Credit sweep

Credit sweep
See also

Credit sweep refers to a contract between the bank and the customer (usually a corporation) which says that all free funds and surpluses on deposit accounts will be used to repay short-term loans under the credit line. The target balance is usually set by the client, it determines how much of his funds will be used[1].

Use of credit sweep

Credit sweep is used to minimize costs of having line of credit. Customer of a bank that has line of credit can define that all idle funds in a deposit account will be used to pay down short-term borrowings. Usually customer defines also the lowest state of the account that enables such payment[2].

Characteristics

If necessary, the bank may withdraw its support or change the terms of the contract to suit the new situation. As the borrower's situation is changing in a dynamic competitive market, the availability of a bank loan must be continually reassessed. Sweeps, carried out annually so that they coincide with the financial statements, are also an important tool for credit supervision. They are particularly recommended for working capital loans, as the borrower's working capital is constantly changing[3].

The sweeps also formalize the right to repay on demand a loan that has not passed the exam. In addition, sweeps are applied to term loans (even if it is not possible to make changes to the credit without violating the terms of the contract), not only to check whether there has been a breach of contract, but also to know in advance about a decrease in the borrower's creditworthiness or to prevent such a decrease. This task can be entrusted to persons acting as a sponsor (which contributes to increasing their responsibility) or an independent unit at the bank (which is a form of additional internal control)[4].

Credit Sweeps in Banks

Characteristics of Credit Sweeps in Banks [5]:

  • Banks use sweep accounts as a legal workaround to the prohibition to pay interest on business checking. By "sweeping" funds overnight to an investment vehicle of some sort, otherwise idle cash (credit) can be more effective in generating marginally more return
  • There are many forms of sweep arrangements. Commercial banks can afford different solutions, which is why they enjoy aggressive strategies (they offer a much higher rate of return), while smaller entities use the sweep account for their own convenience. Very different service levels are common when establishing a credit sweep agreement.

Footnotes

  1. Richards I. E., (2014),p. 12
  2. Wrbka S., (2014), p. 67
  3. Barone M., (2016), p. 217
  4. Rodgers D., (2013), p. 6
  5. Scott-Quinn B., (2012), p. 25

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References

Author: Monika Sojka