Intraday Credit

Intraday credit is credit that a central bank or a commercial bank extends during the business day and that must be repaid before the day ends. Its main purpose is to let banks send payments through a real-time gross settlement system before the incoming payments they expect have arrived. Without it, banks would have to hold far larger balances at the central bank, or hold back payments until money came in.

The US Federal Reserve calls it a daylight overdraft; the Eurosystem and the Bank of England provide it mainly as collateralised overdrafts or intraday repos. It is different from overnight lending: if the credit is not repaid by the close, it turns into an overnight loan, usually on penalty terms. It is a core tool of liquidity management for any bank that settles payments directly.

Imagine a market stall that must pay its suppliers in the morning but takes most of its cash from customers in the afternoon. If the owner had to have every pound in hand before paying anyone, the stall would barely trade. Instead, a friendly wholesaler lets the owner run a tab during the day, as long as it is cleared before closing time.

Banks face the same timing problem with each other. Payments go out all morning, and payments come in all day, but rarely in the same order. Intraday credit is the tab that the central bank, or a larger bank, lets them run. It keeps payments moving, and because it must be paid back the same day, the lender is not taking on a long loan, just bridging a few hours.

In a gross settlement system every payment settles individually and immediately in central bank money, which gives strong payment finality but uses a lot of liquidity. If each bank waits for funds before paying, the system can stall in gridlock, with everyone waiting for everyone else. Intraday credit breaks that cycle.

Systems also use other tools to save liquidity, such as payment queues and offsetting algorithms that settle matching payments together, a form of netting. These reduce, but do not remove, the need for daytime credit. A settlement bank may in turn pass intraday credit down to the smaller firms that settle through it.

• Federal Reserve. Banks with Fed accounts may run daylight overdrafts up to a net debit cap linked to their capital. Since 24 March 2011, overdrafts backed by pledged collateral carry no fee, while uncollateralised overdrafts are charged at an annual rate of 50 basis points, up from 36.
• Eurosystem. Eligible counterparties obtain intraday credit in T2 against eligible collateral, free of interest. Credit still outstanding at the end of the day is automatically converted into overnight borrowing at the marginal lending rate.
• Bank of England. Settlement banks in the RTGS system that serves CHAPS obtain intraday liquidity through intraday repurchase agreements against high-quality collateral, without an interest charge.

Collateral is valued after a haircut, so the central bank is protected even if the pledged securities fall in price.

The Fed quotes its fee on a 24-hour day and a 360-day year, then scales it by the share of the day that Fedwire is scheduled to operate. The daily charge is:

• $\bar{D}$ is the institution's average uncollateralised daylight overdraft for the day.
• $r$ is the annual fee rate, 0.0050 (50 basis points).
• $h$ is the number of hours in the scheduled Fedwire operating day, currently 22.

Worked example: a bank averages a 500 million dollar uncollateralised overdraft. The effective annual rate is $0.0050 \times \frac{22}{24} = 0.004583$, or about 45.83 basis points. Dividing by 360 gives a daily rate of about 0.00001273, so the day's fee is about $500{,}000{,}000 \times 0.00001273 \approx 6{,}366$ dollars. Pledging enough collateral to cover the overdraft would reduce the fee to zero. A biweekly waiver of $150 spares institutions with only occasional small overdrafts.

For the central bank, the main risk is that a bank fails while overdrawn; collateral, caps and monitoring limit that exposure. For the borrowing bank, the danger is running short of collateral or market access when payments surge, which is a form of liquidity risk. Large outflows late in the day are especially hard to cover, which is one reason banks watch each system's cut-off time closely.

In April 2013 the Basel Committee on Banking Supervision published monitoring tools for intraday liquidity management, asking internationally active banks to report measures such as their largest daily use of intraday liquidity, available intraday liquidity at the start of the day and the timing of payments. Supervisors use these reports to check that banks can meet payment obligations on stressed days as well as normal ones.

• Federal Reserve: Payment System Risk policy
• Basel Committee on Banking Supervision: Monitoring tools for intraday liquidity management
• European Central Bank: T2