It is an explicit agreement whereby a creditor makes available funds, which exceed the current balance in the checking account (overdraw) up to a specified limit (the overdraft limit), to a consumer with a check account at a bank or building society. This arrangement allows flexible short-term borrowing because the borrower’s only constraint is the stated limit. The bank can charge some percentage points over the interest rate on the daily debt balance, or it can offer an arrangement fee. For example, if the consumer makes a purchase with a debit card for $150 but he/she only has $100 in the account, the account will be overdrawn by $50 and the bank may charge a fee or can charge two percentage points over the base rate only on the daily outstanding balance. This is a costly way of borrowing, but when the consumer is a risky borrower (according to its creditworthiness, security offered and bargaining position), overdraft facilities may be the most convenient source of funding. The bank can retain the right to withdraw the facility at short notice after informing the consumer.
Arnold G. (2002), Corporate Financial Management, Pearson Education
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