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Dynamic loan portfolio management in a three time step model

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  • Deb Narayan Barik
  • Siddhartha P. Chakrabarty

Abstract

This paper studies the bank dynamic decision problem in the intermediate time step for a discrete-time setup. We have considered a three-time-step model. Initially, the banks raise money through debt and equity and invest in different types of loans. It liquidates its assets and raises new funds at the intermediate-time step to meet the short-term debt holders claim. Further, it has to meet specific capital requirements given by the regulators. In this work, we have theoretically studied the effect of raising new equity and debt. We show that in some cases, raising equity and debt may increase the return on equity, and in some cases, it may decrease the return on equity. We have discussed several cases and given a bound on the capital that can be raised. We have added an equity holders constraint, which ensures the return on equity and desists the bank from defaulting at the final time point.

Suggested Citation

  • Deb Narayan Barik & Siddhartha P. Chakrabarty, 2025. "Dynamic loan portfolio management in a three time step model," Papers 2501.07856, arXiv.org.
    • Handle: RePEc:arx:papers:2501.07856
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    References listed on IDEAS

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    1. Blum, Jürg M., 2008. "Why 'Basel II' may need a leverage ratio restriction," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1699-1707, August.
    2. Deb Narayan Barik & Siddhartha P. Chakrabarty, 2022. "Does limited liability reduce leveraged risk?: The case of loan portfolio management," Papers 2209.12636, arXiv.org.
    3. Bruno Biais & Thomas Mariotti & Jean-Charles Rochet & StÈphane Villeneuve, 2010. "Large Risks, Limited Liability, and Dynamic Moral Hazard," Econometrica, Econometric Society, vol. 78(1), pages 73-118, January.
    4. Behn, Markus & Daminato, Claudio & Salleo, Carmelo, 2019. "A dynamic model of bank behaviour under multiple regulatory constraints," Working Paper Series 2233, European Central Bank.
    5. Hans-Werner Sinn, 2002. "Risktaking, Limited Liability, and the Competition of Bank Regulators," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 59(3), pages 305-329, August.
    6. Benjamin Cohen, 2013. "How have banks adjusted to higher capital requirements?," BIS Quarterly Review, Bank for International Settlements, September.
    7. Deb Narayan Barik & Siddhartha P. Chakrabarty, 2023. "Loan portfolio management and Liquidity Risk: The impact of limited liability and haircut," Papers 2308.06525, arXiv.org.
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