Which of the following statements is best describes compensating balances?
A) Compensating balance requirements apply only to businesses, not to individuals.
B) Compensating balances are essentially costless to most firms, because those firms would normally have such funds on hand to meet transactions needs anyway.
C) If the required compensating balance is larger than the transactions balance the firm would ordinarily hold, then the effective cost of any loan requiring such a balance is increased.
D) Banks are prohibited from earning interest on the compensating balances they hold.

Question

Quizplus · Accepted Answer

Compensating balances are funds that a borrower is required to keep on deposit at a bank to offset some of the credit risk of the borrowing relationship. If the required compensating balance is larger than the transactions balance the firm would ordinarily hold, then the effective cost of any loan requiring such a balance is increased.

Which of the Following Statements Is Best Describes Compensating Balances