How Do Federal Reserve Banks Get Funded?

By Janet Siroto · August 25, 2022 · 9 minute read

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How Do Federal Reserve Banks Get Funded?

The Federal Reserve is frequently featured in headlines. You may have read about the bank’s chairman announcing that it would be adjusting interest rates up (and up again) recently. Or perhaps you’ve seen stories about how the bank tries to stimulate the economy and how well it maintains its independence.

But how much do you really know about the Federal Reserve system? Who owns the Federal Reserve bank, and how do central banks create money? These questions might seem abstract, but understanding how the system functions is key to getting a clear picture of how the U.S. economy works.

In short, the Federal Reserve — known as “the Fed” — is the country’s central bank. Its goals are much loftier than that of traditional banks: to make sure the U.S. economy works smoothly and serves the public interest.

Specifically, the bank tries to keep the financial system and individual institutions stable, protect consumers, and make sure the transactions system is secure and efficient.

Perhaps most importantly, the bank also manages short-term interest rates, which in turn affects the availability of credit and eventually things like consumer spending, investment, employment, and inflation.

The bank’s goals with these actions is to promote maximum employment, keep prices stable (traditionally, the bank aims for an inflation rate of 2%), and keep long-term interest rates moderate.

Here’s a closer look at the Fed, including:

•   Who owns the Federal Reserve Bank?

•   How do Federal Reserve banks get their money?

•   How is the Federal Reserve funded?

•   How does the Federal Reserve influence interest rates?

Who Owns the Federal Reserve Bank?

Even though parts of the Federal Reserve are structured like a private bank, the Fed is not owned by anyone. Congress created the Federal Reserve in 1913, and it remains an independent government agency. However, the board that oversees it — which is appointed by the president and confirmed by the Senate — still reports to Congress today.

Its leaders are required to testify in Congress and submit a lengthy report on its plans twice a year. The Federal Reserve actually consists of 12 Reserve Banks spread across different regions of the U.S. Although each one has a board of directors and is incorporated, it’s not actually a private entity and the banks aren’t in business to make a profit.

Recommended: Checking vs Savings Accounts: All About the Differences

How Does the Federal Reserve Make Money?

The Federal Reserve does not “make” money exactly, in that it doesn’t print money — that’s the Treasury Department’s job. But it does serve as a bank for other banks and government agencies, allowing them to open accounts to hold their reserves, take out loans, issue government securities, and take other actions.

When it comes to other banks, the Fed is there to lend to them in case they have problems getting funding, either because of unexpected fluctuations in their loans and deposits or due to extreme events, such as the 9/11 terrorist attacks, the 2008 financial crisis, or the COVID-19 crisis.

The Fed lends at a higher rate than the market in order to ensure that it’s used as a last resort. The Federal Reserve does not lend money or provide bank accounts for individuals, as retail banks do. (Beware of scams that claim you can open an account with the Federal Reserve using your Social Security number.)

While the Federal Reserve does not actually print money, it does put in orders with the U.S. Treasury for “Federal Reserve notes” based on the demand it expects both domestically and internationally.

Federal Reserve notes are actually just another name for U.S. paper currency and no different from the dollars in normal circulation. For fiscal year 2022, the Federal Reserve’s board will be ordering between 6.9 billion and 9.7 billion notes, which will be valued at $310 billion and $356 billion. Most of these notes go to replacing bills that are no longer in usable condition.

Here’s more detail on how the Fed works and keeps our economy humming along.

Fractional Reserve Banking and the Money Multiplier

Fractional reserve banking describes the system in which only a fraction of the money on deposit is actually held as cash and available for withdrawals by customers. Here are a few aspects of this system to note:

•   The Federal Reserve wants to ensure that banks keep enough money on hand so that when customers come in seeking cash, they aren’t turned away. To accomplish this, the Fed sets a reserve requirement (often 10% of all deposits) that banks must keep available. In response to the COVID-19 pandemic and the shockwaves it sent through the economy, this was lowered to 0% in an effort to stimulate the economy.

•   The Fed buys treasuries to help create monetary reserves. It sends the funds to banks so they can make loans with it, up to that reserve requirement limit mentioned above.

•   Another aspect of fractional reserve banking is what is known as the money multiplier. Financial analysts use a money multiplier equation to calculate the impact of the funds kept on reserve on the economy in general. It estimates how much money is created in the economy by the reserve system.

   Here’s how the calculation looks: The amount on deposit is multiplied by one divided by the reserve requirement. So if a bank had $100 million on deposit, you would multiply that by one divided by 10% to get $1 billion. That $1 billion represents money potentially created by lending out the 90% not kept on reserve at the bank.

Recommended: What is Fractional Reserve Banking and How Does it Work?

The Credit Market Funnel

Another way of looking at the Federal Reserve’s role in our nation’s economy is the credit market funnel, meaning that the Fed funnels funds to businesses to grow the economy. Say the U.S. Treasury printed $20 billion in new bills, and the Fed credited $80 billion in liquid accounts. You might think the American economy got an infusion of $100 billion. But it’s actually much more than that. Credit markets act as a funnel in terms of distributing funds. As new loans are issued, more money is created. That $100 billion could trigger a tenfold monetary increase to $1 trillion.

Determining the Money Supply

Here’s another facet of what the Federal Reserve does: It considers whether our country’s money supply should be boosted. This can impact the state of the American economy. A larger money supply can lower interest rates and get more cash to consumers, which typically stimulates spending. If the Fed does feel that the money supply needs to be increased, it will typically augment bank reserves. It might purchase Treasury bonds and distribute those to banks’ reserve funds. The banks can then use some of those funds for loans and other activities.

Money Creation Mechanism

As you’ve learned, the Federal Reserve plays a vital role in determining how and when to influence the money supply in the U.S. economy. It often boils down to the Fed buying securities and putting them in the reserves of commercial banks. Those banks can then augment the amount of money in circulation by lending funds to both businesses and consumers.

Recommended: Money Management and Setting Your Financial Goals

How Is the Federal Reserve Funded?

So where does the Fed get its money? Unlike other government agencies, the Federal Reserve doesn’t get its money from Congress as part of the usual budget process.

Instead, Federal Reserve funding comes mainly through interest on government securities that it bought on the open market.

These primarily include U.S. Treasury securities, mortgage-backed securities, and government-sponsored enterprise (GSE) securities.

How much money does the federal reserve have? As of mid-August 2022, the Fed had nearly $8.9 trillion in assets on its balance sheet. Those have grown significantly compared to 15 years ago, when the Fed had just around $870 billion in assets.

The reason for this has to do with the Fed’s response to the Great Recession and the COVID-19 crisis, among other factors. But remember how the Federal Reserve isn’t in it for the profit?

Once it pays its own overhead, the rest of its earnings go right into the country’s coffers in the U.S. Treasury. In 2021, the Fed transferred $109 billion to the Treasury, up from $87 billion in 2020 and $55 billion in 2019.

How the Fed Affects Interest Rates

In its attempts to steer the ship of the U.S. economy on a solid course, one of the main things the Fed does is influence interest rates. The Fed can either raise or lower the federal funds rate , which is the rate at which financial institutions that hold deposits can borrow and lend funds they keep at Federal Reserve banks from each other.

The Federal Open Market Committee, which is made up of some members of the Fed’s Board of Governors and others, meets multiple times a year to determine what they want the federal fund rates to be.

These decisions then influence other longer-term interest rates, such as those on savings accounts, mortgages, and loans.

The Fed often cuts interest rates to energize the economy by making it less expensive for businesses and consumers to borrow money. It raises rates when inflation seems too high, as has been the case recently.

The rate had been cut to the 0-0.25% rate in March of 2020 due to the emergence of the COVID-19 pandemic and its expected economic impacts. However, by July of 2022, with inflation surging to 40-year highs, the rate was raised to the 2.25% to 2.50% range. While this may sound high to those who focus on the previous historic lows, it’s worthwhile to consider a bit of context. A 2.5% rate is far below 5.25%, where it was in June 2006, and way lower than its peak of 20% in 1978 and 1980, when the Fed was reacting to runaway inflation.

The Takeaway

Understanding the role of the Federal Reserve in our economy and how it is funded is an important bit of learning. It explains how the Fed balances our money reserves, controls inflation, and stimulates the economy’s growth. Especially in the current economic climate in which inflation has been high and the effects of the global pandemic are still being felt, knowing how the Federal Reserve works can enhance your financial literacy. This in turn can help you better manage your own money.

Another way to boost your money management can be to bank smarter with SoFi. When you open an online bank account with SoFi, you’ll enjoy perks that can help your money grow faster and streamline your life. For instance, your Checking and Savings account will let you spend and save, all from one convenient place. And when you open an account with direct deposit, you’ll earn a competitive APY and pay zero fees. What’s more, eligible accounts can access their paycheck up to two days early.

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How does the Federal Reserve obtain money?

If you’re wondering where does the Federal Reserve’s money come from, the answer isn’t from Congress, as many people might expect. Rather, the Fed makes money mainly through interest on government securities — such as U.S. Treasury securities, mortgage-backed securities, and government-sponsored enterprise (GSE) securities — that it bought on the open market.

Who gives money to the Federal Reserve?

The Federal Reserve isn’t given money; it finances its operations via the interest made on the securities it owns.

Is the Federal Reserve self-funded?

Yes, the Federal Reserve is self-funded. It doesn’t get money via Congress but through the interest earned on the government securities that it buys.

Does the Federal Reserve print money out of thin air?

While the Federal Reserve has the power to print money, there’s a delicate balance at work. If the Fed just ordered the Treasury Department’s Bureau of Engraving and Printing to print more money without a commensurate increase in economic activity, it could trigger inflationary growth, which isn’t desirable.

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