In the United States, the Daylight Overdraft (also called as intraday overdraft) is a system in which “allows qualifying banks to overdraw on their Federal Reserve accounts in order to make payments via Fedwire. Banks can acquire overdrafts throughout the day to make payments, but must ensure that their accounts are not in a negative position at the end of the day.”
Contents
- History
- The Problems Associated With the Daylight Overdraft
- How the Federal Reserves Deals with the Risks
- Net Debit Cap
- Conclusion
- References
An example of a daylight overdraft is making a $100 deposit at an Automated teller machine which allows for instant withdrawal of the first $100 deposited. This ATM transaction will post the next day; however if you were to transfer the funds from this account to another account using other means (internet, telephone and etc.) the funds would be withdrawn that day and will post your account negative the next day.
Another example is the Federal Reserve policy of daylight overdraft when a fee is not imposed on collateralized daylight overdrafts, but a 50 basis points fee is taken on uncollateralized ones.
Occasionally, banks might not have enough money in their Federal Reserve accounts to fulfill their withdrawals. For example, Let’s assume Bank A has $10 million as their assets and the Federal Reserve requires 10% of their asset as their reserves, which is $1 million. If one day, Bank A needs to transfer out $1.5 million during the day, Bank A is running a daylight overdraft during that day. By the end of that particular day, Bank A has an obligation to payback the Federal Reserve.
History
The histories of Daylight Overdraft starts all the way back in 1985 when the Federal Reserve established policies on large amount transfers between different banks, which allows banks to operate smoothly.
The Problems Associated With the Daylight Overdraft
There is a couple of flaws associated with the system. Sometimes banks are not able to repay back the amount that they overdrew during the day since daylight overdraft is ultimately making transactions with the funds that are not really there at the time of the settlement occurs. Banks where need to payback the Federal Reserves, but do not have enough funds to do so has an option to borrow the funds from other banks. However, borrowing from other banks is not an available option all the time. This situation is called a systemic risk, also known as credit risk.
How the Federal Reserves Deals with the Risks
The Federal Reserve can take a several actions to deal with the risks associated with lending out reserves during the day.
First, the Federal Reserve can monitor the banks that borrowed money by what kind of project they are using the reserves for and or by screening the amount of assets that the banks own.
Second, the Federal Reserve can ask for collateral to whoever is willing to borrow. In this scenario, collateral works as an insurance for the Federal Reserve in case that the borrower is not able to return the overdraft that occurred during the day.
Third, the Federal Reserve might require the daylight overdraft fee to reduce some risks associated with the overdraft during the day. By charging the borrowers fee, the banks would not borrow more than the amount that they need in order to avoid getting charge a large fee.
Net Debit Cap
Banks who are eligible for the Daylight Overdrafts get a net debit cap. Different organizations hold different net debit cap because it is settled by specific regulations and guidelines set up by the Federal Reserve. Along with the policies that the Federal Reserve can ask, net debit cap helps the Federal Reserve to reduce the risks that they might face with the Daylight Overdrafts.
Net Debit Cap = Cap Multiple X Capital Measure
Conclusion
Overall, the Daylight Overdraft is a system that is useful for the banks; however, it comes with costs for the Federal Reserve as a lender. With proper regulations and policies, the Daylight Overdraft system will allow the banks to operate more efficiently.