What are compensating balances and why do banks require them from some customers?

agree with SOHAIL ABBAS ( MBA (BANKING&FINANCE), ICMAP(FOUNDATION)  

Compensating Balance

Sometimes called an offsetting balanceit is a minimum balance that must be maintained in an account(  checking account). The compensating balance is often used to offset a portion of the cost that a bank faces when extending a loan or credit to an individual or business, . Compensating balance is usually calculated as10% of the amount of the loan.The account where the funds are held are typically non-interest bearing, and the bank is free to use the money in other investment opportunities. If the borrower fails to repay the loan, the bank can take the money from the checking account

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Thanks divyesh  A compensating balance results in the borrower's paying an effective interest rate higher than the stated rate on the debt. For example, suppose that a company borrows $10,000,000 from a bank at an interest rate of12%. If the bank requires a compensating balance of $2,000,000 to be held in a noninterest-bearing checking account, the company really is borrowing only $8,000,000 (the loan less the compensating balance). This means an effective interest rate of15% ($1,200,000 interest divided by $8,000,000 cash available for use).

Minimum balance that must be maintained in an account is called compensating balance. It is often used to offset a portion of cost that bank faces when extending credit , loan etc to person or business.

A deposit balance required as compensation for services provide by a lender or correspondent bank.

A minimum balance that must be maintained in an account. The compensating balance is often used to offset a portion of the cost that a bank faces when extending a loan or credit to an individual or business, and is usually calculated as a percentage of the loan outstanding. The account where the funds are held are typically non-interest bearing, and the bank is free to use the money in other investment opportunities.

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 the loan. The compensating balance is usually10%.

Banks resort to in order to modify the balance in banks

This is an extra facility which banks provides to their Corporate customers to make avail of benefit from their large deposits to earn interest. The bank charges a nominal fees to set up an Auto set off between their current and call or short term deposit accounts.