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Some observers mistakenly consider the Federal Reserve to be a private entity because the Reserve Banks are organized similarly to private corporations. For instance, each of the 12 Reserve Banks operates within its own particular geographic area, or District, of the United States, and each is separately incorporated and has its own board of directors. Commercial banks that are members of the Federal Reserve System hold stock in their District's Reserve Bank. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. In fact, the Reserve Banks are required by law to transfer net earnings to the U.S. Treasury, after providing for all necessary expenses of the Reserve Banks, legally required dividend payments, and maintaining a limited balance in a surplus fund.

https://www.federalreserve.gov/faqs/about_14986.htm

Are there significant political advantages for commercial banks to become members of the Federal Reserve System? What do you think they stand to gain from this affiliation, considering the regulatory oversight and responsibilities that come with it? This quote suggests that there's no economic advantage in becoming a Reserve Bank, but what would the political advantages be? If there's no economic advantages, then certainly there must be political advantages in becoming an owner of a Reserve Bank, which is a non-profit organization.

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There are no political advantages.

First, a little background. US central banking system is unique because US was for long time opposed to central banking. US adopted central bank only begrudgingly (see the NY Fed explainer) and although we don't have any direct evidence it is reasonable to hypothesize this private public chimeric set up was done just to placate opposition.

Next, you as a private person cannot become owner of a reserve bank, nor a regular commercial bank can become reserve bank on a whim. The number of reserve banks is set up by the Federal Reserve Act that stipulated that between 8-12 reserve banks have to be set up. No more no less. At this point there already are 12 reserve banks so no more can become reserve banks.

Furthermore, as mentioned you as an individual cannot invest into the reserve system. At least not directly. Private commercial banks are by law obliged to invest into reserve banks. However, these private commercial banks:

  • do not get any voting rights.
  • do not get most of standard shareholder rights, they cannot influence or select top management of Fed. They can influence some positions on board of member banks but these are not political positions, but pure technocratic positions.
  • they do not get any special access to politicians. Fed is supposed to be politically independent.

Private banks do not really have a choice to become part of the reserve system. They must by law become part of reserve system if they want to serve as retail banks in US. Most banks would probably never opt into this system voluntarily.

Private banks become members of the reserve system because they have to.

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The political benefit of being a Reserve Bank is that some of the seats related to the governance of the Federal Reserve system are elected by member banks.

But, the benefit is primarily economic. The fact that the shares don't issue dividends does not mean that there are no economic advantages to having those shares.

While economics textbooks often talk about the government "printing money" to fund themselves, in the U.S., it is the member commercial Reserve Banks in the system, and not the federal government itself, that are the primary economic beneficiaries of increases in the money supply. When the Fed creates money, the commercial Reserve Banks get most of the benefit from figuratively "printing money" (all economically significant amounts are done with ledger entries and not literally currency) in economic terms. This economic benefit flows primarily the right to borrow directly from the Fed and then use the borrowed funds to lend against fractionally backed reserves. This is a very subtle thing, but it is a huge economic book to the profits of that commercial bank in times of inflation fueled by an increased money supply.

A Reserve Bank is also at the heart of the payment system (i.e. the system for processing checks and wire transfers), has input that is taken very seriously into how payment system regulations are changed, and has the modest perk of having "first dibs", so to speak, on having newly distributed currency supplied to it when it needs it.

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  • Can you please provide any peer reviewed evidence that banks benefit from Feds increase in money supply economically? Empirical evidence shows that low interest rates that result in larger money supply hurts bank profitability
    – 1muflon1
    Oct 19, 2023 at 23:02
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    @1muflon1 I'm recalling what I was taught about the practical mechanics of how the money supply is increased from intermediate level college macroeconomics in the textbook (Barro) and lectures from my professor (at Miami University of Ohio, name long forgotten) on the subject.
    – ohwilleke
    Oct 19, 2023 at 23:04
  • then can you please provide citation from the Barro book, I own it, and I can't recall any model that shows increase in money supply makes banks more profitable. I don't even think this is discussed in the book if we talk about the same book, but of course I dont have the book memorized cover by cover.
    – 1muflon1
    Oct 19, 2023 at 23:07
  • @1muflon1 Also "all banks" v. the 8-12 Reserve Banks that are part of the Fed are two very different things.
    – ohwilleke
    Oct 19, 2023 at 23:08
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    I mean what is even mechanism here? Private banks have to borrow that new money from Fed at an interest, they can only earn profit on intermediation margins and empirical evidence shows that when money supply is being expanded through low interest rates profitability plummets because it narrows these margins e.g. see Goodhart, & Kabiri, (2019). What is even the mechanism that makes this profitable in your mind?
    – 1muflon1
    Oct 19, 2023 at 23:18

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