Question

what are the disadvantages of using loan to deposit ratio method to determine the liquidity requirement...

what are the disadvantages of using loan to deposit ratio method to determine the liquidity requirement of a bank?

Homework Answers

Answer #1

Loan-Deposit Ratio = Total Loans / Total deposits

Disadvantages of using Loan to Deposit Ratio (LDR) for determining a Bank's Liquidity:

  1. The LTD ratio is sometimes biased upwards due to non-inclusion of non deposit finance by Banks.
  2. LTD does not reflect the risk adjusted liquidity of the bank. Higher loans given by banks may bring suspicion about the quality of these loans. LTD is not risk-weighted as decribed in Basel III.
  3. LTD doesn't tell us the number of lenders these loans were given to. Dependence of Bank on a few big borrowers may hamper the liquidity of the bank in case of default by those few lenders.
  4. LTD does not take into account the interest given to depositors and interest received from the borrowers. Thus, the LTD may be satisfactory but the interest on these loans and deposits may change the bank's liquidity position.
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