deposit that a bank can use to offset an unpaid loan. No interest is earned on the compensating balance, which is stated as a percentage of the loan. The compensating balance increases the effective interest rate the loan. The compensating balance is usually 10%. Assume a company borrows $50,000 from the bank at a 10% interest rate with a 5% compensating balance. The loan is on a discount basis meaning interest is deducted immediately. The compensating balance is calculated at $2500. The effective interest rate is:

checking account balance used to pay for bank services. The balance offsets bank expenses in servicing a loan or line of credit. Aloan contract, for example, may call for 10 and 5 compensating balances-10% of the credit line at commitment time and an additional 5% when the borrower draws against the credit.

average balance desired by a bank to be kept on deposit in exchange for holding credit available. The more or less standard requirement for a bank line of credit, for example, is 10% of the line plus an additional 10% of the borrowings. Compensating balances increase the effective rate of interest on borrowings.