THE IMPACT OF SAVINGS WITHDRAWALS ON A BANKER’S CAPITAL HOLDINGS SUBJECT TO BASEL III ACCORD

Ryle S. Perera and Kimitoshi Sato ()
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Ryle S. Perera: Department of Applied Finance, Macquarie Business School, Macquarie University, Sydney, NSW 2109, Australia
Kimitoshi Sato: #x2020;Department of Industrial Engineering and Management, Faculty of Engineering, Kanagawa University, Yokohama, Kanagawa 221-8686, Japan

Annals of Financial Economics (AFE), 2020, vol. 15, issue 02, 1-30

Abstract: In this paper, we analyze the impact of savings withdrawals on a bank’s capital holdings under Basel III capital regulation. We examine the interplay between savings withdrawals and the investment strategies of a bank, by extending the classical mean–variance paradigm to investigate the bankers optimal investment strategy. We solve this via an optimization problem under a mean–variance paradigm, subject to a quadratic optimization function which incorporates a running penalization cost alongside the terminal condition. By solving the Hamilton–Jacobi–Bellman (HJB) equation, we derive the closed-form expressions for the value function as well as the banker’s optimal investment strategies. Our study provides a novel insight into the way banks allocate their capital holdings by showing that in the presence of savings withdrawals, banks will increase their risk-free asset holdings to hedge against the forthcoming deposit withdrawals whilst facing short-selling constraints. Moreover, we show that if the savings depositors of the bank are more stock-active, an economic expansion will imply a greater reduction in bank savings. As a result, the banker will reduce his/her loan portfolio and will depend on high stock returns with short-selling constraints to conform to Basel III capital regulation.

Keywords: Bank asset allocation; Basel III Capital Accord; HJB equation; mean–variance optimization; Poisson process; savings deposits (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1142/S2010495220500062

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