What are compensating balances and why do banks require them from some customers? Under what circumstances would banks be most likely to impose compensating balances?
Compensating balances are funds which a bank needs a customer to keep in a non-interest bearing account till the loan is retired. Banks occasionally impose compensating balance needs so as to increase the bank’s return on a loan. Compensating balances are most similarly to be employed when the stated interest rate on a loan is below the bank’s required rate of return.