Each day, the Reserve Banks that are part of the Federal Reserve System process a large number of payment transactions resulting from the Reserve Banks’ role in providing payment services to banks and 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 U.S. payments system.  To address the risk of providing this credit, the Federal Reserve has developed a policy that balances the goals of ensuring smooth functioning of the payments system and managing the Federal Reserve’s direct credit risk from institutions’ use of Federal Reserve intraday credit.
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 banks and depository institutions peaked at levels over $100 billion per day.

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 and banks’ 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.

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