Each country has its own banking system. A banking system is a network of institutions that provide financial services to individuals and businesses. A central bank is an institution that manages a country's or state's money supply, interest rates, and currency. Two of the biggest central banks are the European Central Bank (ECB) and the Federal Reserve in the United States.
The European Central Bank (ECB) is the central bank of the European Union countries that have adopted the euro as their currency. The ECB is headquartered in Frankfurt, Germany, and has been responsible for the monetary policy in the eurozone since 1999, when the euro was first adopted by some of the members of the European Union. Since the Governing Council of the ECB has become too large for all members to vote at each meeting, the ECB has a system of rotating voting rights among the national bank governors. The main goal is price stability, or a state in which prices do not change much over time and there is little inflation or deflation. This involves making important financial decisions and guidelines about money objectives, interest rates, and the supply of reserves, or the amount of money banks must have set aside. The ECB is also responsible for bank supervision. Together with the national supervisory authorities of the participating countries, the ECB operates the Single Supervisory Mechanism (SSM), which is in charge of maintaining and streamlining the European banking system. An example of a bank that falls under the ECB's control is the Franco Bank in Paris, France. When changes are made to the policies and regulations in the ECB, they are quickly adopted and followed at the Franco Bank. This helps with price stability.
Another large central bank is the Federal Reserve of the United States. The Federal Reserve is the central bank in charge of setting monetary policy for the nation. It has a central agency (the Board of Governors) in Washington, DC, and 12 regional Federal Reserve banks that are each in charge of their geographic areas. The Federal Reserve is subject to congressional oversight and is tasked with working to achieve the government’s financial and economic objectives. Suppose Ninth Community Bank in Tennessee is a hypothetical bank that falls under the Federal Reserve's watch; the bank must adhere to and follow the regulations that have been put in place by the central bank of the country. Smaller banks such as national banks, for example, which are essentially commercial banks that are chartered under the Federal Reserve, are examples of how the legislation that affects larger banks will also trickle down to smaller banks. Smaller banks can be defined as regional or community banks and these banks serve a specific community or metropolitan area.
The relationship between the Federal Reserve and the U.S. Government is symbiotic in nature. This means the U.S. Government’s treasury department issues bonds in the form of Treasury bonds. These bonds can be issued to the public, banks, and even the Federal Reserve. At the time of bond maturity, the U.S. Treasury pays interest to the public and the banks. However, within the case of the Federal Reserve, interest is paid to them from the Treasury but at the end of the year all interest is remitted back to the Treasury or U.S. Government.
The Federal Reserve bank can and does lend money to banks due to a lower interest rate that banks can experience to spur economic growth and to increase cash flows to business. However, as stated above, the interest collected is ultimately paid back to the U.S. Government, or Treasury, as profits, or interest.
Thus, the U.S. Government issues bonds and pays interest and the Federal Reserve pays back profits, or interest, to the U.S. Government or U.S. Treasury. As a result, the Federal Reserve can and does collect interest but pays this back to the U.S. Government, or Treasury, and this cycle continues so that banks and the public can invest and ultimately lend money to the public to allow for a free and healthy banking system.In the case of the Federal Reserve Bank, or reserves, these are the reserve balances also called Federal Reserve deposits that private banks keep at their local Federal Reserve Bank. The reason this is done is to protect against certain liabilities to ensure enough money is available to control the monetary supply during inflationary and deflationary periods to stabilize the economy and lending practices. As a result, the Federal Reserve demands that all banks have reserves that can then be issued back to banks to control monetary supply, liability risk, and economic control.