Each day, the Reserve Banks process a large
number of payment transactions resulting from the Banks’ role in providing
payment services to depository institutions. Because depository institutions in
the aggregate generally hold a relatively small amount of funds overnight in
their Reserve Bank accounts, the Reserve Banks extend intraday credit, commonly
referred to as daylight credit or daylight overdraft credit, to facilitate the
settlement of payment transactions and to ensure the smooth functioning of the
Institutions incur daylight overdrafts in
their Reserve Bank accounts because of the mismatch in timing between the
settlement of payments owed and the settlement of payments due. The Federal
Reserve uses a schedule of rules, referred to as daylight overdraft posting
rules, to determine whether a daylight overdraft has occurred in an
institution’s account. The daylight overdraft posting rules define the time of
day that debits and credits for transactions processed by the Reserve Banks will
be posted to an institution’s account. The Federal Reserve relies on an
automated system to measure an institution’s intraday account activity, to
monitor its compliance with the Federal Reserve’s policy, and to calculate the
institution’s daylight overdraft charges. The Reserve Banks’ daylight overdraft
exposure can be significant. For example, in 2003 daylight overdrafts across
depository institutions peaked at levels over $100 billion per day.
The Federal Reserve measures each depository
institution’s account balance at the end of each minute during the business day.
An institution’s peak daylight overdraft for a given day is its largest negative
end of minute balance. The System peak daylight overdraft for a given day is
determined by adding the negative account balances of all depository
institutions at the end of each minute and then selecting the largest negative
end of minute balance. The quarterly average peak is the sum of daily System
peaks for a quarter divided by the number of days in that quarter.
The Federal Reserve’s policy establishes
various measures to control the risks associated with daylight overdrafts.
Beginning in 1985, the policy set a maximum limit, or net debit cap, on
depository institutions’ daylight overdraft positions. In order to adopt a net
debit cap greater than zero, an institution must be in sound financial
condition. Certain institutions may be eligible to obtain additional
daylight-overdraft capacity above their net debit caps by pledging collateral,
subject to Reserve Bank approval. Institutions must have regular access to the
Federal Reserve’s discount window so that they can borrow overnight from their
Reserve Bank to cover any daylight overdrafts that are not eliminated before the
end of the day. Those that lack regular access to the discount window are
prohibited from incurring daylight overdrafts in their Reserve Bank accounts and
are subject to additional risk controls. Beginning in 1994, the Reserve Banks
also began charging fees to depository institutions for their use of daylight
overdrafts as an economic incentive to reduce the overdrafts, thereby reducing
direct Federal Reserve credit risk and contributing to economic efficiency.
Federal Reserve policy allows Reserve Banks
to apply additional risk controls to an account holder’s payment activity, if
necessary to limit risk. These risk controls include unilaterally reducing an
account holder’s net debit cap, placing real time controls on the account
holder’s payment activity so that requested payments are rejected, or requiring
the account holder to pledge collateral to cover its daylight overdrafts