Definition of 'Float'
The float is an important source of funds for banks because it allows them to make loans without having to tie up their own capital. However, the float can also be a source of risk for banks because it can fluctuate significantly from day to day.
There are two main types of float:
* **Clearing float:** This is the amount of money that is in transit between banks. When a customer writes a check, the money is not immediately withdrawn from their account. Instead, the check is sent to the bank on which it is drawn. The bank on which the check is drawn then has a few days to collect the money from the customer's account. During this time, the money is considered to be in clearing float.
* **Transaction float:** This is the amount of money that is in transit between customers and businesses. When a customer makes a purchase with a credit card, the money is not immediately transferred from their account to the merchant's account. Instead, the credit card company has a few days to collect the money from the customer's bank. During this time, the money is considered to be in transaction float.
The float can be a significant source of revenue for banks. Banks typically earn interest on the money that is in float. However, the float can also be a source of risk for banks. If the float declines, banks may have to borrow money to meet their reserve requirements. This can increase their costs and reduce their profits.
Banks manage their float by using a variety of techniques, such as:
* **Optimizing their check clearing process:** Banks can reduce the amount of time that checks are in clearing float by using electronic check clearing systems.
* **Managing their credit card transactions:** Banks can reduce the amount of time that credit card transactions are in transaction float by using real-time processing systems.
* **Hedging their float exposure:** Banks can hedge their float exposure by using interest rate swaps or other financial instruments.
The float is an important concept for understanding how banks operate. By understanding the float, you can better understand the risks and rewards of banking.
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