A compensating balance increases the actual interest rate.

Question

Quizplus · Accepted Answer

A compensating balance is a minimum balance that a borrower must maintain in a bank account in order to take out a loan. Because the borrower cannot use that money during the term of the loan, the effective interest rate on the loan is increased to compensate for the opportunity cost of not being able to use those funds. Thus, a compensating balance increases the actual interest rate.

A Compensating Balance Increases the Actual Interest Rate