Compensating Balance Law and Legal Definition

Banks, while giving a loan requires the borrower to maintain an account with the bank in exchange for loan services. A compensating balance is an amount of money which a borrower keeps in the account as offsetting balance for the loan. The amount in the account is used to offset an unpaid loan. A bank will usually ask for a minimum credit balance account as compensating balance. A compensating balance increases the effective interest rate to the bank as the net amount loaned is reduced and the interest paid remains unchanged.