In banking, float refers to the money that is double counted due to delays in the process of deducting funds from the payer and the depositing of the payee. It is most common in paper checks between different banks when the payee’s bank credits the account as soon as the check is deposited, but the payer’s bank has not yet cleared the check (removed the amount from the payer’s account).
Float is the money that is double counted due to delays in clearing checks.
When the payee deposits their check, their bank automatically credits the account before deducting the amount from the payer’s bank. Timing delays can occur due to seasonal fluctuations, holidays, transportation delays, etc.
Floating checks occur when the payer takes advantage of the float time to replenish insufficient funds.
Taking Advantage of the Float
Usually, when the payer writes a check, it is assumed that they have that money in their account to cover the payout. Floating checks is a strategy whereby the payer takes advantage of the float by writing a check for an amount they do not currently have but is expected to receive before the check is cleared.
For example, a payer writes a check for $500 today to a payee. She does not currently have $500 in her account, but she knows she will receive a direct deposit of $500 in three days’ time, and she expects that the payer will deposit and clear the check in five days’ time.
Issues with Floating Checks
If the expected direct deposit does not materialize before the check is cleared, the check will be rejected. The payer will be charged with a non-sufficient funds (NSF) fee from the bank and potentially a return check fee from the payee as well. Alternatively, if the payee’s bank clears the check earlier than the direct deposit hits, the payer will run into the same problems. Furthermore, large amounts of NSF checks can lead to criminal charges.
If insufficient funds are imminent, it may be better to apply for overdraft protection instead to avoid complications from floating checks. Overdraft protection is a line of credit offered by banks to continue withdrawing funds when the payee has insufficient funds. While overdraft negatively harms credit, it is a better alternative to unsuccessfully floating checks.
Similar to floating checks, kiting involves taking advantage of the float. However, kiting is illegal because the payer, knowing he has insufficient funds, is misusing the float as unauthorized credit.
In such a scenario, the payer keeps two accounts at different banks. He writes a check from Bank A for $5,000 that is not in his account. He then deposits the check into Bank B, which automatically credits the account for $5,000. Immediately, he withdraws the $5,000 from Bank B and eventually deposits the amount into Bank A before Bank B clears the check. In the time it takes for the check to clear, the payer exploits this float time as a short loan with no interest.
Better processing capabilities from technological advancements have significantly lowered times to process checks, and therefore reduced the amount of float outstanding. Banks now offer electronic payments, direct deposits, email money transfers, and other forms of payment, which have been adopted quickly in place of paper checks.
Before such advances, checks can range anywhere between 2-5 days to clear. The float time varies depending on anything that can lengthen processing, such as seasonal fluctuations, holidays, transportation delays, and more. Today, it usually takes around 1-2 days to clear, so it is much harder to take advantage of the float.
Besides the inevitable innovation in processing checks, the push for shorter float times was also partially due to central banks. Because the float artificially inflates money supply, it can obscure the actual amount of money in circulation and the implementation of monetary policy. As a result, the shrinking of the float time has clarified money supply, as well as deterred payers from taking advantage of the float.
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