Compensating Balance for Dummies
noun
What does Compensating Balance really mean?
"Compensating Balance" is a term used in finance and banking that refers to a requirement by a bank for a borrower to maintain a minimum balance in their account as a condition to receiving a loan or credit. In simpler terms, it's like a security deposit that the bank asks you to set aside and not use, while they lend you money or extend credit to you. Let me help you understand it better by using an analogy.
Imagine you have a piggy bank, and you want to borrow some money from a friend. Now, your friend might be worried that you won't be able to pay them back, right? So, to feel more secure about lending you the money, your friend asks you to keep a certain amount of your own money locked away in your own piggy bank. That way, if you aren't able to pay them back, they can take that money from your piggy bank to cover their loss. That locked-away money is like the compensating balance your friend is requesting.
Now, let's relate this analogy back to banking. When you want to borrow money or get a loan from a bank, they also want to feel secure that you will be able to pay it back. So, they ask you to keep a certain amount of your own money in your bank account as a compensating balance. This money stays in your account as long as you have the loan or credit, and it assures the bank that if for some reason you can't pay them back, they can use that money to cover what you owe them.
But, you might be thinking, why would anyone want to keep their own money locked away in a bank account instead of using it for other things? That's a great question! There are a few reasons why people agree to keep a compensating balance. For some, it could be a requirement of the loan agreement with the bank. For others, it might be part of a special agreement that offers them lower interest rates or other benefits in return for keeping that minimum balance.
In summary, "compensating balance" is like a security deposit that a bank requires from a borrower. It's a certain amount of the borrower's own money that needs to be kept in their bank account as a condition for receiving a loan or credit. Just like you keep money locked away in a piggy bank to assure your friend that you can pay them back, the compensating balance assures the bank that you can pay them back if needed.
Revised and Fact checked by James Brown on 2023-10-28 05:42:25
Compensating Balance In a sentece
Learn how to use Compensating Balance inside a sentece
- When you borrow money from the bank and they require you to keep a certain amount of money in your account to pay back the loan, that amount is called a compensating balance.
- If you want to rent an apartment and the landlord asks you to keep a specific amount of money in your bank account as a guarantee, that amount is known as a compensating balance.
- In some business agreements, a company might ask its customers to maintain a certain amount of money in their account as a security deposit, and that amount is referred to as a compensating balance.
- If you are going on a vacation and the hotel requires you to keep a certain amount in your account before confirming the booking, that amount acts as a compensating balance.
- When you want to buy something expensive using a credit card and the store requires you to have a specific amount available in your account before they approve the purchase, that amount is called a compensating balance.
Compensating Balance Synonyms
Words that can be interchanged for the original word in the same context.
Compensating Balance Hypernyms
Words that are more generic than the original word.