Bank_float

What Is Bank Float?

Bank float, a concept central to Financial Operations, refers to the amount of money that is effectively counted twice within the banking system for a brief period. This occurs due to the time lag between when funds are debited from one account and credited to another, particularly in the process of check clearing. For instance, when a check is deposited, the recipient's bank may provisionally credit their demand deposit account even before the funds are actually withdrawn from the payer's account at another bank. This temporary overlap creates bank float. The Federal Reserve Banks of the United States define float as "money in the banking system that is counted twice, for a brief time, because of delays in processing checks or any transfer of cash."

History and Origin

The phenomenon of bank float is deeply intertwined with the evolution of payment systems. In the early 20th century, before widespread electronic transfers, the physical movement of checks between banks created significant delays. The establishment of the Federal Reserve System in 1913, with its mandate to improve the national check clearing system, aimed to mitigate these delays and high interbank check-clearing costs.¹⁵,¹⁴

Throughout the 1970s, driven by high inflation and rising interest rates, companies sought to maximize the time their funds remained in their accounts, leading to practices like "remote disbursement," which amplified bank float.¹³ To address this and improve efficiency, the Depository Institutions Deregulation and Monetary Control Act of 1980 (MCA-80) significantly impacted float by requiring the Federal Reserve to price its payment services, effectively charging banks for the float they generated.¹²,¹¹ Further advancements, such as the Check Clearing for the 21st Century Act (Check 21) enacted in 2003, allowed for the electronic processing of checks, drastically reducing the physical transportation time and, consequently, the duration and amount of bank float.¹⁰,

Key Takeaways

• Bank float represents funds temporarily double-counted in the banking system due to processing delays.
• It primarily arises from the time lag in clearing paper checks or other fund transfers.
• While historically significant for banks and corporations, the amount of bank float has substantially decreased with the rise of electronic funds transfer (EFT).
• For banks, managing float is a component of effective cash management and influences the total volume of bank reserves.
• Misuse of bank float, such as "check kiting," is an illegal activity.

Formula and Calculation

While "bank float" isn't a single numerical value that is "calculated" in a standard formulaic way like a financial ratio, it can be conceptualized and measured in aggregate. Banks and the Federal Reserve often track "average daily float" to understand its impact on the money supply and monetary policy.

One way to conceptualize the value of float from a firm's perspective, representing uncollected funds, is:

$\text{Float} = \text{Firm's Available Balance} - \text{Firm's Ledger Balance}$

Where:

• Firm's Available Balance is the amount of funds immediately accessible in the bank account.
• Firm's Ledger Balance is the balance as recorded in the firm's internal accounting records, which might include recently deposited checks that have not yet cleared.

The difference highlights the uncollected funds or the temporary "extra" funds due to processing delays. For the banking system as a whole, Federal Reserve float is defined as the difference between "Cash Items in Process of Collection" (CIPC) and "Deferred Availability Cash Items" (DACI) on the Federal Reserve's balance sheet.⁹,⁸

Interpreting the Bank Float

Interpreting bank float involves understanding its implications for both individual entities and the broader financial system. A positive bank float generally means that the banking system, or an individual bank, has temporarily more funds on its books than have actually been collected. This "extra" money can, for a brief period, act as an interest-free loan to the banking system.⁷

From a bank's perspective, strategically managing float affects its liquidity and reserve requirements. For corporations, understanding bank float allows for more precise cash flow forecasting and optimizing working capital. A higher positive float for a company means it can retain funds in its account for a longer period before they are officially debited, potentially earning interest or using those funds elsewhere. Conversely, a negative float implies that funds have been debited from an account before they are actually credited to the recipient, which is less common in the modern electronic payment landscape.

Hypothetical Example

Consider "Alpha Co.," a small manufacturing business, and "Beta Supplies," its vendor. On Monday, Alpha Co. writes a check for $10,000 to Beta Supplies for raw materials. Alpha Co.'s bank account has a ledger balance of $50,000 and an available balance of $50,000.

Beta Supplies deposits the $10,000 check on Tuesday. Beta's bank immediately credits their account, making the $10,000 available to Beta Supplies. However, because it's a check drawn on a different bank, it takes two business days for the check to clear.

• Monday:

  • Alpha Co.'s Ledger Balance: $50,000
  • Alpha Co.'s Available Balance: $50,000
  • Beta Supplies' Ledger Balance: (pre-deposit)
  • Beta Supplies' Available Balance: (pre-deposit)

• Tuesday (Check deposited by Beta):

  • Alpha Co.'s Ledger Balance: $40,000 (check recorded internally)
  • Alpha Co.'s Available Balance: $50,000 (check not yet cleared, funds still physically in account)
  • Beta Supplies' Ledger Balance: (pre-deposit) + $10,000
  • Beta Supplies' Available Balance: (pre-deposit) + $10,000 (funds provisionally credited)

During this period (Tuesday and Wednesday), the $10,000 exists simultaneously in Alpha Co.'s available balance and Beta Supplies' available balance—this is the bank float. On Thursday, the check clears, and Alpha Co.'s available balance decreases to $40,000. This example illustrates how the time delay in payment systems creates bank float.

Practical Applications

Bank float, though diminished by digital advancements, still holds practical relevance in specific areas of finance and regulation:

• Treasury Management: Large corporations use sophisticated treasury management systems to predict and manage their float, optimizing cash positions and maximizing interest earnings on available funds. This involves forecasting the timing of incoming payments (collection float) and outgoing payments (disbursement float).
• Monetary Policy Monitoring: Central banks, such as the Federal Reserve, traditionally monitored aggregate float levels because they can influence the total amount of bank reserves in the system, which is a key input for conducting monetary policy. While less volatile now, float used to be an unpredictable factor affecting the money supply.
  *⁶ Fraud Prevention: Understanding float is crucial in identifying and preventing check kiting schemes, where individuals or entities exploit the float period by writing checks against non-existent funds, hoping to deposit real funds before the checks clear. Banking regulations and technologies aim to minimize the window for such fraudulent activities.
• Payment System Efficiency: The continuous drive to reduce bank float has spurred innovations in payment processing, including the development of Automated Clearing House (ACH) networks, wire transfer systems, and real-time payment solutions like FedNow. The Federal Reserve has been instrumental in modernizing payment systems to enhance their safety and efficiency.,
  ^{5
  4}## Limitations and Criticisms

The primary criticism and limitation of bank float in modern finance is its diminishing relevance in an increasingly digital world. As electronic payment methods become dominant, the time lag that creates float is significantly reduced or eliminated. Systems like real-time gross settlement (RTGS) mean that funds are transferred almost instantaneously, leaving no room for float.

Historically, one criticism of significant float was that it could distort the true picture of the money supply, making it more challenging for central banks to precisely manage liquidity and implement effective monetary policy. H³igh levels of float also presented opportunities for illicit activities such as check kiting, which involved intentionally exploiting the clearing delay. The E.F. Hutton scandal in the 1980s, where the brokerage firm pleaded guilty to 2,000 counts of mail and wire fraud related to an elaborate check kiting scheme, highlighted the risks associated with manipulating float. Efforts to reduce float, such as those initiated by the Monetary Control Act of 1980, aimed to eliminate this "interest-free loan" to banks and encourage more efficient payment processing.

²## Bank Float vs. Check Float

While often used interchangeably, "bank float" and "check float" are closely related but can refer to slightly different perspectives within payment processing.

Bank float is the broader term, referring to any funds that are counted in two places simultaneously within the overall banking system due to temporary delays in the settlement of transactions. This includes delays from various forms of fund transfers, though historically, checks were the primary driver. It represents a temporary inflation of the money supply.

Check float, more specifically, refers to the float created solely by the process of paper check clearing. It is the time difference between when a check is written and when the funds are actually deducted from the payer's account and credited to the payee's account. This type of float includes "collection float" (the time it takes for a payee to collect funds) and "disbursement float" (the time a payer's funds remain in their account after writing a check). The advent of electronic check processing, enabled by laws like Check 21, has drastically reduced check float.

In essence, check float is a specific type or component of bank float, focusing on the delays inherent in the paper-based check system.

FAQs

What causes bank float?

Bank float is primarily caused by the time delays inherent in the processing of financial transactions, most notably the physical movement and electronic clearing of paper checks between different financial institutions. Factors like weekends, holidays, geographical distances, and bank processing schedules can contribute to these delays.,

Has bank float decreased over time?

Yes, bank float has significantly decreased over time. The widespread adoption of electronic payment methods like direct deposit, Automated Clearing House (ACH) transfers, wire transfers, and the introduction of faster clearing technologies like Check 21 have largely minimized the delays that traditionally created float.,

¹### Is bank float relevant in today's digital banking?
While its magnitude is much smaller than in the past, bank float still exists to some extent, particularly with paper checks. However, with the rise of instant payment systems, its impact on the overall money supply and banking operations is far less significant than it once was. Its historical importance lies in understanding the evolution of payment systems and central bank policy.

Can individuals benefit from bank float?

Individuals may experience a very brief form of disbursement float if they write a check and the funds are not immediately debited from their account. However, attempting to intentionally exploit this float by writing checks without sufficient funds is illegal and can lead to severe penalties for check kiting. Most consumers now rely on immediate electronic transactions where float is negligible.