Deposit that a bank can use to offset an unpaid loan. No interest is earned on the compensating balance, which is stated as a percentage of the loan. The compensating balance increases the Effective Interest Rate on the loan. The compensating balance is usually 10%. Assume a company borrows $50,000 from the bank at a 10% interest rate with a 5% compensating balance. The loan is on a discount basis meaning interest is deducted immediately. The compensating balance is calculated at $2500. The effective interest rate is:
