Loan to Deposit Ratio Implication

Loan to Deposit Ratio Implication

Except their own capital, commercial banks fund themselves mainly by two ways, such as wholesale funding and core depositary funding. Banks then make loans or invest by themselves to the bond market, foreign exchange market, stock market etc to profit.

What is loan to deposit ratio? The amount of a bank's loans divided by the amount of its deposits at any given time. The higher the ratio, the more the bank is relying on borrowed funds, which are generally more costly than most types of deposits.

What a proper loan-deposit ratio is necessary for a bank to stay healthy and stable when the economy goes down. Though there are no regulations about how much ratio a bank has to maintain, a bank has to find the right ratio to make maximum profit and minimize its risk. Especially it has to make sure when it encounters a major economic down turn, its banking operation stay safe or will not be paralyzed.

Since 2006, the sub-prime crisis burst, many major banks in the United States went to bankrupt or at the edge of bankruptcy. Investment banks are forced to merge with the commercial banks to avoid the fate of bankruptcy due to its liquidity and solvency problems. In order to put an end to the credit crisis and save the financial system, banks are partly nationalized. There is a common character for the banks in trouble, which is they are short of money. They loaned out or invest so much that they do not have enough money to defend themselves during a time.

In the article of “China’s economy, domino or dynamo?” from the Economist, the author illustrated how China’s economy is placed pretty well to cushion a global down turn. In this article, some statistics show that China’s banking system is funded mainly by deposits rather than capital markets. Its loans only account for 65% of their deposit. As for the housing market, the loans account for 7% of total lending. This is due to a higher down payment of initial house buying, which is...