Question

Explain why firms would want to maintain a bank balance exceeding the compensating balance requirements.

Answer 1

It is not just preferable but also necessary to maintain a bank balance which exceeds the compensating balance. The compensating balance is the balance maintained in the bank account which is required by the bank and is not available for use. However a business has many immediate applications that are required to be met and for this the business needs to have liquid cash at hand. Hence necessary to keep sufficient bank balance so that the business does not default on its current liabilities which will be detrimental to the Goodwill of the business.