What is Loan to Deposit (LDR)?
What is the loan / deposit ratio (LDR)?
The loan-to-deposit ratio (LDR) is used to measure a bank’s liquidity by comparing a bank’s total loans to its total deposits for the same period. LDR is expressed as a percentage. If the ratio is too high, it means that the bank may not have enough cash to cover the unforeseen needs of the funds. On the other hand, if the ratio is too low, the bank might not earn as much as it could be.
Formula and calculation for LDR
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To calculate the deposit-to-deposit ratio, divide the total amount of a bank’s loans by the total amount of deposits for the same period. You can find the numbers in a bank’s balance sheet. Loans are recorded as assets and deposits as liabilities.
What does LDR tell you?
A deposit-to-deposit ratio shows a bank’s ability to cover loan losses and withdrawals made by its customers. Investors monitor the banks’ LDR to ensure that there is sufficient liquidity to cover the loans in the event of an economic downturn leading to defaults.
In addition, the LDR helps to show how much a bank attracts and retains its customers. If a bank’s deposits increase, new sums of money and new customers are integrated. As a result, the bank will probably have more money to lend, which should increase profits. Although counterintuitive, loans are an asset to a bank because banks collect interest income on loans. Deposits, on the other hand, are liabilities because banks have to pay an interest rate on these deposits, albeit at a low rate.
LDR can help investors determine if a bank is being managed properly. If the bank does not increase its deposits or if its deposits go down, it will have less money to lend. In some cases, banks will borrow money to meet the loan demand in order to increase interest income. However, if a bank uses debt to finance its lending operations rather than deposits, it will have to pay a debt service fee because it will have to pay interest on the debt.
As a result, a bank that borrows money to lend to its customers will generally have lower profit margins and higher debt. A bank would prefer to use deposits to lend because the interest rates paid to depositors are much lower than those it would charge to borrow money. The LDR helps investors identify banks that have enough deposits to make loans and will not need to resort to an increase in debt.
The right LDR is a delicate balance for the banks. If banks lend too much of their deposits, they may overexploit, especially in times of economic slowdown. However, if banks lend too little of their deposits, they could have an opportunity cost because their deposits would remain on their balance sheets without generating income. Banks with low LTD ratios could have lower interest income, which would result in lower profits.
Several factors can lead to changes in loan / deposit ratios. Economic conditions may affect the demand for loans and the amount of investor deposits. If consumers are unemployed, they are unlikely to increase their deposits. The Federal Reserve Bank regulates monetary policy by raising and lowering interest rates. If rates are low, the demand for credit may increase depending on economic conditions. In short, many external factors affect the creditworthiness of a bank.
What is an ideal LDR?
Generally, the ideal loan / deposit ratio is between 80% and 90%. A deposit-to-deposit ratio of 100% means that a bank lent one USD to customers for every USD received on deposits received. It also means that a bank will not have significant reserves to deal with contingencies or unforeseen events.
Keys to take away
- The loan-to-deposit ratio is used to estimate the cost of a bank. liquidity by comparing the total loans of a bank to its total deposits for the same period.
- To calculate the deposit-to-deposit ratio, divide the total amount of a bank’s loans by the total amount of deposits for the same period.
- Generally, the ideal loan / deposit ratio is between 80% and 90%. A deposit-to-deposit ratio of 100% means that a bank lent one USD to customers for every USD received on deposits received.
Example of LDR
If a bank has deposits of 500 million USD and loans of 400 million USD, the LDR ratio of the bank will be calculated by dividing the total loans by the total of its deposits.
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LDR / LTV ratio
The loan-to-value ratio (VT) is an assessment of the loan risk that financial institutions and other lenders review before approving a mortgage. Generally, valuations with a high loan-to-value ratio pose a higher risk and, therefore, if the mortgage is approved, the loan costs the borrower more.
The LTV ratio measures the value of the property in relation to the loan amount, while the LDR measures the ability of a bank to cover its loans with its deposits.
Limits of the LDR
The LDR helps investors assess the health of a bank’s balance sheet, but this ratio is limited. LDR does not measure the quality of loans that a bank has issued. Nor does the LDR reflect the number of loans that are past due or likely to be past due in their payments.
As with all financial ratios, LDR is more efficient than banks of similar size and constitution. It is also important for investors to compare several financial indicators when comparing banks and making investment decisions.
Concrete example of LDR
On 31/12/2018, Good Bank Corporation (BAC) reported its financial results based on its statement of $ 8,000 and the following figures.
- Total loans: 946.9 billion USD
- Total deposits: 1,381.50 billion USD
- Good Bank’s LDR is calculated as follows: USD 946.9 / USD 1,381.50
- LDR = 68.5%
The ratio indicates that Good Bank had loaned approximately 70% of its deposits at the end of 2018.