Bank Portfolio Management under Credit Market Imperfections

Journal of Mathematical Finance, 2020

31 Pages Posted: 13 May 2020

See all articles by Indrajit Mallick

Indrajit Mallick

Centre for Studies in Social Sciences Calcutta

Date Written: April 18, 2020

Abstract

This paper examines bank portfolio management under banking regulation and asymmetric information about borrower types and screening by banks and imperfect competition in the credit market. A bank tries to maximize expected profits subject to a portfolio variance constraint. The analysis yields the following results: For a monopoly bank, the incentive constraint of the efficient type of borrowers will be binding and the participation constraint of the inefficient type of borrowers will be binding. Further, given the variance constraint being binding, the optimal portfolio will be on the efficiency frontier. The paper also examines duopoly competition between aggressive (predator) and defensive (prey) banks and potential cooperation and reveals that among the alternatives of natural monopoly, entry deterrence, takeovers and efficient portfolio diversification through mergers or interest swaps, the cooperative efficient portfolio diversification strategy will dominate whenever portfolio returns are negatively correlated between any pair of interacting banks as it reduces portfolio variance for a given package of interest and loans.

Keywords: Banking, Portfolio Management, Adverse Selection

JEL Classification: E, F

Suggested Citation

Mallick, Indrajit, Bank Portfolio Management under Credit Market Imperfections (April 18, 2020). Journal of Mathematical Finance, 2020, Available at SSRN: https://ssrn.com/abstract=3579409

Indrajit Mallick (Contact Author)

Centre for Studies in Social Sciences Calcutta ( email )

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