Compensating Balance

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A minimum balance that a borrower must maintain in a bank account as a condition of a loan agreement. This requirement effectively increases the true cost of borrowing since it reduces the usable portion of the loan and lowers the effective interest rate. For example, a $100,000 loan with a 10% compensating balance requirement provides only $90,000 in usable funds, making the effective interest rate higher than the stated rate.

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