Posted in Finance, Accounting and Economics Terms, Total Reads: 400
Definition: Twenty Percent Rule
When a bank provides loan or other services to the customers it may require the customer to keep a certain portion of the loan amount as a compensatory balance in the bank account. As a rule of thumb this amount is generally 20 percent of the loan amount. However this may vary from 15 to 25 percent of the loan outstanding.
As the bank makes money by lending it to the customer, thus the larger the deposit bank has the greater the bank’s income. The compensatory balance is generally kept in low or no interest paying accounts. This enables the bank to use the money in other profitable ventures. One other factor affecting compensatory balance is the interest rate.
If the compensatory balance deposited is less than the stipulated amount then the interest charged on the loan will trend upwards to offset the decline in compensatory balance. However there are instances when bank don’t ask for compensatory balance looking at the credit history of the customers and such other factors.