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An Optimal Portfolio and Capital Management Strategy for Basel III Compliant Commercial Banks

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  • Grant E. Muller
  • Peter J. Witbooi

Abstract

We model a Basel III compliant commercial bank that operates in a financial market consisting of a treasury security, a marketable security, and a loan and we regard the interest rate in the market as being stochastic. We find the investment strategy that maximizes an expected utility of the bank’s asset portfolio at a future date. This entails obtaining formulas for the optimal amounts of bank capital invested in different assets. Based on the optimal investment strategy, we derive a model for the Capital Adequacy Ratio (CAR), which the Basel Committee on Banking Supervision (BCBS) introduced as a measure against banks’ susceptibility to failure. Furthermore, we consider the optimal investment strategy subject to a constant CAR at the minimum prescribed level. We derive a formula for the bank’s asset portfolio at constant (minimum) CAR value and present numerical simulations on different scenarios. Under the optimal investment strategy, the CAR is above the minimum prescribed level. The value of the asset portfolio is improved if the CAR is at its (constant) minimum value.

Suggested Citation

  • Grant E. Muller & Peter J. Witbooi, 2014. "An Optimal Portfolio and Capital Management Strategy for Basel III Compliant Commercial Banks," Journal of Applied Mathematics, Hindawi, vol. 2014, pages 1-11, February.
    • Handle: RePEc:hin:jnljam:723873
    DOI: 10.1155/2014/723873
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    Cited by:

    1. Chang Liu & Dongtao Lin & Yifeng Wang & Shuai Qi, 2023. "A new market risk management approach for commercial banks' fixed‐income securities trading accounts," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(1), pages 225-235, January.
    2. Dawen Yan & Xiaohui Zhang & Mingzheng Wang, 2021. "A robust bank asset allocation model integrating credit-rating migration risk and capital adequacy ratio regulations," Annals of Operations Research, Springer, vol. 299(1), pages 659-710, April.

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