{"id":19510,"date":"2022-04-22T08:30:00","date_gmt":"2022-04-22T12:30:00","guid":{"rendered":"https:\/\/einvestingforbeginners.com\/?p=15599"},"modified":"2023-05-18T23:26:52","modified_gmt":"2023-05-19T03:26:52","slug":"loan-to-deposit-ratio-daah-2","status":"publish","type":"post","link":"https:\/\/einvestingforbeginners.com\/loan-to-deposit-ratio-daah-2\/","title":{"rendered":"How to Calculate the Loan to Deposit Ratio; Average LDR of the Big Banks"},"content":{"rendered":"\n
Updated 3\/30\/2023<\/em><\/p>\n\n\n\n Deposits continue as the lifeblood of banks, and loans help generate income for the bank. The more deposits, the more loans, leading to higher income. <\/p>\n\n\n\n \n After the Great Financial Crisis (GFC) from 2007 to 2009, banks received much focus, and the meltdown caused bankruptcies and many banks to run out of money. Because of that increased focus, government agencies placed regulatory restrictions in the form of the Dodd-Frank Act, focusing more on liquidity and ways to measure that liquidity. \n<\/p>\n\n\n\n Stress tests<\/a>, capital ratios such as CETI, Tier 1 ratios<\/a>, and many more emerged with more importance after the GFC. <\/p>\n\n\n\n \n And one of the biggest takeaways from the Covid-induced depression was the greater liquidity of the banking industry. Initially, there was great fear of massive defaults, but those never materialized. Instead, the banking industry survived quite well. \n<\/p>\n\n\n\n \n One of the easiest ways to measure the liquidity of Bank of America is to look at the loan-to-deposit ratio. \n<\/p>\n\n\n\n \n In today’s post, we will learn:\n<\/p>\n\n\n\n Okay, let’s dive in and learn more about the loan-to-deposit ratio. <\/p>\n\n\n\n <\/p>\n\n\n\n \n The loan-to-deposit ratio, according to Investopedia<\/a>, is:\n<\/p>\n\n\n\n \n “The loan-to-deposit ratio (LDR) is used to assess a bank’s liquidity by comparing its total loans to its total deposits for the same period. The LDR is expressed as a percentage<\/em>.”\n<\/p>\n\n\n <\/p>\n\n\n\n If Bank of America’s loan-to-deposit ratio remains too high, it could indicate a bank in danger of running short of liquidity. Likewise, if the ratio is too low, the bank isn’t earning as much as it should. <\/p>\n\n\n\n \n In finance, we use liquidity to define how easily a company can convert its assets into cash. In the event of an emergency, liquidity is an important ingredient to allow a business to deal with that emergency.\n<\/p>\n\n\n\n\n\n\n\n \n In the case of banks, having enough liquidity is paramount in a crisis, and cash is needed. If the bank doesn’t have enough liquidity, the absence of liquidity could put the bank and system at risk. Lack of liquidity was one of the biggest concerns during the Great Financial Crisis and led to the creation of stress tests helping test the amount of liquidity Bank of America has in a crisis.\n<\/p>\n\n\n\n The loan-to-deposit ratio is a quick, easy way to assess the bank’s amount of liquidity in a percentage form<\/strong>, making the ratio easily relatable. <\/p>\n\n\n\n \n Let’s think about the impact of the ratio for a moment if the loan isn’t paid back when a bank lends money to someone to buy a home. This leads to the loan loss, granted the bank could resell the home and recoup some of the loss. But the bigger issue is they lose out on the potential interest income, which is the bread and butter of banks.\n<\/p>\n\n\n\n \n Banks also have to repay deposits upon request, so if there is a run on a bank, having a large portion of their deposits out on loans means they have less cash on hand to satisfy the demand for deposits, putting the bank at risk. \n<\/p>\n\n\n\n \n Before diving into the calculations, let’s explore the idea of deposits and how banks lend that money out.\n<\/p>\n\n\n <\/p>\n\n\n\n Most people think that when a bank takes a deposit, they can lend out that $100 from their savings account. In theory, that is true, but it is a touch more complicated. The usual mantra is without deposits, there would be no loans. <\/p>\n\n\n\n \n However, fractional reserve banking means don’t apply anymore. Because of fractional banking, the bank can use the money multiplier to lend out more than they have in reserve. Without going down a complete rabbit hole, keep this in mind. The bank has reserves of cash they must keep on hand or in their deposits. \n<\/p>\n\n\n\n \n The banks are then assigned a money multiplier based on their reserves, allowing them to lend out above their reserves. For example, if Bank of America has a reserve of 10%, it can lend out ten times more than its reserves. So the bank can lend out $1,000 from our $100 deposit. \n<\/p>\n\n\n\n As a general rule, deposits help drive loans, but the fractional banking system allows bigger loan balances, creating more income opportunities for the bank. Deposits aren’t the whole picture, but it is helpful to remember that more loans give more lending opportunities from a general viewpoint. <\/p>\n\n\n\n <\/p>\n\n\n\n \n The formula for calculating the loan-to-deposit ratio is as follows:\n<\/p>\n\n\n\n LDR = Total Loans \/ Total Deposits<\/strong>\n<\/p>\n\n\n\n \n To calculate the ratio, we divide the total loans by the total deposits from the bank’s balance sheet. \n<\/p>\n\n\n\n \n Total loans are found in the asset section, while deposits are in the liabilities section. That might seem counter-intuitive, but loans are assets because they generate income in the form of interest income. At the same time, deposits cost the banks because they have to pay interest to encourage those deposits. The money is on-demand, meaning deposits must be returned to customers whenever they demand it. \n<\/p>\n\n\n\n \n Let’s look at the ratio for Bank of America using their latest quarterly report, 10-q, dated April 29, 2021:\n<\/p>\n\n\n\n <\/p>\n\n\n\n Pulling the information from the above balance sheet snippet: <\/p>\n\n\n\n\n
What is the Loan to Deposit Ratio?<\/h2>\n\n\n\n
How Do We Calculate the Loan to Deposit Ratio?<\/h2>\n\n\n\n