What are compensating balances and why do banks require them?
A compensating balance is a balance that must be kept with a lender in order for a borrower to qualify for a line of credit or instalment loan. Effectively it acts as collateral and thus compensates the lender for the risk of making the loan.
What is an example of compensating balance?
Let’s take a look at a quick example. Your business is looking to take out a line of credit for the amount of $50,000. The bank instead offers you a line of credit for $60,000, which includes a $10,000 compensating balance.
How much is the compensating balance?
Compensating balance is the least or minimum balance that an organization or an individual needs to keep with the lender. The primary objective of such a balance is to reduce the lending cost of a borrower. For instance, a company takes a loan of $50,000 from a bank and agrees never to use $5,000.
What effect does a compensating balance requirement have on the effective interest rate on loan?
Compensating balances also decrease the proceeds of the loan. As proceeds decline, the effective interest rate rises. Example: You borrow $ 30,000 at 12%. The Bank requires that you maintain a 10% compensating balance.
What are compensating balances what is the relationship between the amount of compensating balance requirement and the return on the loan to the FI?
A compensating balance is the portion of a loan that a borrower must keep on deposit with the credit-granting FI. Thus, the funds are not available for use by the borrower. As the amount of compensating balance for a given loan size increases, the effective return on the loan increases for the lending institution. 9.
What is the minimum cash balance to be maintained by banks?
As per the extant instructions , the scheduled commercial banks (excluding RRBs) are required to maintain a minimum level of 65.0 per cent of CRR balances required to be maintained by banks on each of the day of the reporting fortnight beginning the first working day upto the 13th day and on the 14th day of the …
Which of the following correctly describes compensating balance?
Which of the following describe compensating balances? Compensating balances are a specified balance a borrower of a loan is asked to maintain in a low-interest or noninterest-bearing account at the bank.
What is a compensating balance arrangement?
Compensating balances are funds that a borrower is required to keep on deposit in a bank to satisfy the terms of the commercial real estate loan agreement. Depending upon the stipulated agreement, the deposit may be held in a checking account, savings account, or certificate of deposit.
Is compensating balance legally restricted?
Compensating balances For example, a company might agree to keep $500,000 in a bank account in exchange for that bank extending a $5 million line of credit. Compensating balances are considered restricted cash and must be reported on a company’s financial statement.
How does compensating balance work?
What is the relationship between the amount of compensating balance requirement and the return on the loan to the FI?
The compensating balance has the strongest effect on the gross return on the loan. Without the compensating balance, the gross return would equal 11.75 percent, a reduction of 1.22 percent.
What advantages do compensating balances have for banks are the advantages to banks necessarily disadvantages to corporate borrowers?
What advantages do compensating balances have for banks? The use of a compensating balance or minimum required account balance allows the banker to generate a higher return on a loan because not all funds are actually made available to the borrower.
Is compensating balance considered cash?
Compensating balances are considered restricted cash and must be reported on a company’s financial statement.
What is the minimum balance when it comes to account requirement?
A minimum balance requirement is the minimum amount of money that you have to keep in your bank account, usually in order to waive the account’s monthly fee. For example, if a bank account has a $100 minimum balance requirement, you want to make sure that you don’t let your balance fall to $99.99 or less.
Which of the following conditions must be met before a transfer of receivables can be recorded as a sale?
Which of the following conditions must be met before a transfer of receivables can be recorded as a sale? Transferor does not maintain control through repurchase agreement.
What if a compensating balance is not legally restricted?
Treatment of compensating balance 1. If the deposit is not legally restricted as to withdrawal by the borrower because of an informal compensating balance agreement, the compensating balance is part of cash.
What happens if my account balance falls below the minimum requirements?
If the account falls below the minimum balance it may be assessed fees, denied interest payments, or closed. The minimum balance is usually calculated as the actual dollar balance in the account but may be an average balance in the account over a certain period of time.
What is the lowest minimum balance required for a savings account?
Key Takeaways. A minimum account balance for a traditional savings account is the smallest amount of money you need in your account to avoid fees. Typical minimum account balance requirements for traditional savings accounts range from $300 to $500, although amounts vary and some banks have no minimum requirements.