What is Concentration Banking?

Concentration banking is the practice of shifting the funds in a set of bank accounts into an investment account, from which the funds can be more efficiently invested. Concentration banking usually requires that an organization keep all of its bank accounts with a single bank. By doing so, the bank can shift the funds in individual accounts into an investment account with a simple memo entry. When cash is being concentrated from accounts managed by other banks, the concentration process is both more involved and more expensive.

When to Use Concentration Banking

Concentration banking is needed when a business has a number of subsidiaries or locations, each with its own accounts. When cash is widely distributed in this manner, local managers are more likely to make non-optimal cash investment decisions (such as leaving cash uninvested), resulting in a low or nonexistent return on investments. By using concentration banking, an organization can hire an investment manager who is responsible for investing all of the funds that have been shifted into a centralized location. Further, the investment manager can forecast the company’s total cash needs and use this forecast as the basis for shifting some of the excess funds into longer-term investments, which generate a higher rate of return.

Advantages of Concentration Banking

There are several key advantages to using concentration banking, which are as follows:

Better oversight. Concentration banking brings the bulk of an organization’s cash under central management, where it can be more precisely managed by a finance professional.
Better cash availability. By keeping cash in one location, it is easier to apportion it as needed within the organization.
Less idle cash. By shifting cash into a central account, there is little idle cash left in outlying bank accounts that is not earning interest. The result is more investment income.
Tighter control. By centralizing cash, a business is less at risk of having large amounts of cash fraudulently removed from outlying bank accounts.

Problems with Concentration Banking

The use of concentration banking can present legal problems, since the funds are being taken away from subsidiaries that are legal entities, and whose financial positions may suffer as a result of the cash withdrawal. To remedy this problem, the cash transfers are recorded as loans from the subsidiaries to the corporate parent. By doing so, the parent now has an obligation to eventually return the funds to each subsidiary, along with the interest payable on each loan.