Define: Compensating Balances

A compensating balance refers to the minimum amount of funds that a borrower must maintain in a bank account as a condition for obtaining a loan or credit facility.

Yes, compensating balances are legal and commonly used in commercial lending agreements.

Yes, a lender can require a compensating balance as a condition for providing a loan or credit facility. It is typically included in the loan agreement or credit facility terms.

The required compensating balance is usually a percentage of the loan amount or credit facility limit. The specific percentage is negotiated between the lender and borrower.

In most cases, the borrower cannot use the compensating balance funds for their own purposes. The funds are held as collateral by the lender to mitigate the risk of default.

If a borrower fails to maintain the required compensating balance, they may be considered in default of the loan agreement or credit facility terms. This could result in penalties, increased interest rates, or even the lender calling the loan due.

Yes, there are alternatives to compensating balances, such as providing additional collateral or obtaining a standby letter of credit. These alternatives may be negotiated with the lender based on the borrower’s specific circumstances.

Compensating balances are typically not refundable unless explicitly stated in the loan agreement or credit facility terms. The funds are held as collateral and released once the loan is repaid or the credit facility is terminated.

A borrower cannot unilaterally terminate a compensating balance requirement. However, if the loan agreement or credit facility terms allow for it, the borrower may be able to negotiate a reduction or elimination of the compensating balance requirement with the lender.