A very important ratio for banks to calculate is their loans to deposits ratio. A high loans to deposits ratio means that the bank is issuing out more of its deposits in the form of interest-bearing loans, which, in turn, means it’ll generate more income. The problem is that the bank’s loans aren’t always repaid.
Plus, the bank has to repay deposits on request, so having a ratio that’s too high puts the bank at high risk.
A very low ratio means that the bank is at low risk, but it also means it isn’t using its assets to generate income and may even end up losing money.
Here is how to calculate the loans to deposits ratio:
Follow these steps to put this equation to use:
Use the income statements of the current year and previous year to calculate the average net loans and average deposits:
Add the net loans of the current year and previous year and divide the answer by 2; this is the average net loans.
Add the deposits of the current year and previous year and divide the answer by 2; this is the average deposits.
Divide the average net loans by the average deposits to find the loans to deposits ratio.
Analysts should use this ratio in conjunction with other banking ratios, particularly the loan loss coverage ratio.