A traditional signal that a bank may not have enough liquid assets to cover a sudden loss of funding has increased dramatically at small banks in recent decades. Small banks’ median ratio of the value of their loans outstanding to the value of their deposits has risen from around 60 percent in the second half of the 1980s to around 80 percent today. Meanwhile, the same measure of liquidity has increased about 5 percentage points at large banks. How can we explain this big increase in loan-to-deposit (LTD) ratios among small banks? Are higher LTD ratios here to stay? Do they pose risks to the safety and soundness of our small banks?
This article appeared in the Third Quarter 2017 edition of Economic Insights. Download and read the full issue.