The Evolution of the Federal Reserve's Intraday Credit Policies

Abstract

One of the Federal Reserve's roles is to provide payment services to depository institutions and to the U.S. Treasury. Many of the nation's transfers of funds--whether they are large-dollar payments for financial market transactions or small-value business and consumer payments--settle through depository institutions' accounts held at the Federal Reserve for reserve-maintenance purposes and transaction processing. If a depository institution has insufficient balances during the day to cover its debits, it will run a negative balance or "daylight overdraft" in its Federal Reserve account until sufficient funds are received later in the day. Because depository institutions generally hold a relatively small amount of funds overnight in their Federal Reserve accounts in relation to the trillions of dollars of payments processed by the Federal Reserve each day, the Federal Reserve extends intraday credit to ensure the smooth functioning of the U.S. payment system. To reduce the risks that depository institutions present to the Federal Reserve through their use of daylight credit and to address the risks that payment systems, in general, present to the banking system and other sectors of the economy, the Federal Reserve Board in 1985 developed a payments system risk (PSR) policy. One of the primary goals of the PSR policy is to control depository institutions' use of Federal Reserve intraday credit, and as the policy has evolved, the Board has adopted specific methods for controlling daylight overdrafts. The history of the Board's PSR policy, trends in daylight overdraft and payment activity, and a possible future policy direction are discussed in this article.