Since the global financial crisis, European banks have decreased their risk profiles. The loan-to-deposit ratio (LDR), the key metric for assessing liquidity, has declined from 127.15% at the end of June 2015 to 104.8% in the third quarter of 2022.
The decline suggests that loans and deposits in Europe are now evenly matched, which translates to a lower probability of a funding gap and credit risk.
The LDR ratio is not homogeneous across Europe. Scandinavian countries show high LDRs, reflecting high levels of credit extension. For example, Danske Bank’s loan-to-deposit ratio stood 157% at the end of the second quarter of 2022, a decrease from 189% at the end of 2019.
Nordic banks have traditionally relied on other types of funding such as debt market financing. The need for market funding exposes banks to an additional liquidity risk. Customer deposits remain the main funding channel for southern European banks.
Banks with high LDRs do not necessarily have an exaggerated risk profile if they retain a good capital base and liquidity assets.
In the current rising rates environment, lenders with a deposit-driven funding model and a lower LDR are likely to benefit the most. Deposits represent a relatively stable type of funding, while banks that rely on bond markets for funding face much higher funding costs for new bond issuance.
