Loan-To-Deposit Ratio and Financial Stability: macroprudential policy perspective

This paper evaluates the relation between the loan-to-deposit ratio (LTD) and financial stability and hence the usefulness of the LTD as a macroprudential policy indicator or instrument. In general, an increase of the LTD should indicate a financial stability decrease. Subsequently we adopt a macroprudential policy perspective and test financial sector stability with respect to the currency (domestic/foreign) in which loans and deposits are denominated. This is done in a linear empirical framework by using large factor-augmented VAR model (FAVAR) which is not limited to number of variables used. For such analysis, it is appropriate to choose an open economy with a bank-based financial system and potential substitutability between domestic and foreign currency loans and deposits. Therefore, we analyze the Czech Republic and Hungary as these countries meet the above listed characteristics. Our results suggest that the structure of financial transactions in terms of domestic/foreign currency denomination cannot be ignored or disregarded in relation to financial stability objective.