What is a Compensating Balance?

The compensating balance is that the loan issuing bank requires the borrowing company to deposit the loan amount into the loan issuing bank based on the total loan amount or a certain percentage of the actual borrowing amount (generally 10% to 20%). The compensatory balance helps the bank reduce the risk of the loan and compensate for the risks it may suffer. For the borrowing company, the compensatory balance increases the actual interest rate of the borrowing, the interest paid by the enterprise remains unchanged, and the total actual loan received decreases Increased the financial burden of the enterprise.

Compensatory balance

Compensatory balance loan

The company borrowed 10 million yuan from a compensating balance

An enterprise borrows 2 million yuan from a bank at an annual interest rate of 4.5%, and the bank requires a 10% compensation balance to be retained. What is the actual interest rate of the loan?

Real interest rate = 4.5% ÷ (1-10%) = 5%

Since the long-term borrowing interest obtained by a company from a bank can be deducted before taxation, it helps the company reduce the tax burden. Therefore, the actual interest rate (also called the actual cost rate) of the long-term borrowing = nominal interest rate * Income tax rate) / (1-Compensating balance ratio), so that is more reasonable.

As in the example above, the actual interest rate = 4.5% × (1-25%) ÷ (1-10%) × 100% = 3.75%