13.3: Structure of the Federal Reserve System

The Federal Reserve System was designed to strike a careful balance between national oversight and regional autonomy. This structure reflects a long-standing American suspicion of centralized financial power (an attitude rooted in the nation's early history). Rather than establishing a single, all-powerful central bank in Washington, D.C., the 1913 Federal Reserve Act created a decentralized system composed of a central governing board and a network of regional banks. The goal was to avoid concentrating financial authority in one place while still providing the tools necessary to stabilize the economy. 

Board of Governors 

At the top of the system is the Board of Governors, located in Washington, D.C. This body serves as the central authority for the Federal Reserve and plays a major role in shaping national monetary policy. The board consists of seven members who are appointed by the President and confirmed by the Senate, each serving staggered 14-year terms. This long term is intended to shield members from short-term political influence. One member is selected by the President to serve as Chair for a renewable four-year term. The Board of Governors supervises the overall functioning of the Federal Reserve System, including regulatory responsibilities and the implementation of interest rate policies like the Interest on Reserve Balances (IORB). 

Reginal Federal Reserve Banks 

In response to concerns about giving too much power to Washington or New York, the system includes 12 regional Federal Reserve Banks spread across major cities such as New York, Chicago, and San Francisco. See figure 1. Each bank serves a specific district and operates with a degree of independence, conducting research on local economic conditions, supervising regional banks, and facilitating financial services like clearing checks and distributing currency. These regional banks are governed by their own boards of directors and led by presidents who provide valuable input into national monetary decisions. The inclusion of these banks reflects the Federal Reserve Act’s original intent to distribute power geographically and politically, ensuring that rural, agricultural, and industrial interests had a voice in monetary policy. 

Figure 1 CC BY-SA 3.0 

Private banks must be a member of the Federal Reserve System and are required to hold stock in their regional Federal Reserve Bank. This stock ownership is a condition of membership, but it is not like regular corporate stock. 

When a private (commercial) bank chooses (or is required) to become a member bank of the Federal Reserve System, it must purchase stock in its regional Federal Reserve Bank. This stock is equal to 6% of the bank's capital and surplus, though only half (3%) is paid in, and the other half remains on call. 

However, this stock does not give member banks control or typical shareholder rights. They: 

• Cannot sell or trade the stock. 
• Receive a fixed dividend (currently up to 6%) rather than variable returns. 
• Do not have a say in national Fed policy. 

Owning this stock simply reflects the bank’s participation in the Federal Reserve System and helps fund the operations of the regional Reserve Banks. 

FOMC 

The Federal Open Market Committee (FOMC) is the key policymaking body within the Federal Reserve System, responsible for setting monetary policy. It sets the target for the federal funds rate (the interest rate at which banks lend reserves to each other overnight) which influences a wide range of economic activity. In addition, the FOMC also sets the Interest on Reserve Balances (IORB) rate, which is the interest the Federal Reserve pays on bank reserves held at the Fed. The IORB rate has become a primary tool in modern monetary policy, especially under the Fed’s ample reserves regime. The FOMC is composed of the 7 members of the Board of Governors, the president of the New York Fed (a permanent member), and 4 other regional Reserve Bank presidents who rotate into voting positions. 

Figure 2 

What about Investment Banks? 

A commercial bank primarily serves individuals and businesses by accepting deposits, offering checking and savings accounts, and making loans for purposes like home purchases or business expansion. In contrast, an investment bank helps corporations and governments raise capital (i.e., money) by underwriting and selling securities such as stocks and bonds, and provides advisory services for mergers, acquisitions, and other financial transactions. While commercial banks focus on traditional banking services, investment banks operate in capital markets and typically do not take consumer deposits. 

After the financial crisis of 2008, major changes were made to U.S. banking regulations to address the weaknesses that contributed to the collapse. One of the most significant changes was the extension of Federal Reserve oversight to large investment banks, which previously operated outside of the Fed’s direct regulatory authority. 

Before the crisis, investment banks such as Lehman Brothers, Bear Stearns, and Merrill Lynch were not subject to the same regulatory framework as commercial banks. They were overseen by the Securities and Exchange Commission (SEC) and operated with higher leverage and lower capital requirements, taking on more risks. 

This lack of oversight contributed to systemic instability. When the value of mortgage-backed securities collapsed, these firms faced liquidity crises. Some failed (Lehman Brothers), some were sold under distress (Merrill Lynch), and others were rescued (Bear Stearns, later acquired by JPMorgan Chase). 

This shift effectively ended the era of standalone investment banks in the U.S. All large firms conducting banking-like activities were now regulated like commercial banks. 

Legislative Reinforcement: Dodd-Frank Act (2010) 

The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010, codified these changes and expanded the Fed’s regulatory powers. Under Dodd-Frank: 

• The Fed was given authority to regulate systemically important financial institutions (SIFIs), whether or not they were traditional banks. 
• All large financial firms had to meet stricter capital and liquidity requirements. 
• The Volcker Rule limited proprietary trading by banks, aiming to separate customer services from risky investment activities. 

The unique structure The Fed gave rise to the term “quasi-governmental agency” because the Federal Reserve embodies both public and private elements. On the one hand, it is accountable to Congress, its leaders (Federal Reserve Governors) are appointed by the federal government, and it performs key public functions like managing monetary policy and regulating banks. On the other hand, the regional Reserve Banks are organized like private corporations (commercial banks that are members of the Federal Reserve System are required to hold stock in their district Reserve Bank and receive a fixed dividend, though they do not control monetary policy). This mix of public authority and private sector involvement is what makes the Federal Reserve a quasi-governmental institution.