Compensating Balance

DEFINITION of 'Compensating Balance'

A minimum balance that must be maintained in an account. The compensating balance is often used to offset a portion of the cost that a bank faces when extending a loan or credit to an individual or business, and is usually calculated as a percentage of the loan outstanding. The account where the funds are held are typically non-interest bearing, and the bank is free to use the money in other investment opportunities.

BREAKING DOWN 'Compensating Balance'

By requiring money to be deposited to offset some of a loan's cost the bank is able to extend other loans and pursue other investment opportunities, while the individual or business will generally see a lower interest rate. If the deposit falls below a certain level the interest rate on the loan may adjust upward to compensate.

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