What is a Compensating Balance?
Compensating balances are minimum balances that may be maintained in an account and still meet the requirements for a loan. Bankers often offer this as a means of obtaining a more favorable interest rate on loans extended to existing bank customers. In the event that the compensating balance drops below the minimum required, the interest rate applied to the loan will rise accordingly. Sometimes referred to as an offsetting balance, the purpose of the compensating balance is to offset the expenses associated with extending and servicing the loan. By allowing the funds to remain in the non-interest bearing account for the duration of the loan, the bank is free to make use of those funds as part of their investment strategies. In this manner, the cost for providing loans is reduced, and both the bank and the borrower benefit from the transaction. In addition to loans, a compensating balance approach may be used to secure a line of credit. Just as with a loan, the individual or business en
