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Journal of Applied Mathematics
Volume 2014, Article ID 723873, 11 pages
Research Article

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

University of the Western Cape, Private Bag X17, Bellville 7535, South Africa

Received 3 October 2013; Accepted 5 January 2014; Published 19 February 2014

Academic Editor: Francesco Pellicano

Copyright © 2014 Grant E. Muller and Peter J. Witbooi. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.


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.