What it is:
A daylight overdraft occurs when a bank transfers out more in a day than it has in its reserves.
How it works (Example):
Let's say Bank XYZ has assets of $100 million. The Federal Reserve requires the bank to maintain 10% of this in reserves, or $10 million. If, one day, the bank transfers $12 million out of various accounts, it creates a $2 million daylight overdraft. The overdraft is a "daylight overdraft" because Bank XYZ covers the $2 million shortage by the end of the day by borrowing from the Federal Reserve. The Federal Reserve charges a fee for daylight overdrafts.
Why it Matters:
Daylight overdrafts can create financial risk because they can destabilize the banking system if enough banks do it. Accordingly, the Federal Reserve charges fees to discourage daylight overdrafts. Additionally, if a bank incurs frequent daylight overdrafts, the Federal Reserveoften institute additional oversight.