Bank Profitability Indicators under Regulation

I. Schoeman, M.A. Petersen, and K. Thosago (South Africa)


Stochastic Modelling; Bank Profitability; Stochastic Dif ferential Equations


In our paper, we model the profitability of banks in a stochastic manner by means of a L´evy process-driven model. In this regard, we highlight two measures of bank profitability, viz., the return on assets (ROA; measure of the operational efficiency of the bank) and the return on equity (ROE; measure of the owner’s returns on their investment). Banks manage the amount of capital they hold to prevent bank failure and to meet bank capital requirements set by the regulatory authorities. However, they do not want to hold too much capital because by doing so they will lower the returns to equity holders. In order to accomplish this, we derive stochastic differential equations that provide in formation about the dynamics of the value processes of net profit after tax, equity capital and total assets. Further in vestigations will include the incorporation of appropriate numerical examples, simulations and optimizations of the ROE and the ROA.

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