Loan-to-Deposit Ratio (LDR)
What Is Loan-to-Deposit Ratio (LDR)?
The loan-to-deposit ratio (LDR) is utilized to survey a bank's liquidity by contrasting a bank's total loans with its total deposits for a similar period. The LDR is communicated as a percentage. Assuming the ratio is too high, it means that the bank might not have sufficient liquidity to cover any unexpected fund requirements. On the other hand, on the off chance that the ratio is too low, the bank may not be earning however much it very well may be.
Formula and Calculation for LDR
To work out the loan-to-deposit ratio, partition a bank's total amount of loans by the total amount of deposits for a similar period. You can find the figures on a bank's balance sheet. Loans are listed as assets while deposits are listed as liabilities.
What Does LDR 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 ensure there's adequate liquidity to cover loans in the event of an economic downturn bringing about loan defaults.
Likewise, the LDR assists with showing how well a bank is attracting and holding customers. On the off chance that a bank's deposits are expanding, new money and new clients are being on-boarded. Thus, the bank will probably have more money to loan, which ought to increase earnings. Despite the fact that it's illogical, loans are an asset for a bank since banks earn interest income from lending. Deposits, then again, are liabilities since banks must pay an interest rate on those deposits, but at a low rate.
The LDR can assist investors with deciding whether a bank is managed appropriately. On the off chance that the bank isn't expanding its deposits or its deposits are contracting, the bank will have less money to loan. Now and again, banks will borrow money to fulfill its loan demand trying to support interest income. Be that as it may, on the off chance that a bank is utilizing debt to finance its lending operations rather than deposits, the bank will have debt servicing costs since it should pay interest on the debt.
Thus, a bank that borrows money to loan to its customers will ordinarily have lower profit edges and more debt. A bank would prefer to utilize deposits to loan since the interest rates paid to depositors are far lower than the rates it would be charged for borrowing money. The LDR assists investors with spotting the banks that have an adequate number of deposits available to loan and won't have to resort to expanding their debt.
The legitimate LDR is a fragile balance for banks. Assuming banks loan too quite a bit of their deposits, they could overstretch themselves, especially in an economic downturn. In any case, assuming banks loan too not many of their deposits, they could have opportunity cost since their deposits would be perched on their balance sheets earning no revenue. Banks with low LTD ratios could have lower interest income bringing about lower earnings.
Different factors can drive changes in the loan-to-deposit ratios. Economic conditions can impact loan demand as well as how much investors deposit. In the event that consumers are jobless, they're probably not going to increase their deposits. The Federal Reserve bank directs monetary policy by raising and lowering interest rates. In the event that rates are low, loan demand could increase relying upon the economic conditions. In short, there are many outside factors that impact a bank's LDR.
What Is an Ideal LDR?
Normally, the best loan-to-deposit ratio is 80% to 90%. A loan-to-deposit ratio of 100% means a bank loaned one dollar to customers for each dollar received in deposits it received. It likewise means a bank won't have huge reserves accessible for expected or unexpected possibilities.
Regulations additionally factor into how banks are managed and eventually 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 Corporation don't set least or maximum loan-to-deposit ratios for banks. Nonetheless, these agencies monitor banks to check whether their ratios are consistent with section 109 of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Interstate Act).
Illustration of LDR
On the off chance that a bank has $500 million in deposits and $400 million in loans, the bank's LDR ratio would be calculated by separating the total loans by its total deposits.
LDR versus LTV Ratio
Loan-to-value (LTV) ratio is a assessment of lending risk that financial institutions and different lenders inspect before supporting a mortgage. Regularly, assessments with high LTV ratios are higher risk and, thusly, assuming 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 measure's a bank's ability to cover its loans with its deposits.
Limitations of the LDR
The LDR assists investors with evaluating the strength of a bank's balance sheet, yet there are limitations to the ratio. The LDR doesn't measure the quality of the loans that a bank has issued. The LDR additionally doesn't mirror the number of loans that are in default or may be delinquent in their payments.
Likewise with every financial ratio, the LDR is best when compared to banks of a similar size, and comparative cosmetics. Additionally, investors should compare numerous financial metrics while looking at banks and pursuing investment choices.
Real World Example of LDR
Starting around 12/31/2018, Bank of America Corporation (BAC) reported its financial outcomes as indicated by its 8K statement and had the following numbers.
- Total loans: $946.9 billion
- Total deposits: $1,381.50 trillion
- Bank of America's LDR is calculated as follows: $946.9/$1,381.50
- LDR = 68.5%
The ratio lets us know that Bank of America loaned generally 70% of its deposits toward the finish of 2018.
Highlights
- The loan-to-deposit ratio is utilized to survey a bank's liquidity by contrasting a bank's total loans with its total deposits for a similar period.
- To compute the loan-to-deposit ratio, partition a bank's total amount of loans by the total amount of deposits for a similar period.
- Regularly, the best loan-to-deposit ratio is 80% to 90%. A loan-to-deposit ratio of 100 percent means a bank loaned one dollar to customers for each dollar received in deposits it received.
