Analysts and regulators routinely evaluate a bank's ability to
repay depositors and other creditors without incurring excessive
costs and while continuing to fund growth. This so-called "liquidity"
of a bank is evaluated using a whole host of tools and techniques,
but the traditional loan-to-deposit (LTD) ratio is a measure that
often receives the most attention.
The LTD ratioa bank's gross loans divided by total depositsindicates
the percentage of a bank's loans funded through deposits. An upswing
in the LTD may indicate that a bank has less of a cushion to fund
its growth and to protect itself against a sudden recall of its
funding, especially a bank that relies on deposits to fund growth.
Some analysts have argued more recently that the LTD ratio does
not convey as much useful information as it once did. For example,
it is much more feasible for banks to sell consumer loans than it
was in the past. Thus, a bank with a high LTD may have an easy time
making new loans and earning fees simply by disposing of its old
loans. Banks also have new sources of nondeposit funding such as
those provided by the Federal Home Loan Banks. In addition, banks
have a much greater array of financial techniques to allow them
to better manage their exposure to their funders and maintain their
growth in lending, despite having a relatively high LTD ratio.
How does to the LTD ratio measure up?
To test the integrity of the LTD ratio, we used a unique survey
of agricultural bankers in the Ninth District. In each survey the
banks were asked if they turned down a loan because they did not
have available funds. If the LTD ratio still conveys its traditional
meaning and is being interpreted correctly, those banks that turned
down loans would be expected to have higher LTD ratios. If this
relationship does not hold up at smaller agricultural banks, it
is reasonable to believe that the LTD is even less useful for reviewing
the liquidity of larger banks with access to newer financial technologies
and more funding sources.
About 9 percent of the 100 banks surveyed each quarter between
1993 and 1998 refused a loan at some time because of liquidity constraints.
These banks had an average LTD of 79 percent, compared with 67 percent
for banks that did not refuse loans.
On the surface, then, it appears that high LTD ratios are related
to loan refusals. But, to be more certain of this relationship,
we needed to account for factors other than the LTD ratio that may
hinder a bank's ability to meet loan demand. A more sophisticated
statistical test called regression analysis controls for factors
that may influence a bank's ability to fund loans. In addition to
the LTD ratio, we also examined variables relating to a bank's use
of insured and noninsured deposit funding, loan growth, a bank's
equity level and the time period when the financial and survey variables
were reported. We did not include the size of the bank or the concentration
of loans to certain types of borrowers since the banks we examined
were all small, agriculturally focused institutions.
The logic for including equity levels is that a bank with high
levels of equity provided by stockholders may be better suited to
respond to periods of high loan demand. Likewise banks which have
had higher insured and uninsured deposit growth may be less likely
to turn down loans. In contrast, banks experiencing rapid loan growth
may be more likely to turn down additional loans.
Using regression analysis, we found that the LTD ratio was highly
statistically significant and robust in explaining the likelihood
that a bank would refuse a loan: The higher the LTD the more likely
a bank would refuse a loan. Other of the variables were not statistically
significant or did not relate to the loan refusal in the manner
Of course, this initial test is far from the last word on this
topic. Because of the importance of liquidity issues to regulators
in this district and throughout the country, we will continue to
review which tools help identify banks that may be experiencing