The effective cost to the borrower of an unsecured bank loan is increased if a compensating balance is required.

Question

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A compensating balance is an amount of funds that the borrower must keep on deposit with the lending bank as a condition of the loan. This reduces the amount of funds that are available to the borrower and increases the effective cost of the loan because the borrower is essentially paying interest on funds that they cannot use.

The Effective Cost to the Borrower of an Unsecured Bank