Federal Reserve Regulations

What Are Federal Reserve Regulations?

Federal Reserve regulations are rules put in place by the Federal Reserve Board to regulate the practices of banking and lending institutions, usually in response to laws enacted by the legislature. Regulating and supervising the banking system is one of the primary functions of the Federal Reserve System. The goal of most Federal Reserve regulations is to promote the stability of the banking system.

Understanding Federal Reserve Regulations

One of the primary functions of the Federal Reserve System is to regulate and supervise the nation’s banking system. The Fed Board of Governors is ultimately responsible for these activities, which it executes through the regional Fed banks. The Board promulgates regulations for banking practices and capital requirements to further its own monetary and financial policy and to implement laws enacted by Congress.

Federal Reserve regulations are legally binding on member banks and banks that violate them can be shut down by the Fed. They are explicit, written rules that banks must follow. The Fed also conducts supervision of the banks, examining banks’ practices, evaluating their compliance with the letter and intent of Federal Reserve regulations, and taking enforcement actions.

Federal Reserve regulation and supervision follow two broad principles of microprudential and macroprudential functions. Microprudential regulation and supervision involves the examination and enforcement of regulations upon specific banks to hold them to prudential standards of lending honesty, riskiness, and sound capital requirements. Macroprudential regulation and supervision involves broad rules that are aimed at promoting the soundness of the financial system as a whole against systemic risk.

Fed regulation of the financial system has been a frequent topic of debate and a target of criticism following episodes of financial crisis such as the Great Recession. As a quasi-public entity, nominally privately owned but established and empowered by federal law, the Fed is generally expected to act in the public interest. However, like any regulator, the Fed can be subject to conflicts of interest and public choice issues including rent-seeking and regulatory capture, which may be reflected in its policies and regulations.

History of Federal Reserve Banking Regulation

Prior to the Civil War, the regulation of banks was mostly a matter dealt with by the individual states, with the exceptions of First and Second Banks of the U.S., short-lived precursors to the Federal Reserve System that were administered by the federal government. Otherwise, national regulation of the banking system essentially consisted only of the Constitution's requirement that no state could require anything other than gold or silver as legal tender for debts.

This period was known as the era of free banking, because state-regulated banks were generally free to compete in the issuance of loans and paper notes backed by gold or silver money. Banks that over-issued notes relative to their reserves risked market discipline in the form of bank runs and failing public confidence, and states that allowed their chartered banks to do so risked market discipline in the form of local economic downturns due to debt deflation. Banking panics and financial crises were not uncommon, but they were short lived and localized due to the decentralized nature of the banking system. Overall, the country maintained an extended period of economic growth and stability.

Beginning in 1862, in order to help finance the war, the federal government enacted the Legal Tender Act and the National Banking Acts, a series of laws that sought to drive state-chartered banks out of the market and replace them with nationally chartered banks using a single, national paper currency. This included the creation of national charters for banks (with accompanying regulations and reserve requirements), the abandonment of the gold standard in favor of the issuance of the first federally sanctioned paper currency (known as “greenbacks”), and heavy punitive taxes on state banks in order to drive their notes off the market in favor of the new paper money issued by federally chartered banks.

The power and importance of nationally chartered banks operating out of the country's major financial centers such as New York increased and the activity of state-chartered banks was suppressed. State-chartered and state-regulated banks recovered somewhat in the decades following the war with the increasing popularity of checking accounts in place of bank-issued notes.

The previously short-lived, local financial panics now tended to broaden in scale and scope and threaten the interests of the large financial institutions of the northeastern financial centers. This culminated in the Panic of 1907 and a national recession from 1907-1908. In the wake of the Panic of 1907, Congress members form the northeastern states and representatives of the major Wall Street banks began to draw up plans to further centralize control and regulation of the banking system in order to protect the interests of the large, well-established, and well-connected banks that dominated the nation’s major financial centers.

These plans came to fruition with the establishment of the Federal Reserve System in 1913, under the Federal Reserve Act. Under the Act, all banks were legally required to join the Federal Reserve System, which would then function as a kind of national banking cartel controlled by the largest and most powerful banks, accountable in turn to congressional committees whose members are normally closely connected to the major banking interests. Through its regulatory and supervisory functions, the Federal Reserve acts as the legal enforcer of this cartel, to constrain member banks from engaging in lending or other activities that may be profitable to them individually but may increase risks to the interests of the financial sector as a whole.

Since its establishment, the Fed has issued a large volume of specific regulations and requirements for member banks. Some Fed regulations have later been reversed, and some of those have later been reinstated. The overall content of the Fed banking rules and policies represents a complex, emergent outcome of competing financial and political stakeholders interacting through the process of authorizing legislation, regulation, lobbying, and negotiation with special interest groups.

List of Federal Reserve Regulations

Because many of the Federal Reserve regulations have lengthy official titles, they are more often referred to by their assigned regulation letter, such as Regulation D, T, or Z. These letters are assigned in alphabetical order as new regulations are enacted, with newer regulations having to resort to a double-letter format such as AA, BB, etc. A summary of Federal Reserve regulations is as follows: