Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / Why Central Banks Watch the Loan-to-Deposit Ratio
Transcript
- Lucas: So the loan to deposit ratio — LDR for short — is one of those metrics that central banks watch closely, but most people outside of banking have never heard of it. Luna: I've seen it in bank filings. It's basically loans divided by deposits, right? Shows how much of a bank's lending is funded by customer deposits. Lucas: Exactly. And the reason it matters for central banks is that it tells you something about a bank's funding stability. If a bank has an LDR of 80 percent, it's funding 80 cents of every dollar lent with deposits. That's pretty conservative. Luna: But what happens when the ratio goes above 100 percent? I've seen some banks with LDRs of 110, 120 percent. That means they're lending more than they have in deposits. Lucas: Right, and that's where the central bank starts paying attention. When LDR exceeds 100 percent, the bank is funding loans with wholesale borrowing — things like interbank loans, commercial paper, or even central bank facilities. That makes the bank vulnerable if those funding sources dry up. Luna: And we saw exactly that in the 2023 regional banking crisis. Silicon Valley Bank had an LDR well above 100 percent, I think around 110 or so. Lucas: Yeah, SVB's LDR was about 112 percent at the end of 2022. First Republic was even higher — around 130 percent. When deposit outflows accelerated, those banks didn't have enough stable funding to cover their loan books. They had to sell assets at a loss, and that was the beginning of the end. Luna: So central banks monitor LDR as an early warning signal. If a whole banking sector has rising LDRs, it might indicate that credit growth is outpacing deposit growth, which could be a systemic risk. Lucas: Exactly. And there's a monetary policy angle too. The LDR is connected to the money multiplier. When a bank makes a loan, it creates new deposits in the economy. But if the bank is already at a high LDR, it can't lend as much without getting more deposits or wholesale funding. Luna: So a high LDR can constrain the effectiveness of monetary policy. If a central bank cuts rates to encourage lending, but banks are already maxed out on their LDR, the transmission might be weaker. Lucas: That's a really important point. In fact, some central banks set explicit LDR limits. The People's Bank of China, for example, has a 75 percent cap for the largest banks. That's designed to ensure banks maintain a stable funding base and don't overextend on credit. Luna: Seventy-five percent seems low compared to what we saw in the US. But I guess in a fast-growing economy like China, it's a way to rein in credit booms. Lucas: Exactly. And it's worth noting that the LDR isn't a one-size-fits-all metric. In the US, regulators don't have a hard cap, but they do examine LDR trends. The Federal Reserve uses it as part of the CAMELS rating system — that's capital, assets, management, earnings, liquidity, and sensitivity. Luna: So LDR falls under the 'liquidity' component. That makes sense, because a high LDR without stable deposit funding is a liquidity risk. Lucas: Right. And here's another layer: the LDR can shift with the interest rate environment. Since we're in July 2026, rates are still elevated relative to pre-2022 levels. That means deposits are more expensive for banks to attract, but they're also stickier because depositors want yield. Luna: So in a high-rate environment, deposits might grow more slowly as people put money into money market funds. That could push LDRs up even if loan growth is moderate. Lucas: Exactly. And that's something central banks are watching right now. If LDRs in the banking system creep up, it could signal that banks are becoming more reliant on wholesale funding, which can be flighty. Luna: Speaking of dependency, I want to take a quick step back. You know, we cover all this because listeners like you support the show. A handful of folks chip in monthly through buy me a coffee dot com slash fexingo, and that's what keeps this ad-free and independent. Lucas: Yeah, it really does. If walking through the economy with us has made something click, that's the place. No pressure, just a quiet way to keep these episodes coming. Luna: Alright, back to LDR. So we've talked about the US and China. Are there other central banks that use LDR limits? Lucas: Sure. The Reserve Bank of India has a statutory LDR requirement — it was around 80 percent for a while, though they've relaxed it more recently. And in the European Union, the Basel III framework includes the Net Stable Funding Ratio, which is a broader version of the same idea: match long-term assets with stable funding. Luna: So LDR is sort of the simpler, older cousin of the NSFR. Lucas: Exactly. And it's still useful because it's easy to calculate and transparent. You can look at any bank's balance sheet and compute it in seconds. That's why analysts and regulators keep coming back to it. Luna: Let's talk about a practical example. Suppose a regional bank has an LDR of 95 percent. What should a central banker be thinking? Lucas: I'd ask: is that 95 percent driven by strong loan demand, or by deposit outflows? If it's the latter, that's a red flag. Also, what's the composition of deposits? If they're mostly insured retail deposits, that's more stable than uninsured corporate deposits. Luna: Right, because SVB had a lot of uninsured deposits from venture capital firms. That's part of why they ran so fast. Lucas: Exactly. So the LDR is a starting point, not the whole story. But it's a useful shorthand for funding pressure. And when you see a bank with an LDR above 100 percent and a high share of uninsured deposits, you know there's a vulnerability. Luna: What about the other direction? Could an LDR be too low? Lucas: Yeah, a very low LDR — say below 50 percent — might mean the bank is sitting on excess deposits and not lending enough. That could be a drag on profitability and on economic growth, especially in a region that needs credit. Luna: So central banks want an LDR that's not too hot, not too cold. Lucas: Goldilocks territory. And that's where policy comes in. If the central bank wants to stimulate lending, it might lower reserve requirements or provide cheap funding to banks with low LDRs. Conversely, if it wants to cool a credit boom, it might raise reserve requirements or use macroprudential tools that directly target LDRs. Luna: And I imagine this is especially relevant in emerging markets where deposit bases are smaller and more volatile. Lucas: Absolutely. In many emerging economies, the LDR is a key metric for both monetary and financial stability. The central bank of Brazil, for instance, tracks LDR closely and has used it to calibrate reserve requirements. And in Turkey, high LDRs have been a concern as the lira depreciated and deposits fled. Luna: So the LDR is one of those metrics that connects microprudential supervision with macroprudential policy. It's a bridge between the health of individual banks and the stability of the system. Lucas: Exactly. And for our listeners who are investors or analysts, the LDR is a quick check on a bank's funding profile. Next time you look at a bank's quarterly report, find the LDR and see if it's trending up or down. It'll tell you a lot about what the central bank is probably thinking. Luna: And maybe you'll spot the next SVB before it happens. Lucas: Well, no single metric can do that, but it's a good place to start. For now, that's the loan to deposit ratio — a simple number with a lot of meaning.