What are compensating balances of a US corporate bank account and how may they affect that...

What are compensating balances of a US corporate bank account and how may they affect that corporation’s working capital?

Expert Solution

Compensating balances are the amount of minimum balance that must be maintained with the bank account in order to offset the cost of loan incurred by the bank.It means corporate has to maintain always a certain amount or certain percentage of it's loan as compensating balance . Compensating balance is used by bank to invest it in other Investment opportunities or lending it to other needy borrower and bank charges Interest on the whole amount of loan but at reduced rate which increases the overall cost of capital of the company.

It affects the borrower working capital as the balance they maintain with bank can't be used for any purpose untill the amount of loan is fully repaid and it also increases the cost of capital of the company because of payment bof Interest on the whole amount.On the other hand bank are left with the amount of cash maintained as compensating balance which can be used by them for various other purposes.

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