definitions Compensating balance

Compensating balance

Demand deposits maintained by a firm to compensate a bank for services provided, credit lines, or loans. As a basis for welfare comparisons, the idea that if a policy change (such as a tariff reduction) could be Pareto improving if it were accompanied by appropriate lump-sum transfers that tax winners in order to compensate losers, then it is viewed as beneficial even when those transfers do not occur. The fraction (usually 10% to 20%) of an outstanding loan balance that a bank requires borrowers to hold on deposit in a non-interest-bearing account.