Bank A has a loans/deposits ratio of 10%. Bank B has a loans/deposits ratio of 9

Question

Bank A has a loans/deposits ratio of 10%. Bank B has a loans/deposits ratio of 90%. Which of the following statements are true?

            a. Bank A is better because it has lower liquidity risk.

            b. Bank A is lending out a lot of its funding.

            c. If Bank A is near its borrowing limit, it could lead to future liquidity problems.

d. A loans/deposits ratio shouldn’t be too low because then the bank isn’t making money, however a high ratio means there could be liquidity risk in the future.

            e. None of the above.

Please explain concept and interpret the percentage i.e - does a higher percentage mean they have 90% on hand and 10% lending?

Explanation / Answer

loan to deposit ratio is metric of lending institute to determine whether bank can cover the withdrawals made by its customers. Any lender who accepts deposits must have liquidity to handle daily operations.

It interest rate is high, banks may not be having enough liquidity to cover future requirements during economic crises. This is called liquidity risk when a bank unable to meet short term requirements

since Bank A is lending out 90% of money , it is vulnerable for liquidity risk

hence the correct answer is B)

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