THE FEDERAL RESERVE SYSTEM

3 3.1 3.2 3.3 3.4 3.5 Slide 1 THE FEDERAL RESERVE SYSTEM Structure of the Federal Reserve System Monetary and Fiscal Policy Consumer Protection Role ...
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3 3.1 3.2 3.3 3.4 3.5 Slide 1

THE FEDERAL RESERVE SYSTEM Structure of the Federal Reserve System Monetary and Fiscal Policy Consumer Protection Role in Determining Banks’ Financial Health International Banking and the Federal Reserve System Banking Systems, 2e © Cengage/South-Western

3.1

STRUCTURE OF THE FEDERAL RESERVE SYSTEM

GOALS

Identify the organization of the Federal Reserve System. Explain how the Federal Reserve influences banks and the economy. Describe proposed reorganization of the Fed.

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TERMS Member bank District Reserve Bank

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STRUCTURE OF THE FED

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MEMBER BANKS Member bank Any bank that is part of the Federal Reserve System All national banks are required to be members State-chartered banks may choose to be members

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DISTRICT RESERVE BANKS District Reserve Banks Carry out banking functions for government offices in their area Examine member banks in the district Decide whether to loan banks funds Recommend interest rates Implement policy decisions of the Board of Governors Slide 6

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BOARD OF GOVERNORS Seven governors A 14-year term The policy-making arm of the Fed Decisions control monetary policy

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THE CHAIR The chair and the vice-chair Four-year term May serve multiple terms

Ben Bernanke has been the chair since February 2006.

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 checkpoint

What are the four structural elements of the Federal Reserve?

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FUNCTIONS OF THE FED Serves as the government’s bank Ensures that the financial system remains stable through judicious use of monetary policy Supervises and regulates bank operations Protects consumers’ credit rights Serves as a bank for other banks Slide 11

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THE GOVERNMENT’S BANK IRS tax payments go into accounts at Federal Reserve banks. Money from these accounts is used to pay various government expenses.

Federal Reserve banks sell and redeem government securities.

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THE BANKS’ BANK A reserve bank for other banks Processes payments between banks Electronic funds transfers

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BANK SUPERVISION The Federal Reserve supervises and regulates all member banks. Other agencies also supervise banks. The Fed works to promote consistent policies for international banks that operate in the U.S.

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PROTECTING CONSUMERS The Federal Reserve monitors banks to ensure customers are treated fairly in terms of Fees Prices Penalties Advertising

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 checkpoint

What are the primary functions of the Federal Reserve?

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PROPOSED REORGANIZATION OF THE FED

The recent financial crisis spurred discussion about reorganizing the banking regulation system. President’s Working Group on Financial Markets (PWG) Mortgage Origination Commission (MOC) Payment and settlement systems oversight Insurance Futures and securities Slide 17

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 checkpoint

Why is consideration of reorganizing the Fed such a complicated task?

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3.2

MONETARY AND FISCAL POLICY

GOALS

Explain how the Fed impacts monetary policy. Identify how fiscal policy affects the economy. Explore criticisms of monetary and fiscal policy.

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TERMS Federal Open Market Committee (FOMC) Taylor rule Adverse feedback loop

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MONETARY POLICY The goals of the Federal Reserve’s monetary policy are to Maintain economic growth Stabilize prices Keep international payments flowing smoothly

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OPEN MARKET OPERATIONS Open market operations The Fed buys and sells securities issued by the Treasury Department or other government agencies.

Federal funds rate The rate at which banks borrow from each other

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Primary dealers Setting reserve requirements Adjusting the discount interest rate Discount rate The rate of interest that the Federal Reserve charges banks for short-term loans

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Federal Open Market Committee (FOMC) Makes discount rate decisions The committee consists of The seven-member Board of Governors (including the Chairman) The Chairman of the New York District Reserve Bank Presidents of four other District Reserve Banks who serve on a rotating basis

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ADJUSTING MONETARY POLICY

Tinkering with monetary policy does not occur in a vacuum. Even experts do not always agree on the most effective course of action. Adjusting interest rates is one of the many components of monetary policy. Predicting the impact of these adjustments is not straightforward. Slide 25

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DEVELOPING MONETARY POLICY

Taylor rule Provides ideas for how to use short-term interest rates to achieve the goals of a central bank. Keeping the economy stable Controlling inflation

Three targeted indicators Inflation Full employment Short-term interest rates Slide 26

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NEW TOOLS TO MANAGE MONETARY POLICY

Term Auction Facility (TAF) Term Securities Lending Facility (TSLF) Primary Dealer Credit Facility (PDCF)

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 checkpoint

Why is it hard to predict the impact of monetary policy adjustments?

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FISCAL POLICY Fiscal policy involves adjusting budgetary deficits or surpluses to achieve desired economic goals. Fiscal policy is controlled by Congress The President

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PRIMING THE PUMP Cutting taxes Gives businesses and individuals more money to spend Expanded demand causes industries to Manufacture more products Hire additional employees Invest in new buildings and equipment

The economy expands

Keynesian economics Slide 30

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SLOWING THE BOOM ECONOMY

When demand exceeds supply Prices increase

Inflation When rising prices decrease the value of money

The government may Cut spending Raise taxes Do a combination of both Slide 31

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 checkpoint

Explain Keynesian economics.

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CRITICISM OF MONETARY AND FISCAL POLICY

Monetary policy is relatively more agile than fiscal policy. The Fed can change bank reserve requirements fairly easily. Changing tax levels is relatively more cumbersome.

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Adverse feedback loop When a lack of available cash causes a decline in spending Product demand drops Manufacturing slows Jobs are lost Less cash is available The downward cycle continues

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 checkpoint

What is an adverse feedback loop?

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3.3

CONSUMER PROTECTION

GOALS

Explain the various acts that protect consumer rights. Understand how enforcement responsibilities are shared across agencies.

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TERMS Truth in Lending Act (TILA) Equal Credit Opportunity Act (ECOA) Fair Credit Reporting Act (FCRA) Fair Debt Collection Practices Act (FDCPA) Government Accountability Office (GAO)

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CREDIT TRANSACTION PROTECTION

Truth in Lending Act (TILA) Guarantees that all information about the costs of a loan is provided in writing to consumers Provides for a right of rescission A consumer can change his or her mind about a loan until midnight of the third business day following the signing of the papers

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EQUAL CREDIT OPPORTUNITY ACT

Equal Credit Opportunity Act (ECOA) Prohibits the use of any type of discrimination as a factor in determining creditworthiness Requires that the lender provide the reasons for denial of credit upon request

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FAIR CREDIT REPORTING ACT Fair Credit Reporting Act (FCRA) Aims to protect the information that credit bureaus, medical information companies, and tenant screening services may collect

Risk-based pricing When a business offers less favorable credit terms to a consumer with a relatively weaker credit score

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FAIR DEBT COLLECTION PRACTICES ACT

Fair Debt Collection Practices Act (FDCPA) Protects consumers from unfair collection techniques

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 checkpoint

Name four important pieces of consumer protection legislation.

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OTHER LEGISLATION Fair Credit Billing Act Fair Credit and Charge Card Disclosure Act Home Equity Loan Consumer Protection Act Credit Repair Organization Act Gramm-Leach-Bliley Act

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HOUSING AND REAL ESTATE Various acts provide protections for Requiring flood insurance for designated areas Mandating that real estate settlement costs be disclosed to consumers Protecting against exploitative real estate lending practices

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EDUCATING THE PUBLIC ON THEIR RIGHTS

The Fed offers a variety of brochures on its website aimed at educating consumers about their rights.

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 checkpoint

Name three other pieces of lending legislation.

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ENFORCEMENT OF POLICIES OUTLINED IN ACTS

Shared responsibilities Agencies share enforcement responsibilities. Audits are conducted to test compliance at financial institutions. Government Accounting Office (GAO) The auditing arm of Congress that helps ensure that federal laws and policies are implemented properly

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 checkpoint

Why are so many agencies involved in enforcing consumer protection?

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3.4

ROLE IN DETERMINING BANKS’ FINANCIAL HEALTH

GOALS

Explain the regulatory process and how it works. Review how regulations affect the banking business.

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TERMS Charter Call report System to Estimate Examinations Ratings (SEER) CAMELS

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OVERSIGHT RESPONSIBILITES OF THE FED

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THE REVIEW PROCESS Charter A legal approval to operate a business as a bank

Federal Financial Institutions Examination Council (FFIEC) Fosters information sharing between state and federal agencies with the common goal of providing consistent methods for banking supervision Slide 52

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Call report (Consolidated Reports of Condition and Income) A quarterly report that banks are required to complete Is the basis for the Uniform Bank Performance Report By comparing current financial ratios to past financial ratios, the Uniform Bank Performance Report highlights any changes in a bank’s performance. Slide 54

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System to Estimate Examinations Ratings (SEER) An automated system that analyzes and compares historical supervisory ratings of banks with their Call report data

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 checkpoint

Why is the authority that issued a bank’s charter important in the ongoing operations of the bank?

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THE SCORE CARD CAMELS Capital adequacy Asset adequacy Management Earnings Liquidity Sensitivity to risk

CAMELS ratings are not public information. Slide 57

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MAINTAINING BALANCE IN THE BANKING SYSTEM

Banks are required to get permission from the Fed before they can Acquire another bank Introduce new products Diversify

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TRUST GENERATES TRUST Banking regulations make a code of conduct explicit and mandatory. Mutual trust encourages investment. Investment keeps money flowing through the economic system.

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REGULATIONS THAT ENCOURAGE PRIVATE INVESTORS TO AID AILING BANKS

 Open access to a bank’s financial status allows investors to thoroughly assess the financial standing of a bank prior to investing in a bank.  By being allowed to proactively assess risk, private investors are more willing to invest in ailing banks.

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FUTURE REGULATIONS THAT MAY FACILITATE PRIVATE INVESTMENT

Regulatory changes under consideration include Allowing private equity firms to invest in more than 10 percent of shares Allowing bad debt held by the acquiree to be written off over time

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 checkpoint

Why is society interested in encouraging banks to help other ailing banks?

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3.5

INTERNATIONAL BANKING AND THE FEDERAL RESERVE SYSTEM

GOALS

Explain the role of the Fed in international banking. Discuss how the Fed works to keep the dollar strong. Review how countries work together to provide a stable international banking economy.

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TERMS  Strength of Support Assessment (SOSA)  ROCA score  Fixed exchange rate  Flexible exchange rate  Balance of payments  Federal Reserve System Open Market Account (SOMA)  U.S. Treasury Exchange Stabilization Fund (ESF)

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AN INTERDEPENDENT GLOBAL ECONOMY

Globalization has led to increased interdependency between nations. A mutually acceptable method needs to be in place so that nations that use different currency can exchange funds across international borders.

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SUPERVISION OF INTERNATIONAL BANKS

International Banking Act of 1978 (IBA) Foreign Bank Supervision Enhancement Act of 1991 (FBSEA)

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Strength of Support Assessment (SOSA) Reflects how well a foreign bank is able to provide appropriate guidance, oversight, and financial backing to its U.S. offices

ROCA score

A composite score of performance for Risk management Operational controls Compliance Asset quality

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STABILIZING CURRENCY VALUES

Promoting full employment, price stability, and economic growth is the common goal of many monetary authorities. Fixed exchange rate

A monetary valuation of one country’s currency is tied to the valuation of another country’s currency.

Flexible exchange rate

Enables currencies to fluctuate based on market conditions

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BALANCE OF PAYMENTS Balance of payments A record of all the exchanges of goods and services that occur between two countries for a specified time period

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 checkpoint

How would a balance of payment deficit affect Countries A and B?

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KEEPING THE DOLLAR STRONG

Sterilize The process of minimizing the impact of a sale or purchase of foreign currency by selling or purchasing a corresponding amount of U.S. currency To maintain the federal funds rate set by the FOMC

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Federal Reserve System Open Market Account (SOMA) The account the Fed maintains international reserves in

U.S. Treasury Exchange Stabilization Fund (ESF) The account the Treasury maintains international reserves in Slide 72

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 checkpoint

Why is the Fed interested in stabilizing the value of the dollar?

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INTERNATIONAL COOPERATION

International Monetary Fund (IMF) Bank for International Settlements (BIS) Asia Pacific Economic Cooperation (APEC) International Banking Seminars

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 checkpoint

How does bringing together policy makers and researchers to examine a common topic facilitate smooth transactions for international banking?

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