Appendix E: Federal Reserve Board Payment System Risk Policy: Daylight Overdrafts
Similar to financial institutions offering retail payment services to customers, the Federal Reserve Banks are exposed to credit risk when they process payments for financial institutions holding reserve accounts. The Federal Reserve Banks guarantee payment finality for financial institutions using their systems for Fedwire Funds, NSS, and ACH credit originations. Due to this payment guarantee, the Federal Reserve Banks may incur losses when institutions fail with overdrafts in their accounts.
An integral component of the Federal Reserve's Payments System Risk (PSR) policy controls and reduces the use of Federal Reserve Banks' daylight overdrafts and the Federal Reserve Banks' associated credit risk.See http://www.federalreserve.gov/paymentsystems/psr/default.htm. The PSR policy addresses daylight overdrafts that occur in accounts at Federal Reserve Banks as well as at financial institutions. A daylight overdraft occurs when an institution's Federal Reserve Bank account is in a negative position during the business day.
To control daylight overdrafts, the PSR policy establishes limits, or net debit caps, on the amount of Federal Reserve Bank daylight credit that a depository institution may use during a single day and over a two-week reserve maintenance period. These limits are sufficiently flexible to reflect the overall financial condition and operational capacity of each institution using Federal Reserve Bank payment services. The policy also permits the Federal Reserve Banks to protect themselves from the risk of loss by unilaterally reducing net debit caps, imposing collateralization or clearing-balance requirements, rejecting or delaying certain transactions until sufficient balances exist, or prohibiting an institution from using Federal Reserve Bank payment services.
The PSR policy established daylight overdraft fees to provide a financial incentive for institutions to control their use of Federal Reserve Bank intraday credit and to recognize the risks inherent in the provision of intraday credit. Daylight overdraft fees induce financial institutions to make business decisions concerning the amount of Federal Reserve Bank intraday credit they are willing to use based on the cost of using that credit. The daylight overdraft measurement method, which incorporates a set of nearly real time transaction posting rules, also supports institutions in controlling their use of Federal Reserve Bank intraday credit.
The Federal Reserve Banks use the Account Balance Monitoring System (ABMS) to monitor financial institution accounts intraday. For a limited number of institutions, the system is also used to prevent those institutions from incurring daylight overdrafts in their Federal Reserve Bank accounts beyond a certain threshold (often set to zero) for Fedwire Funds, NSS, and ACH credit origination transactions. In this situation, credit ACH transactions are required to be prefunded, including those settled on behalf of any respondents. If there are insufficient funds available in the account, the batch will reject and a notice will be sent to the ACH sending point and to the settlement financial institution.See IT Handbook "Retail Payment Systems Booklet" for additional information on NSS and PSR policy.
Appendix D: Legal Framework for Interbank Payment Systems
Appendix F: Payment System Resiliency