What is an 'Overdraft Cap'

Under the daylight overdraft system, banks can overdraw their accounts with the Federal Reserve in order to make Fedwire payments to other financial institutions. However, by the end of the day, banks must make sure that their Federal Reserve accounts aren’t overdrawn. The overdraft cap is the maximum dollar limit that a bank may overdraw its Federal Reserve account in order to make payments via this system. The overdraft cap limits the amount that banks will send via the Fedwire network. This cap limits a bank's daylight-overdraft exposure. The overdraft cap is also known as the net debit cap.

BREAKING DOWN 'Overdraft Cap'

For example, Bank X has $100 million in assets and a Federal Reserve obligation to hold 10 percent, or $10 million, in its Federal Reserve account. However, one day, Bank X needs to fulfill $10.5 million in withdrawals; it doesn’t have enough money in its Federal Reserve account to meet this requirement. So, it transfers out an overdraft of half a million dollars, but has an obligation to repay this money by the end of the day. This is allowable as long as Bank X’s overdraft cap is at least half a million dollars.

Overdraft Cap Categories

The overdraft cap varies from one bank to another. It is a multiple of each bank's risk-based capital. The cap applies not only between banks but also between banks, brokerage firms and credit unions, as well as other financial institutions. The Federal Reserve recognizes six overdraft cap categories:

  • Zero
  • Exempt-from-filing
  • De minimis
  • Average
  • Above average
  • High

Overdraft caps are set for a period of one year.

Zero Cap

Zero caps are assigned to institutions that are considered especially weak, don’t have access to the discount window, or are incurring daylight overdrafts that don’t align with Federal Reserve policy. These institutions are considered to pose the most risk to the Reserve Bank.

Exempt-From-Filing Cap

Institutions in this cap category may incur daylight overdrafts of up to $10 million or 20 percent of their capital, whichever is lesser. Most institutions are in this category. In order to be eligible for the exempt-from-filing cap category, the institution must be financially healthy and minimize its reliance on the daylight overdraft credit.

De Minimis Cap

Institutions in this category may incur daylight overdrafts of up to 40 percent of their capital. The institution must submit a yearly board of directors resolution approving use of the daylight overdraft to this extent.

Self-Assessed Cap

Institutions in the average, above average, and high cap categories are self-assessed. They may incur overdrafts of more than 40 percent of their capital, but must also fulfill large self-assessment burdens, including self-assessments of creditworthiness, customer credit policies and controls and intraday funds management and control.

  1. Daylight Overdraft

    A daylight overdraft is when a bank withdraws more money than ...
  2. Overdraft Protection

    Overdraft protection is a fund transfer or loan that banks offer ...
  3. Uncommitted Facility

    An uncommitted facility is an agreement where the lender agrees ...
  4. Capped Rate

    A capped rate is an interest rate that is allowed to fluctuate, ...
  5. Evergreen Loan

    An evergreen loan is a loan that does not require the principal ...
  6. Locally-Capped Contract

    A locally-capped contract is a structured investment product ...
Related Articles
  1. Personal Finance

    Bank Overdraft Changes: What You Need To Know

    New laws to protect consumers should be in place by the summer. Find out what will change and how it could affect you.
  2. IPF - Banking

    When Good People Write Bad Checks

    Overdraft protection can help when you overestimate your balance, but it will cost you.
  3. Personal Finance

    Top Checking Accounts With No Overdraft Fees

    Choosing the right checking account could save you hundreds of dollars in fees every year.
  4. Personal Finance

    5 Bank Fees You May Not Know About

    Banking regulations have recently changed and fees are following suit.
  5. IPF - Banking

    The Most Costly Banking Mistakes You Can Make

    With changing and increasing fees, it can be difficult to avoid bank charges, but investing time in finding out what your bank charges, and when, can help you save money.
  6. Investing

    1Q Small Cap Earnings Preview: The Tide Has Turned

    Earnings growth for small caps should trail large caps badly in the first quarter.
  7. Investing

    What's a Small Cap Stock?

    The “cap” in small cap stocks refers to a company’s capitalization as determined by the total market value of its publicly traded shares. Small cap stocks are generally defined as the stock of ...
  8. Investing

    Small-cap, mid-cap, and large-cap stocks: A 2016 comparison

    Find out what to happened with small-cap, mid-cap, and large-cap stocks in 2016 – and learn why it is important to diversify between all three.
  9. Small Business

    Capitalization Rate

    Capitalization Rate is a financial term most commonly used in the real estate investment industry. It is often simply called the Cap Rate.
  1. Can a checking account go negative?

    Find out about negative checking account balances and their ramifications. Read Answer >>
  2. How do mortgage lenders check and verify bank statements?

    Find out how mortgage companies verify your bank statements for mortgage approval. The lender sends a form to your bank requesting ... Read Answer >>
  3. How long does it take a check to clear?

    It usually takes two days for a check to clear, but in some cases it may take longer. Discover how banks treat large deposits ... Read Answer >>
Trading Center