What is an overdraft cap?
The overdraft cap is the maximum dollar limit that a bank can send to another financial institution (FI) in a day. A bank limits the amount in excess of its Federal Reserve account to make FedWire payments, a real-time gross settlement of central bank money used by Federal Reserve banks to transfer money electronically between member institutions. RTGS) system.
Overdraft cap is also known as net debit cap.
- The overdraft cap is the maximum dollar limit that a bank can withdraw from its Federal Reserve account each day to make Fedwire payments to other financial institutions (FIs).
- Some banks may continue to withdraw money even when their Federal Reserve accounts are empty, provided that the balance Replenished by the end of the day.
- Overdraft limits vary depending on the financial position of the bank, and are set for a period of one year.
- The Federal Reserve is equipped with a number of tools to deal with breaches, including advisory measures, revising caps, and in severe cases, closing accounts.
Understanding Overdraft Caps
In the United States, eligible banks are allowed to make additional withdrawals from their Federal Reserve accounts to make Fedwire payments to other financial institutions. Under the daylight overdraft system, some banks may continue to withdraw money even if they have no funds left until their Federal Reserve account balance is reached by the end of the day. are restored back above zero.
The overdraft limit varies depending on the financial position of the bank. Those who register a lot of incoming payments and are believed to have little difficulty recoupling any borrowed funds by the end of the FedWire operating day are significantly waived. Meanwhile, other institutions may not be allowed to overdraft their accounts at all.
Daylight overdrafts help increase the liquidity and efficiency of the financial system, but they also potentially pose a systemic risk.
The overdraft cap is a multiple of each bank’s risk-based capital, the theoretical amount of capital required to absorb the risks involved in its business operations, and is set for a period of one year.
When an organization exceeds its overdraft limit, it is called a cap breach. The Federal Reserve is equipped with a number of tools to deal with breaches, including advisory measures, revision of limits, and in severe cases, closing accounts. Daylight overdrafts that aren’t funded by FedWire’s shutdown are also charged a much higher fee.
overdraft cap example
Bank X has $100 million in assets and the Federal Reserve has an obligation to hold 10%, or $10 million, in its Federal Reserve account. On day one, Bank X is required to meet $10.5 million in withdrawals. It doesn’t have enough money in its Federal Reserve account to meet this requirement, so it does an overdraft transfer of half a million dollars.
Bank X has an obligation to repay this money by the end of the day. This is acceptable, provided that Bank X has an overdraft cap of at least $500,000.
Types of Overdraft Cap
As mentioned earlier, the overdraft cap varies from one bank to another. The Federal Reserve recognizes the following six overdraft cap categories:
- exemption from filing
- de minimis
- above average
Zero caps are given to institutions that are considered particularly vulnerable, do not have access to discount windows, or are doing daylight overdrafts that do not align with Federal Reserve policy. These institutions are considered to be the riskiest for the Reserve Bank.
Institutions in this cap category, the most common of them, can take overdrafts in broad daylight of up to $10 million or 20% of their capital, whichever is less. To be eligible for the exempt-to-filing cap category, the institution must be financially sound and reduce its reliance on daylight overdraft credits.
de minimis cap
Institutions in this category can take daylight overdraft up to 40% of their capital. To qualify, the bank must submit an annual Board of Directors (D of B) resolution approving the use of daylight overdrafts to that extent.
Institutions are self-rated in the above average, above average, and high-cap categories. They can take overdrafts of more than 40% of their capital, but they will also have to meet a large self-assessment burden, including creditworthiness, customer credit policies and controls, and intraday fund management.