What Is a Credit Sweep?
A credit sweep is also known as an automated credit sweep. This term refers to an arrangement between a bank and a customer (usually a corporation) whereby all idle or excess funds in a deposit account are used to pay down short-term debt under a line of credit. The client usually sets a target balance that will determine how much of its funds will be used. This greatly helps a client reduce its costs paid through interest on outstanding debt.
Key Takeaways
- A credit sweep is an arrangement between a bank and customer whereby any excess funds in an account can be used to pay down the customer's debt.
- This type of arrangement is set up automatically and helps customers reduce their costs paid through interest on outstanding debt.
- Credit sweeps are offered by banks as a cash management tool to help customers manage their accounts.
- Banks often use sweep accounts to help customers earn interest on their idle cash.
Understanding a Credit Sweep
A credit sweep is a cash management tool that is especially beneficial to large corporations that have multiple accounts and great variability in payments from day-to-day. If the balance in a deposit account is above a target balance, a credit sweep account can be set up to automatically transfer the excess funds in the account to pay down the outstanding amount on a loan.
Most credit sweeps also have the opposite arrangement, whereby if the funds in the account are less than the target balance, there will be a drawdown on the line of credit to reach the target. The "sweep" part of a credit sweep is financial jargon; as in, the bank "swept" the remaining balance in one account to another.
Example of a Credit Sweep
Company ABC has a line of credit with Bank XYZ in the amount of $1 million. Currently, ABC is borrowing $300,000 of the $ 1 million, which needs to be repaid. ABC also has a cash deposit account with Bank XYZ that is used to make regular business payments or used for any other business purposes. Company ABC sets up a target balance that stipulates that any amount in the deposit account that is over $285,000 on any given day, can be used to pay down the outstanding $300,00 loan. During one week, on a Friday, the amount in the deposit account is $295,000, so Bank XYZ uses the additional $10,000 above the target balance to pay down $10,000 of the $300,000 borrowed amount.
Sweep Accounts in Banks
On a more technical level, banks use sweep accounts as a legal workaround on the prohibition of paying interest on business checking. By "sweeping" funds overnight to an investment vehicle of some sort, idle cash can be more effective in generating marginally more return. Sweep investment vehicles are often tied to the money market, or more specifically, "Eurodollar Sweeps" and "Repo Sweeps."
There are many forms of sweep arrangements. Commercial banks can afford more sophisticated arrangements, so they enjoy more aggressive strategies, which usually offer a higher rate of return. Smaller entities might use a sweep account simply out of convenience. As such, various levels of service are common when setting up a sweep arrangement.
