A lender may require a compensating balance, which means that the amount of funds is reduced, causing the rate of interest to increase, since the same amount of interest is paid and fewer funds are available.

Question

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A compensating balance is a minimum balance that must be maintained in a bank account, and because this balance cannot be used by the borrower, the effective amount of funds available for use is reduced. This effectively increases the interest rate since the interest cost remains the same but is spread over a smaller amount of usable funds.

A Lender May Require a Compensating Balance, Which Means That