COMPENSATING BALANCE Meaning and
Definition
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A compensating balance refers to a specific requirement that financial institutions impose on borrowers. It refers to a minimum balance that a borrower must maintain in a bank account as a condition for receiving a loan. This minimum balance, usually expressed as a percentage of the loan amount, acts as a form of collateral or security for the lender.
The compensating balance serves as a kind of compensatory measure for the financial institution, offsetting potential risks associated with lending. By maintaining a minimum balance, the borrower assures the lender of their ability to meet their financial obligations. This requirement helps mitigate the lender's risk by providing a buffer against potential loan defaults.
Typically, a compensating balance is non-interest bearing, which means the borrower does not earn any interest on the amount kept in the account. The balance requirement might be either fixed or fluctuate over the term of the loan. It is crucial for borrowers to carefully evaluate the terms and conditions of the loan, including the compensating balance requirement, before entering into an agreement.
While compensating balances provide a measure of security for the lender, they can pose a challenge for borrowers, as the funds required to maintain the balance are essentially tied up and unavailable for other purposes. Therefore, it is essential for borrowers to assess the impact of the compensating balance requirement on their liquidity and overall financial position before committing to a loan agreement.
Common Misspellings for COMPENSATING BALANCE
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Similar spelling words for COMPENSATING BALANCE
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