What is Daylight Overdraft?
A daylight overdraft occurs when a bank transfers out more in a day than it has in its reserves.
How Does Daylight Overdraft Work?
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 Does Daylight Overdraft Matter?
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 Reserve will often institute additional oversight.