Playing the float

An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn". If there is a prior agreement with the account provider for an overdraft, and the amount overdrawn is within the authorized overdraft limit, then interest is normally charged at the agreed rate. If the negative balance exceeds the agreed terms, then additional fees may be charged and higher interest rates may apply.

The first overdraft facility was set up in 1728 by the Royal Bank of Scotland. The merchant William Hog was having problems in balancing his books and was able to come to an agreement with the newly established bank that allowed him to withdraw money from his empty account to pay his debts before he received his payments. He was thus the first recipient of cash credit from a bank in the world. Within decades, the advantages of this system, both for customers and banks, became apparent, and banks across the United Kingdom adopted this innovation into service.

With the onset of industrialization, new businesses needed an easy form of credit to jump-start their activities, without having to take out loans on securities they didn't necessarily have. The importance of this new financial innovation was recognized by the philosopher David Hume who described it in one of his essays as 'one of the most ingenious ideas that has been executed in commerce'.

Overdrafts occur for a variety of reasons. These may include:

Banks in the UK normally offer an overdraft facility free of charge, subject to a pre-arranged limit (formerly known as an authorized overdraft limit). Interest, fees or both would normally be charged if the facility is used but accounts may have an interest-free buffer of a few tens of Pounds or a higher deliberate feature of a few hundred Pounds interest free.

When a transaction would exceed the previously agreed overdraft limit the bank can choose either to decline the transaction or to accept it as an informal request for an increase, formerly often known as an unauthorized overdraft. Charges and interest rates for informal increases will often exceed those for a formal request. There is also normally a fee per declined transaction, often subject to monthly caps. Usually, the bank sends out a letter informing the customer of the charge and requesting that the account be operated within its limits from that point onwards or informing the customer of their new limit. In a BBC Whistleblower programme on the practice, it was noted that the actual cost to the bank was less than two pounds.

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Wikipedia