Question

Explain the following term/concept: Overdraft

Hint:

An overdraft is like a financial safety net for a current account. It allows you to spend "below zero" up to a certain point, but remember, the bank charges interest daily on that negative balance.

Answer 1

Meaning: An overdraft is a short-term credit facility provided by a bank that allows a current account holder to withdraw more money than is available in their account, up to a pre-approved limit. It is essentially a loan on the current account, designed to help businesses manage temporary cash flow shortages. Key Features:

Credit Facility: It is an extension of credit, not the account holder's own money.
Pre-sanctioned Limit: The bank sets a maximum limit for the overdraft based on the customer's creditworthiness.
Interest Calculation: Interest is charged only on the actual amount overdrawn and for the period it is used, not on the entire sanctioned limit.
Flexibility: The borrower can withdraw and repay funds as needed within the limit, making it a highly flexible source of short-term finance.