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:
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.
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.
Record the compensatory balance required from your loan. The bank will record the necessary compensatory balance on your loan application.
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.
Divide the nominal interest due by the available principal to calculate the effective interest rate of your compensatory balance installment loan.