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How much risk lurks in the shadows of daylight
overdraft?
June 7, 2009
With the U.S. banking system in financial distress, the Fed provides payments services to a greater
number of problem banks. So how much of an issue is the credit risk associated with retail
payments today? As you know, financial institutions, much like the commercial and retail
customers they serve, from time to time experience the need for overdraft credit—short-time loans
to accommodate the management of incoming and outgoing funds. The Fed provides daylight
overdraft protection to financial institutions that experience timing differences in ACH service
offerings so that they can meet their cash flow obligations, in the same way a financial institution
provides overdraft protection. The Fed, like any prudent lender, also maintains a responsibility to
carefully manage the credit risk exposure from these provisions of credit. The need for the Fed to
monitor ACH activity for overdraft exposure becomes critical when a financial institution's health is
in question.
How does the Fed monitor the financial health of financial institutions?
It is important to remember that the Fed is also a bank regulator, and it works collaboratively with
other bank regulators to monitor bank conditions. When a bank's financial condition deteriorates,
the agencies communicate the institution's regulatory rating and other relevant information to the
Fed in its U.S. payments oversight role. Wearing that hat, the Fed may choose to restrict lending in
a number of ways, such as limiting access to daylight credit.
Real-time monitor
One tool that can be used to restrict daylight credit access is "real-time monitoring" (RTM), which
is implemented through the Account Balance Monitoring System (ABMS). With RTM, the Fed can
reject certain transactions from posting to an institution's account if that posting would cause the
institution to exceed its daylight credit limits. Under RTM, any funds transfers from the account or
ACH credit originations (which are required to be prefunded) that would cause an institution to
exceed its daylight credit capacity would be rejected.
Interest on reserves and daylight overdrafts
One conundrum in this equation is that the need for overdrafts has diminished recently as banks
began maintaining higher reserves, prompted by the Fed's decision to start paying interest on
reserve balances. Before, banks were reluctant to hold too many reserves because they were a
nonearning asset. Since the Fed didn't compensate banks for holding the reserves, banks could find
more rewarding uses for their funds. With more reserves in the system, the need for intraday
borrowing from the Fed has decreased. Whether that trend will continue as the economy improves
and the financial condition of the banking sector stabilizes, thereby creating more lucrative uses for
excess reserves, remains to be seen—but then maybe we won't have as many high-risk banks as the
economy improves. Let's hope not.
By Cindy Merritt, assistant director of the Retail Payments Risk Forum at the Atlanta Fed
• June 7, 2009 in
◦ ACH
◦ supervision and regulation
• Permalink

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