June 10, 2023 / VOLUME NO. 265

An Old Ratio Gets More Complex

What’s the optimal loan-to-deposit ratio? 

There’s a lot of nuance embedded in the answer, which of course depends on the bank asking the question. But recent industry turmoil demonstrates the true figure may be significantly lower than where bank leaders initially peg it. 

The loan-to-deposit ratio essentially indicates how many deposits on its balance sheet a bank has lent back out: a higher number generally means a bank has loaned out more of its deposits. Asked about the loan-to-deposit ratio that they would be comfortable maintaining, executives and board members responding to Bank Director’s 2023 Risk Survey gave a range from a median of 70% on the low end to 90% on the high end. 

“It probably should be about 10 points lower” than that range, says Chris Nichols, director of capital markets at SouthState Bank. 

Bank Director fielded its 2023 Risk Survey in January — before a run on deposits brought down SVB Financial Corp.’s Silicon Valley Bank, in Santa Clara, California. SVB, which carried an outsized proportion of uninsured deposits on its balance sheet stemming from its focus on tech companies and venture capital firms, had a loan-to-deposit ratio of 43%, according to an earnings update released shortly before the bank failed. 

Until it collapsed, SVB’s low loan-to-deposit ratio indicated the bank had plenty of deposits. But SVB had planted the seeds of its collapse in 2020-21, when it loaded up on securities to generate more income in a low interest rate environment. It tried to raise additional capital and sell $21 billion of those securities at a $1.8 billion loss to generate more liquidity in early March, sparking depositor panic. Ultimately, the bank couldn’t access additional funding quickly enough or at the scale required to replace billions in outflows. 

Recent bank failures could significantly shift the conversations executives and directors have around the optimal loan-to-deposit ratio. As Nichols says, customers, shareholders and analysts are now likely to factor in securities along with deposits when thinking about that ratio. 

Put simply, liquidity is just as important as credit — perhaps even more so. “Banks need more resources put on the deposit side,” he says. “That starts with marketing and ends with good product design and sales. I think that's the major practice missing in banks. Look at how banks are handling raising deposits now. It's a game of rates, and it should never come to that.”

Greater insight into the deposit base, including the bank’s percentage of uninsured deposits and the average deposit size, can help bank leaders determine what the optimal loan-to-deposit ratio actually is for their institution. Factoring securities into that calculation could provide a fuller picture of where that figure should land. 

• Laura Alix, director of research for Bank Director

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 — Jill Castilla, Citizens Bank of Edmond 

• Kiah Lau Haslett, managing editor of Bank Director

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