This post is part of a series titled “Supervising Our Nation’s Financial Institutions."
Like most corporations, each of the nation’s 12 Federal Reserve banks and their branch offices is governed by a board of directors. While many of their duties are similar to those of corporate boards, these boards do have some unique responsibilities as well as restrictions on activities and oversight.
By law, Federal Reserve bank directors represent many sectors of the economy, including banking. That’s not too surprising, given the nature of Reserve bank activities. But how directors who are bankers are selected, and what they do—and don’t do—as directors is not well known. Similarly, the role of Fed member banks in selecting Reserve bank directors is unfamiliar to many. So too are the guardrails on affiliations, stockholdings and participation in Reserve bank operations.
Here’s a look at how bankers interact with Reserve bank boards of directors.
Director Selection Process
Commercial banks that are Federal Reserve members hold stock in their Federal Reserve district’s Reserve bank, and like stockholders of corporations, they are responsible for nominating and electing board members.1 Member banks, by law, elect six of the nine total head office directors; the other three are selected by the Federal Reserve Board of Governors in Washington. The Federal Reserve Act stipulates that the six elected by member banks are divided into Class A and Class B directors. Class A directors represent member banks in the district; they are usually bankers, but they don’t have to be. Class B directors represent the public.2
For purposes of nominating and electing Class A and Class B directors (PDF), member banks are divided into three groups based on capitalization. On a rotating basis, each of the three groups selects one Class A member to represent its banks and one Class B member to represent the public. Dividing member banks into groups based on capital levels ensures that small, midsized and large institutions each have a role in selecting directors.
Class C directors are appointed by the Board of Governors, and the roles of chair and deputy chair of each Reserve bank’s board are reserved for Class C directors. By statute, Class C (as well as Class B) directors are not permitted to be officers, directors or employees of banks. The Board has extended the prohibition to preclude affiliations with any financial institution supervised by the Fed. Along with the restrictions on bank-based employment, Class C directors are not permitted to hold stock in any bank or Fed-supervised financial institution.3
Branch boards have either five or seven members—the majority are appointed by the Reserve bank’s head office board, and the rest are appointed by the Board of Governors. All directors—whether head office or branch—serve staggered three-year terms. The Board of Governors has established limits on the number of terms or years directors may serve, generally two three-year terms.
All head office and branch directors, regardless of background or selection method, play an important role in the Fed’s monetary policymaking. The Reserve bank president participates in the Federal Open Market Committee—the Fed’s main monetary policymaking body. Timely insights from directors on the economic conditions and trends in their industries or geographic areas help inform monetary policymakers’ decisions. Directors also share their views on current or prospective monetary policy decisions, further informing policymakers and providing real-time, on-the-ground perspectives that data and models cannot provide.
In addition, head office directors make formal and regular recommendations to the Board of Governors regarding the discount rate. A final rate decision is up to the Board of Governors and applies to all 12 Reserve banks.
Head office boards also have management oversight responsibilities, including reviewing the Reserve bank’s strategic plan, budget and overall bank performance as well as the performance of the Reserve bank president and first vice president, major capital projects, and other matters. Class B and Class C directors also have responsibility for appointing the Reserve bank president and first vice president and for reviewing their annual compensation. Head office directors also have responsibility for overseeing the Reserve bank’s audit process and appointing the general auditor, who reports directly to the Reserve bank’s board.
Besides the employment and stockholding restrictions applicable to directors depending on their class designation, there are several banking-related limitations on directors’ activities. The main purpose for these and other limitations is to safeguard against actual or perceived conflicts of interest.
First, Class A directors are not permitted to take part in the selection of a Reserve bank’s president and first vice president, nor are they allowed to sit on search committees for those positions. They are also prohibited from taking part in the selection, appointment and approval of compensation for officers in the Reserve bank’s supervision division.
Similarly, Class B directors who are affiliated with any institution supervised by the Fed are subject to the same limitations per Board of Governors policy. Branch directors appointed by the Board of Governors are subject to the same restrictions as Class B head office directors.
More significantly, no directors are permitted to view or be briefed on confidential supervisory information, and they are excluded from matters related to supervisory actions. These include exam ratings, potential enforcement actions, applications and approvals, and other supervisory activities.
The Federal Reserve is an apolitical institution, independent of partisan politics. As such, its head office and branch directors are also prohibited from engaging in several kinds of partisan political activities that could raise questions about the independence of the Federal Reserve.
Diverse by Design
By design, Reserve bank boards are composed of directors from a wide variety of economic sectors, such as agriculture, banking, commerce, services, industry, labor and consumers. Directors also represent varied demographic groups and geographic areas. This ensures a diversity of perspectives, as well as wide-ranging economic intelligence.
The 12 Reserve bank boards are organized to balance oversight and accountability with independence. One of the great strengths of the Federal Reserve System is this independent, federated structure, which ensures that a diversity of views are heard by the nation’s leaders.
Notes and References
1 While member banks are paid a dividend on their Federal Reserve stock, this stock may not be traded, sold or pledged as loan collateral.
2 In selecting Class B directors, consideration is given to the interests of agriculture, commerce, industry, services, labor and consumers.
3 Class B and Class C directors are permitted to have some limited affiliations and stockholdings with savings and loan holding companies and other companies that own a bank or savings association. See Roles and Responsibilities of Federal Reserve Directors (PDF), pp. 23-26.