Question

What advantages do compensating balances have for banks? Are the advantages to banks necessarily disadvantages to corporate borrowers?

Short answer

The compensating balance helps in generating higher returns for the bank and it is not disadvantageous to the corporate borrowers.

Step-by-step solution

Advantage of compensating balance to banks

The compensating balance is advantageous to the banks as it allows the banker to generate a higher return on the loan since all the funds are not made available to the borrower.

The impact of the bank’s advantage on the corporate borrowers

The advantage of the bank may not turn out to be a disadvantage for the corporate borrowers as the borrower will have to pay a lower quoted interest rate which will reduce their financial obligations.