers in exchange for other program-eligible collateral. It is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally.[109] Like the Term Auction Facility, the TSLF was done in conjunction with the Bank of Canada, the Bank of England, the European Central Bank, and the Swiss National Bank. The resource allows dealers to switch debt that is less liquid for U.S. government securities that are easily tradable. It is anticipated by Federal Reserve officials that the primary dealers, which include Goldman Sachs Group. Inc., J.P. Morgan Chase, and Morgan Stanley, will lend the Treasuries on to other firms in return for cash. That will help the dealers finance their balance sheets.[citation needed] The currency swap lines with the European Central Bank and Swiss National Bank were increased. Primary dealer credit facility The Primary Dealer Credit Facility (PDCF) is an overnight loan facility that will provide funding to primary dealers in exchange for a specified range of eligible collateral and is intended to foster the functioning of financial markets more generally.[98] This new facility marks a fundamental change in Federal Reserve policy because now primary dealers can borrow directly from the Fed when this previously was not permitted. Interest on reserves As of October 2008, the Federal Reserve banks will pay interest on reserve balances (required & excess) held by depository institutions. The rate is set at the lowest federal funds rate during the reserve maintenance period of an institution, less 75bp.[110] As of October 23, 2008, the Fed has lowered the spread to a mere 35 bp.[111] Term deposit facility The Term Deposit Facility is a program through which the Federal Reserve Banks will offer interest-bearing term deposits to eligible institutions. By removing "excess deposits" from participating banks, the overall level of reserves available for lending is reduced, which should result in increased market interest rates, acting as a brake on economic activity and inflation. The Federal Reserve has stated that: Term deposits will be one of several tools that the Federal Reserve could employ to drain reserves when policymakers judge that it is appropriate to begin moving to a less accommodative stance of monetary policy. The development of the TDF is a matter of prudent planning and has no implication for the near-term conduct of monetary policy.[112] The Federal Reserve initially authorized up to five "small-value offerings are designed to ensure the effectiveness of TDF operations and to provide eligible institutions with an opportunity to gain familiarity with term deposit procedures."[113] After three of the offering auctions were successfully completed, it was announced that small-value auctions would continue on an on-going basis.[114] The Term Deposit Facility is essentially a tool available to reverse the efforts that have been employed to provide liquidity to the financial markets and to reduce the amount of capital available to the economy. As stated in Bloomberg News: Policy makers led by Chairman Ben S. Bernanke are preparing for the day when they will have to start siphoning off more than $1 trillion in excess reserves from the banking system to contain inflation. The Fed is charting an eventual return to normal monetary policy, even as a weakening near-term outlook has raised the possibility it may expand its balance sheet.[115] Chairman Ben S. Bernanke, testifying before House Committee on Financial Services, described the Term Deposit Facility and other facilities to Congress in the following terms: Most importantly, in October 2008 the Congress gave the Federal Reserve statutory authority to pay interest on balances that banks hold at the Federal Reserve Banks. By increasing the interest rate on banks' reserves, the Federal Reserve will be able to put significant upward pressure on all short-term interest rates, as banks will not supply short-term funds to the money markets at rates significantly below what they can earn by holding reserves at the Federal Reserve Banks. Actual and prospective increases in short-term interest rates will be reflected in turn in higher longer-term interest rates and in tighter financial conditions more generally. ... As an additional means of draining reserves, the Federal Reserve is also developing plans to offer to depository institutions term deposits, which are roughly analogous to certificates of deposit that the institutions offer to their customers. A proposal describing a term deposit facility was recently published in the Federal Register, and the Federal Reserve is finalizing a revised proposal in light of the public comments that have been received. After a revised proposal is reviewed by the Board, we expect to be able to conduct test transactions this spring and to have the facility available if necessary thereafter. The use of reverse repos and the deposit facility would together allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so. When these tools are used to drain reserves from the banking system, they do so by replacing bank reserves with other liabilities; the asset side and the overall size of the Federal Reserve's balance sheet remain unchanged. If necessary, as a means of applying monetary restraint, the Federal Reserve also has the option of redeeming or selling securities. The redemption or sale of securities would have the effect of reducing the size of the Federal Reserve's balance sheet as well as further reducing the quantity of reserves in the banking system. Restoring the size and composition of the balance sheet to a more normal configuration is a longer-term objective of our policies. In any case, the sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments and on our best judgments about how to meet the Federal Reserve's dual mandate of maximum employment and price stability. In sum, in response to severe threats to our economy, the Federal Reserve created a series of special lending facilities to stabilize the financial system and encourage the resumption of private credit flows to American families and businesses. As market conditions and the economic outlook have improved, these programs have been terminated or are being phased out. The Federal Reserve also promoted economic recovery through sharp reductions in its target for the federal funds rate and through large-scale purchases of securities. The economy continues to require the support of accommodative monetary policies. However, we have been working to ensure that we have the tools to reverse, at the appropriate time, the currently very high degree of monetary stimulus. We have full confidence that, when the time comes, we will be ready to do so.[116] Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility The Asset Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (ABCPMMMFLF) was also called the AMLF. The Facility began operations on September 22, 2008, and was closed on February 1, 2010.[117] All U.S. depository institutions, bank holding companies (parent companies or U.S. broker-dealer affiliates), or U.S. branches and agencies of foreign banks were eligible to borrow under this facility pursuant to the discretion of the FRBB. Collateral eligible for pledge under the Facility was required to meet the following criteria: was purchased by Borrower on or after September 19, 2008 from a registered investment company that held itself out as a money market mutual fund; was purchased by Borrower at the Fund's acquisition cost as adjusted for amortization of premium or accretion of discount on the ABCP through the date of its purchase by Borrower; was rated at the time pledged to FRBB, not lower than A1, F1, or P1 by at least two major rating agencies or, if rated by only one major rating agency, the ABCP must have been rated within the top rating category by that agency; was issued by an entity organized under the laws of the United States or a political subdivision thereof under a program that was in existence on September 18, 2008; and had a stated maturity that did not exceed 120 days if the Borrower was a bank or 270 days for non-bank Borrowers. Commercial Paper Funding Facility The Commercial Paper Funding Facility is also called the CPFF. On October 7, 2008 the Federal Reserve further expanded the collateral it will loan against, to include commercial paper. The action made the Fed a crucial source of credit for non-financial businesses in addition to commercial banks and investment firms. Fed officials said they'll buy as much of the debt as necessary to get the market functioning again. They refused to say how much that might be, but they noted that around $1.3 trillion worth of commercial paper would qualify. There was $1.61 trillion in outstanding commercial paper, seasonally adjusted, on the market as of October 1, 2008, according to the most recent data from the Fed. That was down from $1.70 trillion in the previous week. Since the summer of 2007, the market has shrunk from more than $2.2 trillion.[118] Quantitative policy A little-used tool of the Federal Reserve is the quantitative policy. With that the Federal Reserve actually buys back corporate bonds and mortgage backed securities held by banks or other financial institutions. This in effect puts money back into the financial institutions and allows them to make loans and conduct normal business. The Federal Reserve Board used this policy in the early 1990s when the U.S. economy experienced the savings and loan crisis.[citation needed] The bursting of the United States housing bubble prompted the Fed to buy mortgage-backed securities for the first time in November 2008. Over six weeks, a total of $1.25 trillion were purchased in order stabilize the housing market, about one-fifth of all U.S. government-backed mortgages.[119] Quantitative easing Quantitative easing is another way to influence monetary policy, only recently begun to be used in the United States. Other countries, such as Japan, have provided a template for some Fed actions. Essentially, quantitative easing provides a method for the central bank to provide funds at lower than zero interest rates, in order to increase the monetary supply and combat deflationary forces. This is accomplished by the Fed purchasing U.S. government debt with newly printed U.S. currency. In essence, the Fed is monetizing the debt. In the current (late 2007 to today) macro-economic environment, the slowing velocity of money has induced U.S. central bankers to pursue a variety of new, and to some radical, policies to produce economic stimulus. Measurement of economic variables The Federal Reserve records and publishes large amounts of data. A few websites where data is published are at the Board of Governors Economic Data and Research page,[120] the Board of Governors statistical releases and historical data page,[121] and at the St. Louis Fed's FRED (Federal Reserve Economic Data) page.[122] The Federal Open Market Committee (FOMC) examines many economic indicators prior to determining monetary policy.[123] Net worth of households and nonprofit organizations Components the U.S. money supply (currency, M1 and M2), 1960–2010 The net worth of households and nonprofit organizations in the United States is published by the Federal Reserve in a report titled, Flow of Funds.[124] At the end of fiscal year 2008, this value was $51.5 trillion. Money supply Further information: Money supply The most common measures are named M0 (narrowest), M1, M2, and M3. In the United States they are defined by the Federal Reserve as follows: Measure Definition M0 The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency. M1 M0 + those portions of M0 held as reserves or vault cash + the amount in demand accounts ("checking" or "current" accounts). M2 M1 + most savings accounts, money market accounts, and small denomination time deposits (certificates of deposit of under $100,000). M3 M2 + all other CDs, deposits of eurodollars and repurchase agreements. The Federal Reserve stopped publishing M3 statistics in March 2006, saying that the data cost a lot to collect but did not provide significantly useful information.[125] The other three money supply measures continue to be provided in detail. Personal consumption expenditures price index Further information: Personal consumption expenditures price index The Personal consumption expenditures price index, also referred to as simply the PCE price index, is used as one measure of the value of money. It is a United States-wide indicator of the average increase in prices for all domestic personal consumption. Using a variety of data including U.S. Consumer Price Index and Producer Price Index prices, it is derived from the largest component of the Gross Domestic Product in the BEA's National Income and Product Accounts, personal consumption expenditures. One of the Fed's main roles is to maintain price stability, which means that the Fed's ability to keep a low inflation rate is a long-term measure of the their success.[126] Although the Fed is not required to maintain inflation within a specific range, their long run target for the growth of the PCE price index is between 1.5 and 2 percent.[127] There has been debate among policy makers as to whether or not the Federal Reserve should have a specific inflation targeting policy.[128][129][130] Inflation and the economy There are two types of inflation that are closely tied to each other. Monetary inflation is an increase in the money supply. Price inflation is a sustained increase in the general level of prices, which is equivalent to a decline in the value or purchasing power of money. If the supply of money and credit increases too rapidly over many months (monetary inflation), the result will usually be price inflation. Price inflation does not always increase in direct proportion to monetary inflation; it is also affected by the velocity of money and other factors. With price inflation, a dollar buys less and less over time.[77] The effects of monetary and price inflation include:[77] Price inflation makes workers worse off if their incomes don't rise as rapidly as prices. Pensioners living on a fixed income are worse off if their savings do not increase more rapidly than prices. Lenders lose because they will be repaid with dollars that aren't worth as much. Savers lose because the dollar they save today will not buy as much when they are ready to spend it. Debtors win because the dollar they borrow today will be repaid with dollars that aren't worth as much. Businesses and people will find it harder to plan and therefore may decrease investment in future projects. Owners of financial assets suffer. Interest rate-sensitive industries, like mortgage companies, suffer as monetary inflation drives up long-term interest rates and Federal Reserve tightening raises short-term rates. Unemployment rate Further information: Unemployment_rate#United_States_Bureau_of_Labor_Statistics and List of U.S. states by unemployment rate One of the stated goals of monetary policy is maximum employment. The unemployment rate statistics are collected by the Bureau of Labor Statistics, and like the PCE price index are used as a barometer of the nation's economic health, and thus as a measure of the success of an administration's economic policies. Since 1980, both parties have made progressive United States unemployment rates 1975–2010 showing variance between the fifty states LIABILITIES: Currency in Circulation 1031.30 Reverse repurchase agreements 68.09 Deposits 91.12 Term Deposits 0 U.S. Treasury, general account 76.56 U.S. Treasury, supplementary financing account 5 Foreign official 0.17 Service Related 2.53 Other Deposits 6.85 Funds from AIG, held as agent 0 Other Liabilities 73.06 Total liabilities 1263.73 CAPITAL (AKA Net Equity) Capital Paid In 26.71 Surplus 25.91 Other Capital 4.16 Total Capital 56.78 MEMO (off-balance-sheet items) Marketable securities held in custody for foreign official and international accounts 3445.42 U.S. Treasury Securities 2708 Federal Agency Securities 737.31 Securities lent to dealers 30.46 Overnight 30.46 Term 0 ASSETS: Gold Stock 11.04 Special Drawing Rights Certificate Acct. 5.20 Treasury Currency Outstanding (Coin) 43.98 Securities Held Outright 2647.94 U.S. Treasury Securities 1623.78 Bills 18.42 Notes and Bonds, nominal 1530.79 Notes and Bonds, inflation-indexed 65.52 Inflation Compensation 9.04 Federal Agency Debt Securities 115.30 Mortgage-Backed Securities 908.85 Repurchase Agreements 0 Loans 12.74 Primary Credit 12 Secondary Credit 0 Seasonal Credit 53 Credit Extended to AIG Inc. 0 Term Asset-Backed Securities Loan Facility 12.67 Other Credit Extended 0 Commercial Paper Funding Facility LLC 0 Net portfolio holdings of Maiden Lane LLC, Maiden Lane II LLC, and Maiden Lane III LLC 60.32 Preferred Interest in AIG Life-Insurance Subsidiaries 0 Net Holdings of TALF LLC 0.75 Float -1.05 Central Bank Liquidity Swaps 0 Other Assets 133.56 Total Assets 2914.51 changes in the basis for calculating unemployment, so that the numbers now quoted cannot be compared directly to the corresponding rates from earlier administrations, or to the rest of the world.[131] Budget Further information: seignorage The Federal Reserve is self-funded. The vast majority (90%+) of Fed revenues come from open market operations, specifically the interest on the portfolio of Treasury securities as well as "capital gains/losses" that may arise from the buying/selling of the securities and their derivatives as part of Open Market Operations. The balance of revenues come from sales of financial services (check and electronic payment processing) and discount window loans.[132] The Board of Governors (Federal Reserve Board) creates a budget report once per year for Congress. There are two reports with budget information. The one that lists the complete balance statements with income and expenses as well as the net profit or loss is the large report simply titled, "Annual Report". It also includes data about employment throughout the system. The other report, which explains in more detail the expenses of the different aspects of the whole system, is called "Annual Report: Budget Review". These are comprehensive reports with many details and can be found at the Board of Governors' website under the section "Reports to Congress"[133] Net worth Balance sheet One of the keys to understanding the Federal Reserve is the Federal Reserve balance sheet (or balance statement). In accordance with Section 11 of the Federal Reserve Act, the Board of Governors of the Federal Reserve System publishes once each week the "Consolidated Statement of Condition of All Federal Reserve Banks" showing the condition of each Federal Reserve bank and a consolidated statement for all Federal Reserve banks. The Board of Governors requires that excess earnings of the Reserve Banks be transferred to the Treasury as interest on Federal Reserve notes.[134][135] Below is the balance sheet (http://www.federalreserve.gov/monetarypolicy/bst_fedsbalancesheet.htm) as of July 6, 2011 (in billions of dollars): Total combined assets for all 12 Federal Reserve Banks. Total combined liabilities for all 12 Federal Reserve Banks. Analyzing the Federal Reserve's balance sheet reveals a number of facts: The Fed has over $11 billion in gold stock (certificates), which represents the Fed's financial interest in the statutory-determined value of gold turned over to the U.S. Treasury in accordance with the Gold Reserve Act on 30 January 1934.[136]. The value reported here is based on a statutory valuation of $42 2/9 per fine troy ounce. As of March 2009, the market value of that gold is around $247.8 billion. The Fed holds more than $1.8 billion in coinage, not as a liability but as an asset. The Treasury Department is actually in charge of creating coins and U.S. Notes. The Fed then buys coinage from the Treasury by increasing the liability assigned to the Treasury's account. The Fed holds at least $534 billion of the national debt. The "securities held outright" value used to directly represent the Fed's share of the national debt, but after the creation of new facilities in the winter of 2007–2008, this number has been reduced and the difference is shown with values from some of the new facilities. The Fed has no assets from overnight repurchase agreements. Repurchase agreements are the primary asset of choice for the Fed in dealing in the open market. Repo assets are bought by creating depository institution liabilities and directed to the bank the primary dealer uses when they sell into the open market. The more than $1 trillion in Federal Reserve Note liabilities represents nearly the total value of all dollar bills in existence; over $176 billion is held by the Fed (not in circulation); and the "net" figure of $863 billion represents the total face value of Federal Reserve Notes in circulation. The $916 billion in deposit liabilities of depository institutions shows that dollar bills are not the only source of government money. Banks can swap deposit liabilities of the Fed for Federal Reserve Notes back and forth as needed to match demand from customers, and the Fed can have the Bureau of Engraving and Printing create the paper bills as needed to match demand from banks for paper money. The amount of money printed has no relation to the growth of the monetary base (M0). The $93.5 billion in Treasury liabilities shows that the Treasury Department does not use private banks but rather uses the Fed directly (the lone exception to this rule is Treasury Tax and Loan because the government worries that pulling too much money out of the private banking system during tax time could be disruptive).[citation needed] The $1.6 billion foreign liability represents the amount of foreign central bank deposits with the Federal Reserve. The $9.7 billion in 'other liabilities and accrued dividends' represents partly the amount of money owed so far in the year to member banks for the 6% dividend on the 3% of their net capital they are required to contribute in exchange for nonvoting stock their regional Reserve Bank in order to become a member. Member banks are also subscribed for an additional 3% of their net capital, which can be called at the Federal Reserve's discretion. All nationally chartered banks must be members of a Federal Reserve Bank, and state-chartered banks have the choice to become members or not. Total capital represents the profit the Fed has earned, which comes mostly from assets they purchase with the deposit and note liabilities they create. Excess capital is then turned over to the Treasury Department and Congress to be included into the Federal Budget as "Miscellaneous Revenue". In addition, the balance sheet also indicates which assets are held as collateral against Federal Reserve Notes. Federal Reserve Notes and Collateral Federal Reserve Notes Outstanding 1128.63 Less: Notes held by F.R. Banks 200.90 Federal Reserve notes to be collateralized 927.73 Collateral held against Federal Reserve notes 927.73 Gold certificate account 11.04 Special drawing rights certificate account 5.20 U.S. Treasury, agency debt, and mortgage-backed securities pledged 911.50 Other assets pledged 0 Criticism Main article: Criticism of the Federal Reserve The Federal Reserve System has faced intensified criticism following the Troubled Asset Relief Program of 2008–09. Longtime critics of the Fed gained new audiences as New York Times columnist Frank Rich noted, "Ron Paul and Jim DeMint, political heroes of the tea party right, and Bernie Sanders and Alan Grayson, similarly revered on the left, have found a common cause in vilifying the Federal Reserve Bank and its chairman, Ben Bernanke."[137] Influence on economics researchers Some criticism involves economic data compiled by the Fed. The Fed sponsors much of the monetary economics research in the U.S., and Lawrence H. White objects that this makes it less likely for researchers to publish findings challenging the status quo.[138] Accountability The Federal Reserve System and the individual banks undergo regular audits by the GAO and an outside auditor. GAO audits are limited and do not cover "most of the Fed’s monetary policy actions or decisions, including discount window lending (direct loans to financial institutions), open-market operations and any other transactions made under the direction of the Federal Open Market Committee" ...[nor may the GAO audit] "dealings with foreign governments and other central banks." [139] Various statutory changes, including the Federal Reserve Transparency Act, have been proposed to broaden the scope of the audits. Bloomberg L.P. News brought a lawsuit against the Board of Governors of the Federal Reserve System to force the Board to reveal the identities of firms for which it has provided guarantees.[140] Bloomberg, L.P. won at the trial court level,[141] and as of early September 2010 the case is on appeal at the United States Court of Appeals for the Second Circuit.[142] Role in business cycles and inflation In his 1995 book The Case Against the Fed, economist Murray N. Rothbard argues that price inflation is caused only by an increase in the money supply, and only banks increase the money supply, then banks, including the Federal Reserve, are the only source of inflation. Adherents of the Austrian School of economic theory blame the economic crisis in the late 2000s[143] on the Federal Reserve's policy, particularly under the leadership of Alan Greenspan, of credit expansion through historically low interest rates starting in 2001, which they claim enabled the United States housing bubble. See also Consumer Leverage Ratio Core inflation Economic reports by U.S. government agencies Executive Order 11110 Fed model Federal Reserve 800 billion dollar Consumer Loan and bond plan Federal Reserve Police Federal Reserve Statistical Release Fort Knox Bullion Depository Free banking Gold standard Government debt Greenspan put History of Federal Open Market Committee actions Independent Treasury Legal Tender Cases Money market Term auction facility Holding company From Wikipedia, the free encyclopedia A holding company is a company or firm that owns other companies' outstanding stock. It usually refers to a company which does not produce goods or services itself; rather, its purpose is to own shares of other companies. Holding companies allow the reduction of risk for the owners and can allow the ownership and control of a number of different companies. In the U.S., 80% or more of stock, in voting and value, must be owned before tax consolidation benefits such as tax-free dividends can be claimed.[1] Sometimes a company intended to be a pure holding company identifies itself as such by adding "Holdings" or " (Holdings)" to its name, as in Sears Holdings. Contents 1 History 2 United States 2.1 Broadcasting 2.2 Personal holding company 2.3 Public utility holding company 3 Parent company 4 See also 5 External links 6 Notes History United States In the United States, Berkshire Hathaway is the largest publicly-traded holding company; it owns numerous insurance companies, manufacturing businesses, retailers, and other companies. Two other large notable holding companies are United Continental Holdings and AMR Corporation, publicly traded holding companies whose primary purposes are to wholly own United Airlines and American Airlines, respectively. In some instances, holding companies have held capital for pending investments. Broadcasting Further information: Media conglomerates In U.S. broadcasting, many major media conglomerates have purchased smaller broadcasters outright, but have not changed the broadcast licenses to reflect this, resulting in stations that are (for example) still licensed to Jacor and Citicasters, effectively making them subsidiary companies of their owner Clear Channel Communications. This is sometimes also done on a per-market basis; for example in Atlanta both WNNX and later WWWQ are licensed to "WNNX LiCo, Inc." (LiCo meaning "license company"), both owned by Susquehanna Radio (which was later sold to Cumulus Media). In determining caps to prevent excessive concentration of media ownership, all of these are attributed to the parent company, as are leased stations, as a matter of broadcast regulation. Personal holding company In the United States, a personal holding company is defined in section 542 of the Internal Revenue Code. A corporation is a personal holding company if both of the following requirements are met:[2] Personal Holding Company Income Test. At least 60% of the corporation's adjusted ordinary gross income for the tax year is from dividends, interest, rent, and royalties. Stock Ownership Requirement. At any time during the last half of the tax year, more than 50% in value of the corporation's outstanding stock is owned, directly or indirectly, by five or fewer individuals. Public utility holding company Regarding the regulation of natural gas or electric utilities, a "Public Utility Holding Company" is a company which owns a subsidiary which distributes electricity or gas to retail customers. Such companies are subject to the Public Utility Holding Company Act of 2005. Parent company A parent company is a company that owns enough voting stock in another firm (subsidiary) to control management and operations by influencing or electing its board of directors. A parent company could simply be a company that wholly owns another company. This would be known as a "wholly owned subsidiary." Financial intermediary From Wikipedia, the free encyclopedia Financial intermediation consists of “channeling funds between surplus and deficit agents”. A financial intermediary is a financial institution that connects surplus and deficit agents. The classic example of a financial intermediary is a bank that transforms bank deposits into bank loans.[1] Through the process of financial intermediation, certain assets or liabilities are transformed into different assets or liabilities.[1] As such, financial intermediaries channel funds from people who have extra money (savers) to those who do not have enough money to carry out a desired activity (borrowers).[2] In the U.S., a financial intermediary is typically an institution that facilitates the channeling of funds between lenders and borrowers indirectly. That is, savers (lenders) give funds to an intermediary institution (such as a bank), and that institution gives those funds to spenders (borrowers). This may be in the form of loans or mortgages. Alternatively, they may lend the money directly via the financial markets, which is known as financial disintermediation. Contents 1 Functions performed by financial intermediaries 2 Advantages of financial intermediaries 3 Types of financial intermediaries 4 Summary & conclusion 5 See also 6 References 7 Bibliography Functions performed by financial intermediaries Financial intermediaries provide 3 major functions: 1. Maturity transformation Converting short-term liabilities to long term assets (banks deal with large number of lenders and borrowers, and reconcile their conflicting needs) 2. Risk transformation Converting risky investments into relatively risk-free ones. (lending to multiple borrowers to spread the risk) 3. Convenience denomination Matching small deposits with large loans and large deposits with small loans Advantages of financial intermediaries There are 2 essential advantages from using financial intermediaries: 1. Cost advantage over direct lending/borrowing[citation needed] 2. Market failure protection the conflicting needs of lenders and borrowers are reconciled, preventing[citation needed] market failure The cost advantages of using financial intermediaries include: 1. Reconciling conflicting preferences of lenders and borrowers 2. Risk aversion intermediaries help spread out and decrease the risks 3. Economies of scale using financial intermediaries reduces the costs of lending and borrowing 4. Economies of scope intermediaries concentrate on the demands of the lenders and borrowers and are able to enhance their products and services (use same inputs to produce different outputs) Types of financial intermediaries Financial intermediaries include: Banks Building societies Credit unions Financial advisers or brokers Insurance companies Collective investment schemes Pension funds Summary & conclusion Financial institutions (intermediaries) perform the vital role of bringing together those economic agents with surplus funds who want to lend, with those with a shortage of funds who want to borrow. In doing this they offer the major benefits of maturity and risk transformation. It is possible for this to be done by direct contact between the ultimate borrowers, but there are major cost disadvantages of direct finance. Indeed, one explanation of the existence of specialist financial intermediaries is that they have a related (cost) advantage in offering financial services, which not only enables them to make profit, but also raises the overall efficiency of the economy. The other main explanation draws on the analysis of information problems associated with financial markets.[3]