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.

Compensating balance reported:

Step 1

Review the loan application to find the principal amount of your loan, the stated interest rate of the loan, and the amount’of the necessary compensating balance.

Step 2

Multiply the loan principal by the statedinterest rate to calculate the nominal interest ‘clue on the loan. A \$100,000 loan with a 5 percent interest rate would have nominal interest of \$5,000.

Step 3

Record the compensatory balance required from your loan. The bank will record the necessary compensatory balance on your loan application.

Step 4

Subtract the compensatory balance from the total principal to calculate the available balance. If your total loan is for \$100,000 and the compensatory balance is \$5000 your available balance is \$95,000.

Step 5

Divide the nominal interest due by the available principal to calculate the effective interest rate of your compensatory balance installment loan.