We have an ACH program in place for our customer payroll accounts. We must send the tape to the FED 2 days prior to the actual debit from the customer payroll account. In order to do this, we establish a limit based on the customer activity and balances. We basically underwrite the customer the same as we do for a line of credit. If the balance in the payroll account is insufficient to cover the ACH draft, we would treat it as any other NSF item and begin collection. Would this be considered an extension of credit under Reg O?

IMHO yes. You are providing a short-term unsecured loan.

Only if you truly develop an overdraft do you have to concern yourself with Reg. O definitions. Simply allowing the file to go out the door to days before debiting the customer doesn't equate to an extension of credit. If the ACH debit comes through against an NSF, now you've got one.

Thanks for your response, John.
If the ACH debit comes through against an NSF, now you've got one.
If we pay the item, charge a fee and start the collection process just like any other customer (no special treatment) we would be fine with Reg O restrictions as well?

Not stated in the original question is whether this customer is an insider subject to Reg. O. I assume he or she is. If that is the case, an overdraft is an extension of credit, and it would be included in determining whether the total credit of the insider requires prior board approval, has hit a ceiling, or any of a few other Reg. O challenges.