The US Federal Reserve System

From Banking Chaos to Federal Regulation

The Federal Reserve building in Washington, D.C.
Chip Somodevilla / Getty Images

The Federal Reserve System, created with the enactment of the Federal Reserve Act on December 23, 1913, is the central banking system of the United States. Popularly known as the Federal Reserve or simply the Fed, the Federal Reserve System was created in the belief that centralized, regulated control of the nation’s monetary system would help alleviate or prevent financial crises like the Panic of 1907. In creating the Fed, Congress sought to maximize employment, stabilize the prices of goods and services, and moderate the long-term effects of changes in the interest rate. Since it was first created, events like the Great Depression in the 1930s and the Great Recession during the 2000s have resulted in the modification and expansion of the Federal Reserve System’s roles, responsibilities, and authorities. 

Banking in the United States before the creation of the Federal Reserve System was, to say the least, chaotic.

Early American Banking: 1791-1863

Banking in the America of 1863 was far from easy or dependable. The First Bank (1791-1811) and Second Bank (1816-1836) of the United States were the only official representatives of the U.S. Treasury Department - the only sources that issued and backed official U.S. money. All other banks were operated under a state charter, or by private parties. Each bank issued its own individual, "banknotes." All of the state and private banks competed with each other and the two U.S. Banks to make sure that their notes were redeemable for full face value. As you traveled around the country, you never knew exactly what kind of money you would get from the local banks.

With America's population growing in size, mobility, and economic activity, this multiplicity of banks and kinds of money soon grew chaotic and unmanageable.

The National Banks: 1863-1913

In 1863, the U.S. Congress passed the first National Bank Act providing for a supervised system of "National Banks." The Act set up operational standards for the banks, established minimum amounts of capital to be held by the banks, and defined how the banks were to make and administer loans. In addition, the Act imposed a 10% tax on state banknotes, thus effectively eliminating non-federal currency from circulation.

What Is a "National" Bank?

Any bank using the phrase, "National Bank" in its name must be a member of the Federal Reserve System. They must maintain minimum levels of reserves with one of the 12 Federal Reserve banks and must deposit a percentage of their customers' savings account and checking account deposits in a Federal Reserve bank. All banks incorporated under a national charter are required to become members of the Federal Reserve System. Banks incorporated under a state charter may also apply for Federal Reserve membership.

1913: Creation of the Federal Reserve System

By 1913, America's economic growth both at home and abroad required a more flexible, yet better controlled and safer banking system. The Federal Reserve Act of 1913 established the Federal Reserve System as the central banking authority of the United States.

Functions of the Federal Reserve System

Under the Federal Reserve Act of 1913 and amendments over the years, the Federal Reserve System:

  • Conducts America's monetary policy
  • Supervises and regulates banks and protects consumers' credit rights
  • Maintains the stability of America's financial system
  • Provides financial services to the U.S. federal government, the public, financial institutions, and foreign financial institutions

The Federal Reserve makes loans to commercial banks and is authorized to issue the Federal Reserve notes that comprise America's entire supply of paper money.

The Federal Reserve System Board of Governors

Overseeing the system, the Board of Governors of the Federal Reserve System controls operations of the 12 Federal Reserve Banks, several monetary and consumer advisory committees and the thousands of member banks across the United States.

The Board of Governors sets minimum reserve limits (how much capital banks must have on hand) for all member banks, sets the discount rate for the 12 Federal Reserve Banks, and reviews the budgets of the 12 Federal Reserve Banks.

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Your Citation
Longley, Robert. "The US Federal Reserve System." ThoughtCo, Jul. 31, 2021, Longley, Robert. (2021, July 31). The US Federal Reserve System. Retrieved from Longley, Robert. "The US Federal Reserve System." ThoughtCo. (accessed June 3, 2023).