Lock Box system and Concentration Banking, Compensating Balances
Lock Box System
The Lockbox Banking is the service offered by the commercial banks to the companies wherein, the payment made by the customers is directed to the special post office box rather than to the company.
Under the lockbox banking system, the company opens up a lockbox account with a bank, which is generally at the central location, easily accessible to the bank. The box is emptied several times in a day, and as the money receipts are collected, the bank deposits the same into the company’s account and inform about it to the company via electronic data transmission.
Through lockbox banking, the company’s burden of accepting mails and the payments from the customers has reduced drastically. And with time to time updations from the bank, a company can put money in the work as soon as it is received.
But however, there is a fear that the bank employees who have access to the lockbox can commit a fraud. The fraud can be in the form of check counterfeiting as the checks in the lockbox contains all the information sufficient to make a check counterfeit. To overcome this limitation, the company must choose a bank which they trust and should keep a regular check on the lockboxes.
The Concentration Banking is the arrangement used by the firms, wherein the funds from all the regional banks in different locations gets concentrated or collected into the single bank account.
In other words, a firm has its operations in several parts of the country and in order to ease the complexity of handling multiple bank accounts at different locations, the firm may opt for a concentration banking service, whereby all the funds from different regional banks gets forwarded to a single bank account called as a concentration account.
Although the organizations can have many accounts in different banks, but they usually have a single account in which major transactions take place, such account is called the concentration account and the bank in which the account is held is called the concentration bank.
How does the Concentration Banking operate?
- First of all, the places are identified where company’s major customers are placed and then the local bank accounts are opened at each location.
- Once the accounts are opened, the local collection center (agents) or the bank branch is identified where all the cheques are collected from the customers at the respective locations.
- The remittances from the customers can be collected either in person or through the post. Once the cheques are collected are deposited in the local banks for the clearance.
- On the realization of cheques, the funds are transferred to the head office bank account (concentration account) through any telegraphic/electronic transfer schemes.
The concentration banking helps the organizations in reducing the mailing float. Since the remittances from the customers are either collected in person or by local post, the mailing float has substantially reduced. Also, it has reduced the cheque processing float at company’s office, as the detailed list of all the remittances received is sent to the company’s head office as a credit advice.
Through concentration banking, the banking processing float has also been reduced considerably, as the cheques are cleared locally and the funds are readily made available. Thus, the time required for the clearance of the outstation cheques have reduced manifold.
A compensating balance is a minimum bank account balance that a borrower agrees to maintain with a lender. The purpose of this balance is to reduce the lending cost for the lender, since the lender can invest the cash located in the compensating bank account and keep some or all of the proceeds. The borrower may also benefit from being granted a somewhat lower interest rate. However, the borrower is also paying interest on a net loan balance that is smaller than the amount of the loan, so the effective interest rate for the entire arrangement is higher.
For example, a corporation has a Rs. 5 million line of credit with a bank. The borrowing agreement states that the corporation will maintain a compensating balance in an account at the bank of at least Rs. 250,000. When the two sides of the arrangement are netted, the loan is actually Rs. 4,750,000.