Assume a clothing store needs a 100,000 line of credit (LOC) to manage its operating cash flow each month. The store plans to use the LOC to make inventory purchases at the beginning of the month, and then pay down the balance as the store generates sales. The bank agrees to charge a lower interest rate on the LOC if the clothing store deposits a $30,000 compensating balance. The bank loans the clothing store’s compensating balance to other borrowers, and profits on the difference between the interest earned and the lower rate of interest paid to the clothing store.
Why can't the bank provide only 70,000 loan to the clothing company at an adjusted equivalent interest rate?
I can't see the value of compensating balance.