In the

United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territori ...

, federal funds are overnight borrowings between

bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Because ...

s and other entities to maintain their

bank reserves Bank reserves are a commercial bank's cash holdings physically held by the bank, and deposits held in the bank's account with the central bank. Under the fractional-reserve banking system used in most countries, central banks typically set mini ...

at the

Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...

. Banks keep reserves at Federal Reserve Banks to meet their

reserve requirement Reserve requirements are central bank regulations that set the minimum amount that a commercial bank must hold in liquid assets. This minimum amount, commonly referred to as the commercial bank's reserve, is generally determined by the centra ...

s and to clear financial transactions. Transactions in the federal funds market enable

depository institutions Colloquially, a depository institution is a financial institution in the United States (such as a savings bank, commercial bank, savings and loan associations, or credit unions) that is legally allowed to accept monetary deposits from consumers. ...

with reserve balances in excess of reserve requirements to lend reserves to institutions with reserve deficiencies. These loans are usually made for one day only, that is, "overnight". The interest rate at which these deals are done is called the

federal funds rate In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an uncollateralized basis. Reserve balances a ...

. Federal funds are not collateralized; like

eurodollars Eurodollars are U.S. dollars held in time deposit accounts in banks outside the United States, which thus are not subject to the legal jurisdiction of the U.S. Federal Reserve. Consequently, such deposits are subject to much less regulation than ...

, they are an unsecured interbank loan. Federal funds transactions by regulated financial institutions neither increase nor decrease total reserves in the banking system as a whole. Instead, they redistribute reserves. Before 2008, this meant that otherwise idle funds could yield a return. (Since 2008, the Fed has paid interest on bank reserves,http://www.federalreserve.gov/monetarypolicy/20081006a.htm interest on reserves including excess reserves.) Banks may borrow these funds in order to meet the reserves required to back their deposits. Federal funds are definitive money, meaning that they are available for immediate spending, while checks and many other forms of money must be cleared by banks and typically take several days before becoming available for spending. Participants in the federal funds market include

commercial bank A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit. It can also refer to a bank, or a division of a large bank, which deals with co ...

savings and loan association A savings and loan association (S&L), or thrift institution, is a financial institution that specializes in accepting savings deposits and making mortgage and other loans. The terms "S&L" or "thrift" are mainly used in the United States; simi ...

government-sponsored enterprise A government-sponsored enterprise (GSE) is a type of financial services corporation created by the United States Congress. Their intended function is to enhance the flow of credit to targeted sectors of the economy, to make those segments of th ...

s, branches of foreign banks in the United States, federal agencies, and securities firms. Many relatively small institutions that accumulate reserves in excess of their requirements lend reserves overnight to money center and large

regional bank A regional bank is a depository institution, i.e. a bank, savings and loan, or credit union, which is larger than a community bank, which operates below the state level, but smaller than a national bank, which operates either nationally or intern ...

s, as well as to foreign banks operating in the United States. Federal agencies also lend idle funds in the federal funds market. The Fed, which is the

central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central b ...

of the United States, conducts

monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often a ...

primarily by targeting a certain value for the federal funds rate. If the Fed wishes to move to, for example, a more expansionary monetary policy, it conducts

open market operations In macroeconomics, an open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can either buy or sell government bonds (or other financial a ...

, which includes primarily bank reserves; since this puts more liquidity into the banking system, it pushes down the federal funds rate.

References

External links

Federal Funds - Fedpoints - Federal Reserve Bank of New YorkInstruments of the Money Market: See Chapter 2 - Federal Funds
{{Authority control Federal Reserve System Interest rates

See also

References

External links