The Federal Reserve System (Federal Reserve or System), our nation’s central bank, is unique among governmental entities in many respects, particularly in its finances. Unlike many government agencies whose operations are funded through the Congressional appropriations process, the Federal Reserve deducts operations and other expenses from its revenues and transfers the remaining amount to the U.S. Department of the Treasury (Treasury). Although the primary mission of the Federal Reserve is to support a stable economy, not to make a profit or maximize its transfer to Treasury, System revenues contribute to total U.S. revenues; thus, deductions from System revenues represent a cost to U.S. taxpayers. In today’s constrained budget environment, Congress seeks to be well informed on all activities that affect the government’s finances. For this reason, Members of Congress have requested our assistance in providing information about the revenues and costs of the Federal Reserve, factors that could affect Federal Reserve finances, and about the mechanisms used to control costs and conduct strategic planning. The Federal Reserve was created by the Federal Reserve Act of 1913 “. . . to provide for the establishment of Federal reserve banks, 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.” The Federal Reserve’s basic structure includes a federal agency in Washington, D.C.—the Board of Governors of the Federal Reserve System (Board), whose seven members are appointed by the president and confirmed by the Senate. Figure 1.1 shows the organizational structure of the Board. The structure also includes 12 federally chartered corporations, located in various regions of the country (Federal Reserve districts), known as Federal Reserve Banks (Reserve Banks). Figure 1.2 shows the boundaries of the Federal Reserve districts. The Federal Reserve is unusual in many respects compared to other entities established to carry out public purposes. It is a federal system that is part public and part private; although the Board is a government agency, the Reserve Banks are not. Also, the Federal Reserve does not follow the familiar federal structure of a “top-down” hierarchy, with all policymaking powers centralized in Washington, D.C. Instead, the Board and the Reserve Banks have shared responsibilities and policymaking authority in many areas of operation. The Federal Reserve’s part-public, part-private composition evolved from efforts to ensure our central bank’s balanced consideration of public and private interests at national and regional levels. A related feature is the Federal Reserve’s structural independence from political influence and direct taxpayer support. The Federal Reserve’s budget is not subject to the approval of Congress or the administration, and the central bank receives no government appropriations. The Reserve Banks are structured as self-supporting corporations, and the Board is financed by a levy on the Reserve Banks. The Reserve Banks are federally chartered corporations wholly owned by private-sector commercial banks (which, as members of the Federal Reserve, are known as member banks.) In terms of assets and personnel, most of the Federal Reserve is in the Reserve Banks: virtually all of the Federal Reserve’s assets, liabilities, revenues, and expenses are carried on the books of the Reserve Banks, and 94 percent of the over 25,000 employees of the Federal Reserve are employed by the Reserve Banks. As of December 31, 1994, the assets of the Reserve Banks were $437.0 billion, and their liabilities and equity were $429.5 and $7.4 billion, respectively. Although the Reserve Banks are privately owned corporations, they differ from most such entities in important ways. The ownership of all stock of the Reserve Banks confers on member banks only some of the typical attributes of control and financial interest. For example, member banks receive dividends on Federal Reserve stock, but these dividends are set by law at 6 percent of paid-in capital. Member banks may not sell the stock or pledge the stock as collateral for loans. Also, member banks elect six directors of the Reserve Banks’ boards of directors; the Board appoints three directors and designates one of these as chairman and another as deputy chairman of the board. Finally, the Reserve Banks have been considered instrumentalities of the federal government in at least one context. Although the Federal Reserve must report to Congress annually on its operations, decisions of System policymakers generally are not subject to ratification by the president or any presidential appointees in the executive branch or by Congress. The Federal Reserve Act not only gives the board of directors at each of the Reserve Banks powers of supervision and control over the Reserve Bank, but it also grants the Board of Governors the power to exercise general supervision over the Reserve Banks. For example, the board of directors at each Reserve Bank appoint and determine the compensation of the top official of each Reserve Bank; however, the Board of Governors is authorized to approve or disapprove these decisions. The Federal Reserve Act does not specifically define the general supervisory responsibilities of the Board of Governors. To help systemwide planning and decisionmaking in a system of shared responsibilities, the Board and the Reserve Banks participate in systemwide conferences. In 1994, the conference structure consisted of three major conferences: the Conference of Presidents (COP), the Conference of First Vice Presidents (COFVP), and the Conference of General Auditors, as described in table 1.1. Each of these conferences is supported by committees, subcommittees, and task forces, involving many Federal Reserve officials and staff. In 1995, a new management structure for financial services took over many of the duties of the COFVP that were related to priced services. The new committee was established to streamline the Federal Reserve’s decisionmaking process and to make the Reserve Bank first vice presidents more accountable for strategic planning of major business lines throughout the entire System. This new structure and details on the Federal Reserve’s decisionmaking authority are discussed further in chapter 5. Many, but not all, of the responsibilities of the Federal Reserve are shared by the Board and the Reserve Banks. This is perhaps best explained in the context of a discussion of the basic mission of the Federal Reserve. The mission of the Federal Reserve today, which is critical to the nation’s economy, can be generally described in terms of four major functions or responsibilities: conducting monetary policy; maintaining the stability of the financial system and containing systemic risk that may arise in financial markets; providing services to financial institutions and other governmental agencies; and supervising and regulating banks and bank-holding companies. Table 1.2 briefly describes the basic responsibilities of the Federal Reserve and explains how these responsibilities are shared by components of the System. The budgetary controls and oversight structures internal to the Federal Reserve reflect the fact that each of the Reserve Banks has its own management structure in addition to being supervised by the Board. Concerning budget controls—the primary control over spending—the Reserve Banks and the Board have similar, but separate, processes, and the Board approves all final budgets. The Federal Reserve’s internal oversight structure includes general auditors at each of the Reserve Banks and the Office of the Inspector General (OIG) at the Board. The OIG is authorized to audit activities for which the Board has primary responsibility. In addition, some Board divisions, such as the Division of Reserve Bank Operations and Payment Systems (DRBOPS), Division of Human Resources Management (DHRM), and Division of Banking Supervision and Regulation (DBS&R), conduct operations reviews using the Board’s delegated authority to supervise the Reserve Banks. DRBOPS also conducts financial examinations, operational audits, and annual performance evaluations of the Reserve Banks. The budgetary controls and oversight structures of the Federal Reserve are discussed further in chapter 5. The Reserve Banks use accrual accounting to track expenses. For this reason, the Reserve Banks’ operating expenses reflect only the depreciation costs of capital acquisitions. Each major unit of the Reserve Banks has an operations budget and a capital asset budget, and each is controlled by the same process. Each year, the Federal Reserve deducts operations and other expenses from current revenue and transfers the remaining amount to Treasury. For example, in 1994, the Federal Reserve deducted about $3.5 billion from the current revenue of about $24 billion and returned about $20.5 billion to Treasury. The amount returned to Treasury has varied during the period of 1988 to 1994, as shown in table 1.3. The return of these remaining revenues to Treasury is in accordance with a policy established by the Board of Governors, and is not required by statute. The amount that the Federal Reserve transfers to Treasury each year is a function of the amount of System revenues and deductions, which are affected by a variety of factors. The Federal Reserve has three major sources of recurring revenue: interest on U.S. securities held primarily to collateralize currency (currency-related securities), other interest earned, and fee income. Table 1.4 briefly identifies the sources of revenue and briefly describes the primary factors that determine the amounts received from each source. As detailed in this table, only in the case of priced services and net payments for fiscal agent services can the Federal Reserve set fees in response to fluctuations in the costs it incurs. Most Federal Reserve revenue comes from interest earned on U.S. government securities that are held by Reserve Banks and used to back, or collateralize, Federal Reserve notes. The Federal Reserve Act introduced Federal Reserve notes—the “paper money” that we use today. Before being issued to the public, Federal Reserve notes must be secured by legally authorized collateral—gold certificates, special drawing rights (SDR), and U.S. Treasury and federal agency securities purchased through open-market operations. About $381.5 billion in Federal Reserve notes were in circulation as of December 31, 1994, and as shown in table 1.4, the assets that collateralized those notes accounted for about 87 percent of the Federal Reserve assets at that time. Those assets represented mainly U.S. Treasury and federal agency securities.