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Federal Funds
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

Literally, "FUNDS AT THE Fed," i.e., immediately available funds at a Federal Reserve bank.  Sources of federal funds include excess reserves (reserve balances at a Federal Reserve bank in excess of legal reserve requirements) of member banks, checks on the U.S. Treasury's or foreign balances at a Federal Reserve bank, and checks drawn in payment for purchases by the Fed of U.S. government securities.

The principal sources of demand for federal funds are member banks deficient in required reserves (see LEGAL RESERVES) and using federal funds as a fine very short-term (as short as one day) adjustment in reserve position, and other member banks (e.g., a major New York City member bank which announced the policy in 1964) which deliberately use federal funds as a source of additional reserves for earning assets, a situation feasible at times of tight money but high money rates.  Nonbank demand for federal funds is principally from U.S. government securities dealers to finance their inventories; there is also participation by foreign banks and their agencies and domestic noncommercial bank financial institutions.

Intermediaries in the market for federal funds, bringing together buyers and sellers of federal funds, consist of some banks and brokers in New York City, correspondent banks, and similar interbank contacts.  In addition, there is direct contact between buyers and sellers of federal funds.

The standard unit of trading in federal funds among the larger banks is $1 million, and among the smaller banks, $200,000.  The straight one-day transaction in federal funds is unsecured and involves the accounting shift of reserve balances on the books of the Federal Reserve bank, the selling bank's reserve balance being debited and the buying bank's reserve balance being debited and the buying bank's reserve balance being credited.  These entries are reversed on the following day, the interest involved being paid by separate entry.  Secured transactions in federal funds, secured by U.S. government securities, are often found among the smaller banks, in lieu of repurchase agreements.  Purchases of federal funds by national banks are not indebtedness subject to the general limitation on a national bank's borrowing (not over capital stock unimpaired plus 50% of unimpaired surplus fund), pursuant to Comptroller of the Currency's Ruling 7518.  Nor is such a purchase of federal funds subject to the general 10% limit on loans to any one single borrower (10% of the bank's capital and surplus), pursuant to the Comptroller of the Currency's Ruling 1130.

Federal Funds Rates

Since member banks have recourse to borrowing from the Federal Reserve banks, it would be supposed that the discount rate would serve as a ceiling on federal funds rates.  Rates on Federal funds, however, may go above discount rates of Federal Reserve banks because in periods of tight money and deficiencies in reserves member banks may already have borrowed from the Fed or may wish to avoid doing so, and also because some banks may use borrowed federal funds as a source of funds for earning asset expansion.  Federal funds rates as guides to monetary policy:

The table appended herewith gives the ranges of market rates on federal funds in recent years.


Board of Governors of the Federal Reserve System.  Annual Report.  Federal Reserve Bulletin.  Various issues.

GOODRIEND, M.  "A Model of Money Stock Determination with Loan Demand and a Banking System Balance Sheet Constraint."  Federal Reserve Bank of Richmond Economic Review, January/February, 1982.

GOODFRIEND, M., and HARGRAVES, M.  "A Historical Assessment of the Rationales and Functions of Reserve Requirements."  Federal Reserve Bank of Richmond Economic Review, March/April, 1983.

HUMPHREY, T.M., and KELEHER, R.E.  "The Lender of Last Resort:  A Historical Perspective."  Cato Journal, Spring/Summer, 1984.

RINGSMUTH, D.  "Custodial Arrangements and Other Contractual Considerations."  Federal Reserve Bank of Atlanta Economic Review, September, 1985.

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