Loan-to-Deposit Ratio (LDR)

What Is Loan-to-Deposit Ratio (LDR)?

The loan-to-deposit ratio (LDR) is used to assess a bank's liquidity by comparing a 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.

Formula and Calculation for LDR

LDR = Total Loans Total Deposits \begin{aligned} &\text{LDR} = \frac{ \text{Total Loans} }{ \text{Total Deposits} } \\ \end{aligned} LDR=Total DepositsTotal Loans

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 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 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 its 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.

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 bank 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 is 80% 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 Corporation do 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 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 = $ 4 0 0  million $ 5 0 0  million = . 8 = 8 0 % \begin{aligned} &\text{LDR} = \frac{ \$400 \text{ million} }{ \$500 \text{ million} } = .8 = 80\% \\ \end{aligned} LDR=$500 million$400 million=.8=80%

LDR vs. LTV Ratio

Loan-to-value (LTV) ratio is an assessment of lending risk that 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 measure's a bank's ability to cover its loans with its deposits.

Limitations of the LDR

The LDR helps investors to 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.

Real World Example of LDR

As of 12/31/2018, Bank of America Corporation (BAC) reported its financial results according to its 8K statement and had the following numbers.

The ratio tells us that Bank of America lent roughly 70% of its deposits by the end of 2018.