Whether you are looking for a financially viable company to invest in or trying to make a decision about where to do your banking, you should be curious about the financial health of any organization with which you choose to do business. If you do some research, you may uncover the organization's loan-to-deposit ratio, which could help you make your decision.
Loan-to-Deposit Ratio Definition
The loan-to-deposit ratio is a measure of a financial institution's liquidity. The ratio is an expression of how much money a bank or other financial institution retains in deposits compared to the total amount of outstanding loans. It may also be expressed as the total percentage of loans funded through deposits. The loan-to-deposit ratio is calculated by dividing the total amount of loans by the total amount in deposits. The resulting figure is typically expressed as a percentage.
How It Works
Most banks and lending institutions provide a variety of financial services -- such as checking and savings accounts, individual retirement accounts and investment accounts -- in addition to mortgage loans, automotive loans and small business loans. A traditional bank accepts deposits from customers, who typically receive a small rate of return on their money in exchange for lending those funds to the bank. The bank, in turn, lends out a certain percentage of those funds at higher interest rates in order to build and maintain profitability.
Why It's Important
Most banks are required to maintain at least some level of financial liquidity to ensure it has adequate funds to pay depositors who withdraw their money. If a financial institution is unable to repay depositors, they might be considered insolvent. Many banks maintain a loan-to-deposit ratio of about 79 percent, according to mortgagenewsdaily.com, but others maintain ratios of 70 percent or less.
In a time when just about every company's financial stability can be called into question at any time, it is up to the consumer to protect his investments. The loan-to-deposit ratio is only one of many factors that can be used to determine a company's financial health. It is also subject to change and should be monitored regularly by concerned consumers and investors.