What is a sweep account?
Commercial banks commonly offer sweep accounts as an efficient means of managing cash. A business sweep account is a bank or brokerage account that automatically transfer (aka "sweeps") funds in excess of a balance threshold in a business checking account to a higher-yielding investment option at the close of each business day. This higher-yielding investment option is often a money market fund, which yields higher interest rates than a standard bank account. If the balance in the checking account falls below the minimum threshold, funds are automatically transferred from the sweep account back to the checking account to ensure that the minimum balance is maintained.
What are the benefits of a sweep account?
• Earn a return on idle cash. The primary advantage of maintaining a sweep account is the ability to earn a return on excess cash instead of letting it sit idle while also ensuring there’s enough cash on hand to pay for operating expenses.
• Minimal work needed to maintain. The automation provided by sweep accounts makes the process simple. Rather than manually transferring funds between accounts at the end of each day, owners can set a minimum limit and let the sweep account automatically handle the rest. This enables companies to receive returns on short-term investments that would otherwise be too time-consuming to manage.
• Sweep money invested in money-market mutual funds may not be subject to FDIC receivership. Many questions arose during the Silicon Valley Bank (SVB) collapse about the excess cash that was swept into money market mutual funds. According to Wilson Sonsini and Cooley, two major international law firms, if these money market mutual funds are held at third-party financial institutions (e.g., Western Asset, Morgan Stanley, and BlackRock), they should not be subject to the receivership. These funds do not sit on SVB’s balance sheet. However, it may take time before it’s possible to access these funds during the current FDIC receivership.
Different types of sweep accounts offer additional benefits
• Traditional business sweep: The most common sweep account transfers funds between the operating account and a higher-yield account, such as a money market account. Although these accounts offer a higher interest rate yield, they do not guarantee protection of the investment beyond the $250,000 FDIC insurance limit in the event of the financial institution’s failure.
• Insured cash sweep (ICS): An ICS account is a service that provides FDIC insurance on large business balances while still maintaining access to funds. The FDIC currently insures deposits up to $250,000 (including principal and interest) per depositor, per insured bank. If a business has more than $250,000 in deposits at a single bank, any amount above that limit is not insured by the FDIC. An ICS automatically moves excess funds above that $250,000 FDIC insurance threshold to money market deposit accounts at other FDIC-insured financial institutions without the hassle of opening and managing separate bank accounts.
For example, if a business has $500,000 in deposits at Bank A, only $250,000 of those funds are FDIC insured. By setting up a sweep account that sweeps funds into an account at Bank B, the business could potentially be eligible for a cumulative $500,000 of FDIC insurance coverage ($250,000 at Bank A and $250,000 at Bank B). When funds are needed in the main business account, funds are swept back from the multiple money market deposit accounts within the ICS network.
• Loan or credit line sweep: This type of sweep account uses idle or excess funds in a deposit account to pay down short-term debt under a commercial line of credit. This account helps reduce the cost of a line of credit. The financial institution offering this may also provide the reverse service, where cash is moved from the line of credit into the deposit account if the balance in the account falls below the threshold level.
• Payroll sweep: A payroll sweep account helps businesses manage payroll funds more efficiently. This account automates the transfer of payroll funds from the operating account to the payroll, eliminating time constraints and potential errors from manually moving payroll funds.
Considerations and disadvantages of using a sweep account
It is important to keep track of the expenses associated with sweep accounts, as the advantages of earning higher returns through investment vehicles outside of the checking account may be outweighed by sweep account fees. Some brokerages or banks impose flat fees, while others charge a percentage of the yield.
Understanding the cash flow needed to run your business’s day-to-day operations is important. If cash holdings are small, maintaining a sweep account may not be cost-effective. If there are minimal excess funds, there may not be much of a benefit from the interest earned from a sweep account.