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.

Example of Concentration Banking

Walmart operates thousands of stores across the U.S. and internationally. Each store collects cash and electronic payments from customers daily. Managing these funds efficiently is crucial for maintaining liquidity and optimizing cash flow. Walmart has set up a concentration banking system that operates in the following manner:

Local collection accounts. Each Walmart store deposits daily sales into a local bank account in its region. These local accounts reduce delays in processing deposits and allow Walmart to collect payments faster.
Funds transferred to a central (concentration) account. At the end of each business day or at scheduled intervals, the funds from multiple local collection accounts are electronically transferred to Walmart’s central concentration account (typically held at a major national bank like JPMorgan Chase or Bank of America).
Centralized cash management. Walmart’s treasury team monitors and manages the central account for investment, debt payments, supplier payments, or operational expenses. This system ensures that excess funds from various locations are efficiently utilized instead of sitting idle in multiple accounts.

This system improves Walmart’s cash flow management by consolidated quickly, making them available for corporate use. In addition, there are fewer accounts to manage, which reduces administrative and banking fees.

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.