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Loan to Deposit Ratio

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Loan to Deposit Ratio

The formula for the loan to deposit ratio is exactly as its name implies, loans divided by deposits.

The loan to deposit ratio is used to calculate a lending institution's ability to cover withdrawals made by its customers. A lending institution that accepts deposits must have a certain measure of liquidity to maintain its normal daily operations. Loans given to its customers are mostly not considered liquid meaning that they are investments over a longer period of time. Although a bank will keep a certain level of mandatory reserves, they may also choose to keep a percentage of their non-lending investing in short term securities to ensure that any monies needed can be accessed in the short term.

Liquidity and the Loan to Deposit Ratio

Loans in the numerator of the formula are investments or assets for a bank. Deposits in the denominator of the formula can be considered the same as debt as the individual depositors are essentially granting monies to the bank with a return equal to the deposit rates and that can be called upon at any time. In these respects, the loan to deposit ratio is similar to a liquidity ratio and debt ratio.

Use of Loan to Deposit Ratio

The loan to deposit ratio can be used by investors and internally by the company to determine the financial institutions short term viability. Although many depositors may not be as concerned when a financial institution is insured, the loan to deposit ratio may be used to ensure that any money needed is immediately available. Banking insurance companies may also find this ratio or some variation of it of use when underwriting the policy to determine insurability.

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