Functions of the Fed: To Regulate and Support Institutions

The Fed is also a custodian of the safety and soundness of the deposits place by consumers in banks and savings & loans. It has had the role of ensuring that these institutions restrict themselves largely to the business of banking, though this has been relaxed somewhat by the effective repeal of the Glass-Steagall Act in 1999.

As part of this mission, the Fed has the discretionary ability to shore up bank’s reserves against temporary liquidity crises by being the lender of last resort.When a bank needs to borrow funds to overcome a temporary shortage, the Fed may (or may not) choose to extend a loan, at the rate set for all such loans, known as the discount rate. As specified in Regulation A, such a loan can be extended to cover particular circumstances.

Emergency credit can be extended to entities which are not depository institutions, when it is in the best interests of the United States economy, and when funds are not available from other sources. Extended credit may be given to depository institutions which are undergoing exceptional circumstances, or a group of institutions which are undergoing exceptional liquidity strains (such as a bank run.)

Seasonal credit is reserved for smaller institutions experiencing severe annual cycles in their funding needs, and without access to other funds. Adjustment credit is extended to help borrowers meet their needs when their usual sources, including institutions peculiar to their industry, are not available.The Fed discourages habitual borrowing from the Fed’s discount window. An institution which is in the habit of borrowing funds from the Fed may be considered in abuse of the privilege, and denied funds. It may also be targeted for auditing by the Fed, to evaluate whether it is sound, and being run responsibly.Under abnormal circumstances which affect the economy or financial markets, the Fed is at liberty to be more forgiving of these restrictions, if it is seen to be in the best interest of the nation’s economy.

Not incidentally, the Fed has also replaced the private clearinghouses of the 19th and 20th centuries as the dominant clearinghouse for facilitating transactions between banks. The fact that the Fed holds reserve accounts for so many of the nation’s banks gives it a strong economy of scale in this regard. Generically, this function is also known as payments services.

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