Loan-to-Deposit Ratio (LDR)
Candlefocus EditorThe LDR is important for a bank’s overall financial health because it provides an indication of the ability of the bank to lend out funds, as well as how much it can lend, relative to its deposits. It is also an indication of the degree of liquidity stress and risk that a bank may be facing. A high LDR ratio, exceeding the ideal range, can indicate a higher risk of default, because it suggests the bank is relying excessively on funded sources of funds, such as deposits, to meet its obligations and to lend out.
The LDR is calculable based on the amount of loans offered by the bank divided by its deposits at a specific point in time. Apart from the required regulatory reporting of total loans and deposits received by the bank, the LDR can also be monitored dynamically since it captures the loan and deposit activity every day. This enables the bank to take corrective actions or to assess its current position in the context of its liquidity planning.
As a ratio, the LDR offers a way to compare and contrast the liquidity of different banks. Consequently, it provides lenders with a good measure for measuring the liquidity of a borrowing institution before providing a loan.
The loan-to-deposit ratio is a powerful tool in evaluating the financial health of a bank and their ability to meet their obligations and provide loans to customers. It is always important to monitor a bank’s loan-to-deposit ratio as an indicator of their solvency.