For a DI, what does a high ratio of loans to deposits indicate?

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BlackTom AI · Accepted Answer

Question restated: For a DI, what does a high ratio of loans to deposits indicate?

Option A: 'DI relies heavily on core deposits to fund loans.' A high loan-to-deposit ratio suggests funding is not mostly from core deposits, but rather from other sources. Relying on core deposits would typically result in a lower loan-to-deposit ratio since core deposits are stable, low-cost funds used to back a sizable loan book. Therefore, this statement is inconsistent with a high loans-to-deposits ratio and is not a correct interpretation.

Option B: 'High degree of loan commitments.' A high loan-to-deposit ratio describes the actual funding gap or reliance on external funding to support outstanding loans, not necessarily the presence of loan commitments. Loan commitments are off-balance-sheet contingencies and do not by themselves explain a high ratio. This option confuses funding structure with credit provisioning activity, so it is not the best explanation.

Option C: 'Liquidity concerns are at a bare minimum for the FI.' A high loans-to-deposits ratio typically signals tighter liquidity because more funds are tied up in illiquid or less liquid assets (loans) relative to deposits. This usually implies greater liquidity risk rather than minimal concerns. Hence, saying liquidity concerns are barely present contradicts the usual interpretation of a high ratio and is incorrect.

Option D: 'DI has large amounts of asset-side liquidity.' Asset-side liquidity refers to how quickly assets (like loans) can be converted to cash. A high ratio indicates a heavier loan book relative to deposits, which generally means less asset-side liquidity, not more. Therefore, this statement mischaracterizes the balance sheet and is incorrect.

Option E: 'DI relies heavily on the short-term money market to fund loans.' With a high loans-to-deposits ratio, the institution often finances a substantial portion of its loan book through non-core, more volatile sources. The short-term money market (e.g., interbank markets, repo, etc.) is a typical source to cover funding gaps when deposits are insufficient. This interpretation aligns with how institutions manage liquidity risk when loan growth outpaces traditional funding, making this the correct understanding among the options.

In summary, each incorrect option either misattributes the funding source, confuses liquidity implications, or describes asset/liability dynamics that do not align with a high loans-to-deposits ratio. The correct interpretation centers on increased reliance on short-term external funding sources to support loans when core deposits are not keeping pace. The statement in Option E captures that funding reality most accurately.

For a DI, what does a high ratio of loans to deposits indicate?

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