The Demand for Compensating Balances

Over the past two decades, studies of compensating balances have taken two principal forms: surveys of contemporary compensating balance practices, and attempts to ascertain a theoretical basis for these practices. Surveys by Baxter and Shapiro [2], Burns [3], Cagle [4], and others have concentrated upon bank behavior, but have nevertheless uncovered four principal motives why firms hold compensating balances. These balances: (1) provide the firm with liquidity services, and can be used to compensate the bank for (2) furnishing credit, (3) offering a loan-rate concession, and (4) performing a variety of technical services.1 The parallel theoretical literature on compensating balances has been mainly concerned with two (related) issues: whether compensating balance requirements are rational,2 and the role of competition in explaining these requirements.3 Although many of these studies have paid lip service to all four motives, only the loan rate concession had been made an ex