What Is the Loan-to-Deposit Ratio (LDR)?
The loan-to-deposit ratio (LDR) is used to assessa bank’s liquidity by comparinga bank’s total loans to its total deposits for the same period. The LDR is expressed as a percentage. If the ratio is too high, it means that the bank may not have enough liquidity to cover any unforeseen fund requirements. Conversely, if the ratio is too low, the bank may not be earning as much as it could be.
Key Takeaways
- The loan-to-deposit ratio is used to assessa bank’s liquidity by comparinga bank’s total loans to its total deposits for the same period.
- To calculate the loan-to-deposit ratio, divide a bank’s total amount of loans by the total amount of deposits for the same period.
- Typically, the ideal loan-to-deposit ratio is80%to 90%. A loan-to-deposit ratio of 100% means a bank loaned one dollar to customers for every dollar received in deposits it received.
Formula and Calculation of the LDR
LDR=TotalDepositsTotalLoans
To calculate the loan-to-deposit ratio, divide a bank’s total amount of loans by the total amount of deposits for the same period. You can find the figures on a bank’s balance sheet. Loans are listed as assets while deposits are listed as liabilities.
What the LDR Can Tell You
A loan-to-deposit ratio shows a bank’s ability to cover loan losses and withdrawals by its customers. Investors monitor the LDR of banks to make sure there’s adequate liquidity to cover loans in the event of an economic downturn resulting in loan defaults.
Also, the LDR helps to show how well a bank is attracting and retaining customers. If a bank’s deposits are increasing, new money and new clients are being on-boarded. As a result, the bank will likely have more money to lend, which should increase earnings. Although it’s counterintuitive, loans are an asset for a bank since banks earn interest income from lending. Deposits, on the other hand, are liabilities because banks must pay an interest rate on those deposits, albeit at a low rate.
The LDR can help investors determine if a bank is managed properly. If the bank isn’t increasing its deposits or its deposits are shrinking, the bank will have less money to lend. In some cases, banks will borrow money to satisfy their loan demand in an attempt to boost interest income. However, if a bank is using debt to finance its lending operations instead of deposits, the bank will have debt servicing costs since it will need to pay interest on the debt.
In times of financial crisis, a low LDR will benefit a bank as it will have more liquidity to meet its obligations.
As a result, a bank that borrows money to lend to its customers will typically have lower profit margins and more debt. A bank would rather use deposits to lend since the interest rates paid to depositors are far lower than the rates it would be charged for borrowing money. The LDR helps investors spot the banks that have enough deposits on hand to lend and won’t need to resort to increasing their debt.
The proper LDR is a delicate balance for banks. If banks lend too much of their deposits, they might overextend themselves, particularly in an economic downturn. However, if banks lend too few of their deposits, they might have opportunity cost since their deposits would be sitting on their balance sheets earning no revenue. Banks with low LTD ratios might have lower interest income resulting in lower earnings.
Multiple factors can drive changes in the loan-to-deposit ratios. Economic conditions can impact loan demand as well as how much investors deposit. If consumers are unemployed, they’re unlikely to increase their deposits. The Federal Reserve regulates monetary policy by raising and lowering interest rates. If rates are low, loan demand might increase depending on the economic conditions. In short, there are many outside factors that impact a bank’s LDR.
What Is an Ideal LDR?
Typically, the ideal loan-to-deposit ratio is80%to 90%. A loan-to-deposit ratio of 100% means a bank loaned one dollar to customers for every dollar received in deposits it received. It also means a bank will not have significant reserves available for expected or unexpected contingencies.
Regulations also factor into how banks are managed and ultimately their loan-to-deposit ratios. The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporationdo not set minimum or maximum loan-to-deposit ratios for banks. However, these agencies monitor banks to see if their ratios are compliant with section 109 of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Interstate Act).
Example of How to Use the LDR
If a bank has $500 million in deposits and $400 million in loans, the bank’s LDR ratio would be calculated by dividing the total loans by its total deposits.
LDR=$500million$400million=.8=80%
The Difference Between the LDR and the LTV Ratio
The Loan-to-value (LTV) ratio is anassessment of lending riskthat financial institutions and other lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are higher risk and, therefore, if the mortgage is approved, the loan costs the borrower more.
The LTV ratio measures the value of the property versus the amount of the loan while the LDR measures a bank’s ability to cover its loans with its deposits.
Limitations of Using the LDR
The LDR helps investors assess the health of a bank’s balance sheet, but there are limitations to the ratio. The LDR does not measure the quality of the loans that a bank has issued. The LDR also does not reflect the number of loans that are in default or might be delinquent in their payments.
As with all financial ratios, the LDR is most effective when compared to banks of the same size and similar makeup. Also, it’s important for investors to compare multiple financial metrics when comparing banks and making investment decisions.
Is the Loan-to-Deposit Ratio a Liquidity Ratio?
Yes, the loan-to-deposit ratio (LDR) is a type of liquidity ratio. It assesses a bank’s total loans in relation to its total deposits. The ratio indicates the ability of the bank to meet its obligations (payments to depositors). A liquid bank would not have issues in meeting its obligations.
What Are the Benefits of a High Loan-to-Deposit Ratio?
A high loan-to-deposit ratio (LDR) indicates that a bank has made a large amount of loans when compared to its deposits. This is a sign of increased risk and reduced liquidity. The benefit, however, is that the more loans made, the more interest the bank earns, which increases revenues.
What Is a Risky Loan-to-Deposit Ratio?
Market practices would indicate that a loan-to-deposit ratio (LDR) that is above 80% is risky. This signals that a bank has low liquidity and could have difficulty paying its depositors their funds.
The Bottom Line
The loan-to-deposit ratio (LDR) helps assess a bank’s liquidity by comparing its total loans to its total deposits. This provides insight into how much risk a bank has taken on and if it would be able to meet its liquidity requirements (pay depositors) in a market crunch. Too high of an LDR indicates a bank may have difficulty meeting its obligations while too low of an LDR would indicate a bank is not using its deposits efficiently.
