Audit and Accounting Guide Depository and Lending Institutions, 2nd Edition

Chapter 14 Federal Funds and Repurchase Agreements

Introduction

14.01 This chapter addresses two types of transactions—federal funds and repurchase agreements (repos)—that can be either investing or financing transactions, depending on which side of the transaction the financial institution participates. Federal funds transactions can be an important tool for managing liquidity. Repos also can provide a cost-effective source of funds and may provide a means for the institution to leverage its securities portfolio for liquidity and funding needs.

Federal Funds Purchased

14.02 Federal funds are funds that commercial banks deposit at Federal Reserve Banks. Banks must meet legal reserve requirements on a daily basis by maintaining a specified total amount of deposits at Federal Reserve Banks and vault cash. A bank with excess reserves on a particular day may lend the excess, at an agreed-rate of interest (the federal funds rate), to another bank needing funds to meet its reserve requirements that day. The federal funds market does not increase or decrease total reserves in the Federal Reserve System, but merely redistributes them to facilitate efficient use of bank reserves and resources. However, by setting reserve requirements, the Federal Reserve System may increase or decrease total reserves in the system. No physical transfer of funds takes place; the Federal Reserve Bank charges the seller's reserve balance and credits the buyer's reserve balance. In addition to buying and ...