With a compensating balance
program, the insured frees up cash and receives current tax deductibility for this amount because "economic performance" has been satisfied by the payment of premium to the insurance company.
Because banks cannot attract demand deposits through the payment of explicit interest, they often try to attract these deposits, aside from compensating balances
, through the provision of services at little or no cost.
Banks can optimize the value of these deposits, whereas mortgage bankers typically use them as compensating balances
that reduce their cost of financing.
A corn producer that thinks she will produce 15,000 bushels of corn but only sells one corn futures contract as a hedge is severely under-hedged by 10,000 bushels and will not have compensating balances
The second and third illustrative letters (not reproduced here) may be used to confirm compensating balances
and lines of credit, respectively.
Those funds are used as compensating balances
to reduce the rate of interest charged by the warehouse lender for the borrowed funds.
and a sweep account are not requirements, but could be a potential component of improved efficiencies to be considered.
Early in the year, demand deposits surged as lower rates required businesses to build up compensating balances
and as mortgage servicers held larger balances during the mortgage refinancing boom.
According to data from an annual survey by the Japan Fair Trade Commission, the reliance on these compensating balances
for loans to small businesses declined steadily throughout the 1980s, from 45 percent of surveyed loan contracts in 1980 to 26 percent in 1990.
Even on a fourth-quarter-average to fourth-quarter-average basis, demand deposits increased at a sluggish 3 1/2 percent rate, likely because corporations continued to shift away from compensating balances
, and toward fees, to pay for bank services.