Overdraft

An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero.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. An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero.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 Hogg 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. 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 did not 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'.