The Fed Wire is an electronic funds transfer system linking

  • the Federal Reserve Board of Governors,
  • the twelve regional Federal Reserve Banks and their branches,
  • the US Treasury Department, and
  • other federal agencies.

Settlement of transfers is same-day, which is convenient for large fund transfers. US banks maintain deposits with their regional Federal Reserve banks, which allows them to use the system for settling a variety of interbank transactions, such as loans, certificates of deposit, or repos. The deposits are called Fed funds. The main reason banks hold them is because the Fed requires them to maintain cash reserves as Fed funds.

Deposits at the regional Federal Reserve banks earn no interest, so banks perform a balancing act every day, trying to offset transactions in and out of their accounts so they end each day with Fed funds that equal but do not exceed their reserve requirements for the day.

On any given day, some banks find themselves short Fed funds while other banks find they have excess Fed funds. There are various ways banks can lend each other their Fed funds. Repos are a form of secured lending. There is also a large market for unsecured loans. This is called the Fed funds market. Most of those loans are arranged by brokers. Transactions can be for terms of as long as a year, but the vast majority are overnight loans.

One way the Fed conducts its monetary policy is to set a target interest rate for overnight Fed Funds. The actual rates banks pay are negotiated by those banks, but by expanding or contracting the money supply, the Fed can usually move those rates towards its target rate. When you hear people speak about the Fed funds rate, they may be referring to the Fed’s stated target rate. They may also be referring to the effective fed funds rate. This is a dollar-weighted average of interest rates payable on overnight Fed funds. It is compiled daily by the New York Federal Reserve Bank and is based on transactions arranged by major brokers.