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Finance & Accounting
Pages 3 (753 words)
Surname: Instructor: Course: Date: Credit Rationing Compensating balance is the minimum balance that must be held by an account and qualify an investor whether an individual or a company for the qualifications of a loan. For example, if an investor borrows $100,000 and the bank requires a deposit of $10,000 then that is a compensating balance loan.
In cases whereby the compensating balance falls below the minimum required, the interest rate application on the loan will rise accordingly to compensate. A requirement for borrowers by the bank to deposit money is vital to offset part of the loan cost and qualifies it to issue credit to other borrowers and seek alternative investment projects. The individual will only see a low applicable rate of interest on the issued loan. A compensating balance is an account for holding funds and does not generate any interest, and the banks are free to use the money in other investment opportunities. Compensating balance is also known as offsetting balance since its purpose is to offset expenses associated with servicing and the issuing of loans (Mohr 22). The compensating balance thus helps to reduce the cost of provision for loans by the bank, and this generates benefits for both the bank and the borrower from the agreement. In addition to credit, an approach of compensating balances is used to obtain a credit line. The person or corporation taking the credit line just like the loans must agree to maintain a minimum account balance for the loan period. The individual or corporation must have an account already existing with the bank. ...
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