In the previous article, we have already studied what Swingline loans are. We now know that such loans are different from revolving credit which is offered by many commercial banks. Over the years, Swingline loans have come to occupy a very important place in commercial banking. There are some people who believe Swingline loans are a great innovation whereas there are others who believe that Swingline loans can have negative effects on the health of a business.
In this article, we will try to have a closer look at both the pros and the cons of Swingline loans. This will help the reader make a more informed decision about Swingline loans.
Advantages of Swingline Loans
Swingline loans are popular amongst corporate borrowers since they provide several advantages. Some of the advantages are as follows:
- Faster Access to Cash: The biggest advantage of Swingline loans is the fact that these loans can be accessed within a few hours or even minutes. Swingline loans are like revolving credit. This means that the commercial bank assigns a limit to the corporate borrower based on their credit rating. Hence, when the corporation needs the money, they do not have to go through a lengthy application process. Instead, the loan can be disbursed at very short notice. Many corporations believe that Swingline loans are the corporate equivalent of the overnight funds market to which banks have access.
- Better Cash Flow Management: In the absence of Swingline loans, corporations always have to maintain a buffer when it comes to managing their working capital requirement. This means that they always have to keep a certain percentage of extra funds on hand in order to meet contingencies. The fact that these funds have to be kept extra during the entire year adds tremendously to the cost.
Swingline loans give businesses the ability to access their funds whenever required. Hence, there is no need to maintain extra funds. This helps reduce the amount of working capital required and better manage the overall cash flow.
- Helps Earn Trade Discounts: Suppliers often provide high discounts to customers who are willing to pay cash upfront. These discounts are often higher than the cost of capital for many corporations. Hence, it makes sense for them to borrow money quickly and avail of these discounts. Vendors give such high discounts because sometimes their balance sheets are overleveraged and they do not have access to immediate cash. Corporations can use Swingline loans to lock in better prices while they arrange for the cash flow required to pay off the Swingline loan.
- Avoiding Fines and Penalties: Some statutory payments such as taxes need to be strictly paid before the due date. This is also true for some other payments like electricity and water bills. However, due to the uncertain nature of business, it sometimes becomes difficult to make such payments. This is where Swingline loans are used to overcome the problems posed by an erratic cash flow schedule.
Disadvantages of Swingline Loans
Swingline loans have come under a lot of criticism because of the perceived negative effects that they have on businesses. Some of the negative impacts have been listed below:
- High-Interest Rates: The interest rates charged on Swingline loans is higher as compared to that on traditional bank loans. This is because of the fact that such loans are unsecured and can be risky for the bank to fund. However, many corporations believe that their cost of capital escalates rapidly if they use Swingline loans.
- Restrictive Covenants: Swingline loans come with strict restrictions about how the money can and cannot be used. This makes it an inconvenient source of financing for the business. Since corporations do not have complete freedom to use these borrowed funds as they wish, they consider this loan to be a suboptimal source of funding.
- Fees and Penalties: It is important to note that Swingline loans are meant to be of very short duration. Most Swingline loans are paid off within the same week as their origination. However, if for some reason, the company is not able to pay off the Swingline loan on time, they are likely to face a large number of fees and penalties. Commercial banks are not comfortable lending out money for the long term via Swingline loans. Hence, they levy high charges in order to discourage corporate customers from holding on to such loans for the long term.
- Part of Overall Credit: It is important to note that the Swingline loan is only a part of the overall credit that is offered by a bank to a corporation. This can be better understood with the help of an example. For instance, if the overall credit limit which a bank has to offer is $100, then the Swingline loan will be $20 which will be deducted from the $100 limit. Hence, if a customer decides to avail of their Swingline credit, they cannot obtain other credits. This is because banks decide to limit the overall exposure towards a particular firm. Hence, many firms believe that taking on expensive credit in the form of Swingline loans is a suboptimal use of the banks funding capabilities.
Hence, it can be said that Swingline loans have both pros and cons. Such loans may not be suitable for all types of businesses. However, they do provide a lot of benefits to certain businesses in certain specific scenarios.