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In April 1994 the Federal Reserve began charging fees for daylight overdrafts incurred in accounts at Federal Reserve Banks. The event was an important step in the Federal Reserve's ten-year program to control daylight overdrafts and their associated payment system risk. The fees produced a dramatic decline in overdrafts and led to significant changes in market practices, particularly in the government securities market. This article summarizes the results to date of the implementation of the Federal Reserve's daylight overdraft program, focusing on the effect of fees. It also highlights related policies for large-value payment systems in the private sector.
BACKGROUND
Daylight overdrafts are a form of intraday credit in which a holder of a deposit account at a bank or other depository institution runs a negative balance in its account during the day but ends the day with a balance equal to or greater than zero. An example of a daylight overdraft is the case in which a deposit account holder (1) makes withdrawals from the account in the early part of the day that exceed the account's opening cash balance and (2) does not make deposits sufficient to cover the withdrawals until later in the day. When the customer's withdrawals require its bank to send payments through Federal Reserve systems, this type of customer activity can, in turn, cause daylight overdrafts in the Federal Reserve account of the customer's bank. In addition, the bank's own activity, such as federal funds borrowing and lending and the associated payment activity, can also cause daylight overdrafts.
Historically, intraday credit extensions went largely unmeasured because attention within the banking industry was focused mainly on processing payments rather than on managing associated intraday risks. In addition, nearly unlimited intraday credit was available from the Federal Reserve at no cost. Banks normally accumulated payment instructions during the day and posted thern to customers' accounts at the close of the banking day, a practice that can be viewed as reasonable and cost-effective given the operational and legal infrastructure at that time. As a result, however, settlement conventions related to the transactions most often characterized by same-day settlement--such as financing in the markets for federal funds and repurchase agreements--came to be based upon the availability of unlimited, free intraday overdraft credit from...