David Fettig - Editor
Published July 1, 1996 | July 1996 issue
The loan-to-deposit ratio for Ninth District banks, the traditional measure of liquidity, began increasing in the early 1990s and reached a record high in 1995. The higher this ratio, the fewer funds banks have available to meet unexpected demands for cash.
Loans as a percent of assets have increased at the same time deposits as a percent of liabilities and capital have declined. Thus, with deposits funding a smaller portion of bank liabilities, borrowed money and, to a lesser extent, equity capital are funding a greater portion of loans and other assets.
Recent loan securitization opportunities and new funding sources, however, obscure the loan to deposit ratio's usefulness as a liquidity indicator. Securitization allows banks to sell certain loans to agencies that sell securities backed by these loans. In addition, securitization has greatly increased the marketability and liquidity of loans that would have been considered very illiquid several years ago.
New funding sources available to banks, such as Federal Home Loan Bank System loans, have also enhanced the ability of banks to manage liquidity. Roughly one-third of district banks have joined the Federal Home Loan Bank System and these banks had borrowed $3.3 billion as of June 1995.Despite these developments, district banks' liquidity is a concern. A trade-off exists between the higher return on loans and the higher level of liquidity present in relatively low yielding short-term securities that can easily be converted to cash.
To see how district banks are managing this tradeoff, the Banking Supervision Department surveyed about one-third of the region's community banks in March. None of the banks were having liquidity problems, and 79 percent of respondents considered their current level of liquidity optimal or more than optimal. Nevertheless, 21 percent would like to be more liquid. In addition, the overwhelming majority of bankers did not foresee any significant changes in their liquidity position in 1996.
To manage their liquidity, respondents prefer to use asset management techniques such as selling loans or securities to change their mix of assets. However, they also believe that sufficient funding sources are available if they need to borrow funds.