A bank sweep repurchase agreement – What is it?
A bank sweep repurchase agreement is a financial arrangement where a bank uses the cash balance in a customer`s account to purchase securities. The securities are held as collateral for a short-term loan, and the interest earned on the securities goes to the bank.
This arrangement allows the bank to earn interest on funds that would otherwise sit idle in a customer`s account. It also provides the customer with a convenient way to invest their money without having to actively manage their investments.
How it works
When a customer opens a bank sweep account, the bank automatically transfers any excess cash in the account to a money market fund. The money market fund then invests the cash in short-term securities, such as Treasury bills.
The bank then enters into a repurchase agreement with the money market fund. Under this agreement, the bank agrees to repurchase the securities at a predetermined price within a specified period. The money market fund earns interest on the securities and pays the customer a portion of the interest earned.
Benefits and risks
The main benefit of a bank sweep repurchase agreement is that it allows customers to earn interest on their cash balances without having to actively manage their investments. The arrangement also provides the bank with a low-cost source of funding.
However, there are also risks associated with bank sweep repurchase agreements. If the securities used as collateral for the loan decline in value, the bank may be required to provide additional collateral or sell the securities. This could result in losses for the bank and could lead to a decline in the value of the customer`s account.
Additionally, if the money market fund experiences financial difficulties, the customer`s account may be at risk. The Securities Investor Protection Corporation (SIPC) provides some protections for customers of money market funds, but these protections are limited.
A bank sweep repurchase agreement can be a convenient way for customers to earn interest on their cash balances without having to actively manage their investments. However, there are risks associated with this arrangement, and customers should carefully consider these risks before opening a bank sweep account. Customers should also ensure that the bank and money market fund they are dealing with are reputable and financially sound.