Bouncing a check is a costly mistake for the Average Joe. But every day corporations and banks ``bounce'' over $120 billion - and never pay a cent. These ``daylight overdrafts'' are legitimate. Banks offer big customers free electronic intraday loans so long as they settle up by day's end.
But what if they don't settle? That's been worrying the Federal Reserve Board lately. The volume of daylight overdrafts has been surging at a 20 to 25 percent growth rate in recent years.
If a bank failed to settle, it could trigger a dangerous and expensive chain reaction thoughout the banking system. And the Fed (with taxpayers' money) would have to pick up the tab.
The Federal Reserve guarantees every payment that goes over the Fedwire, an electronic transmission system linking banks. As the overdraft volume has shot up, so has the risk to the Fed.
Last year, the Fed put a ceiling on the amount of daylight overdrafts each bank was allowed. Bankers generally agreed with the move. They beefed up their payment monitoring systems and made a few scheduling adjustments. But the ceiling was high enough to have little effect on most banks. And even though the volume of payments continues to go up, the actual level of overdrafts has stopped rising.
Nonetheless, in its ongoing risk reduction effort, the Fed's Board of Governors is likely to vote today to lower the daylight overdraft ceiling again. A 25 percent reduction in the cap is expected to be implemented in three to six months.
This time around, however, banking support is less uniform. And the ramifications for corporations, municipalities, and taxpayers could be significant. ``The natural fluff in the system is gone. This is going to hurt,'' says one banker. ``The international and specialty banks are going to have major difficulties in this market,'' predicts James Robinson, director of bank consulting at Touche Ross & Co.
Specifically, Mr. Robinson thinks banks that handle securities processing, short-term certificates of deposit for municipalities, and those clearing large dollar payments for foreign corporations and banks will see their transactions bumping up against the new Fed ceilings.
``Manufacturers Hanover, Irving Trust, and Bank of New York do a lot of securities clearing. I imagine this cap is going to give them difficulties,'' said one New York banker.
These banks deny any such problems. Indeed, an Irving Trust spokesman says it's ``aggressively seeking additional business.'' Still, many expect the new caps to pinch. ``On occasion, some banks have already delayed or prioritized payments so as to stay within their cap,'' says Michael Urkowitz, executive vice president of corporate operations and systems at Chase Manhattan. ``As the caps come down, that will occur more often and more widely.''
At Bell Atlantic in Philadelphia, Lawrence O'Malley has noticed some delays in getting funds. ``The bank didn't attribute the holdups to the caps,'' he says. But Mr. O'Malley, director of financial operations, is dubious. ``We're concerned. We'll be watching this closely because any action the Fed takes on this affects us.''
Indeed, it could cost corporations. Many banks are considering extra charges for immediate payments, especially if it forces the bank into an overdraft position. Until now, daylight overdrafts have been interest-free loans.
It's not yet clear whether this cap reduction or the next will provoke new fees. But Mr. Urkowitz at Chase says, ``We are now dealing with finite capacity. And we are providing more than payments processing. Over time, we will reach a point where banks are forced to charge.''
Even if the banks don't up the ante, the Fed might. Today, the Fed is also expected to consider a proposal to levy a fee on daylight overdrafts, a cost the bankers say they will pass along.
One byproduct of the Fed program is added competition. The caps are based on a ratio of the bank's capital, prompting users of bank payment clearing services to take a closer look at the credit quality and capital base of their banks. ``That analysis is redirecting and redistributing business. We're benefiting a great deal from this new sensitivity,'' claims Francesca Lepaige, first vice-president at Security Pacific International Bank.
Urkowitz at Chase sees the overdraft caps as an effective way of forcing banks to more carefully manage risk and develop innovative techniques for making payment transfers. But as payment volume continues to rise at double-digit rates, Robert Spasik, electronic products manager at Pittsburgh's Mellon Bank, wonders: ``At what point do the [overdraft cap] reductions themselves disrupt the system?''
Policing money flow through New York
Every day, some $1.3 trillion passes through the hands of New York bankers.
Money center banks are the traffic cops for the massive cash flows generated in the course of daily commerce: corporations receiving payments and paying creditors, cities funding construction, investors settling securities trades, dealers swapping foreign currency.
Virtually all payments zip electronically down the Federal Reserve's Fedwire ``road'' or a private wire system known as CHIPS.
But, invariably, somebody may be slow in paying a bill. Rather than risk gridlock, the banks let these large customers overdraw their accounts for a few hours. This is a ``daylight overdraft.''
For example, Exxoff has only $5 million in its bank account. But Exxoff owes General Mutters $10 million by noon today. The bank sends GM the $10 million anyway. By 3 p.m., Exxoff must come up with the $5 million it owes the bank. Typically, the money gets transferred from another bank or comes in from another corporation paying its bill. With thousands of banks and corporations whizzing funds around electronically, these intraday loans add up.