Federal reserve credit is a term used to describe loan money that is extended by the Federal Reserve, the United States' central bank, to banking institutions that are in need. The credit the Federal Reserve extends is in the form of short-term loans that are often referred to as swing loans. These loans are intended to help banks that are members of the Federal Reserve System maintain their liquidity and ensure they are able to meet requirements for reserve funds.
To understand what Federal Reserve credit is, it helps to have at least basic knowledge of the Federal Reserve System, which serves as the United States' central banking institution. It is often described as a bank's bank, but is also the banking institution for the United States government. Its purpose is to promote a stable yet flexible financial system within the United States. The Federal Reserve System was created in 1913 and today consists of 12 Federal Reserve System Banks and various branches. These banks generate income, create monetary policy, regulate state-charted banks, and provide services for member banks, including check processing, currency distribution, and automated clearinghouse services.
One of the Federal Reserve's jobs is to help ensure the stability of the United States monetary system, and part of that means making sure money flows between banking institutions and their customers without unnecessary interruption. It is for this purpose that the Federal Reserve extends Federal Reserve credit. By granting short-term loans to other banks, it helps ensure the stability of its member banks as well as the continual flow of funds.
Federal Reserve member banks have to meet certain requirements for reserve funds and may need Federal Reserve credit to do so in some cases. This means they must have a stipulated amount of money deposited with the Federal Reserve. This requirement is intended not only to ensure that banks have the money they need for their depositors, but also to ensure that the Federal Reserve maintains its influence over the supply of money in the United States. To understand how this influence works, consider what happens if the reserve requirement is decreased — essentially, this has the effect of increasing the money supply.
It may seem that Federal Reserve credit is similar to a bailout, but the two are not the same. The banks that borrow this money have collateral to offer in consideration for their loans. Additionally, there are strict regulations that govern the extension of Federal Reserve credit.
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