Next Article in Journal
Spatial Risk Measures and Rate of Spatial Diversification
Next Article in Special Issue
Statistical Inference for the Beta Coefficient
Previous Article in Journal
Practice Oriented and Monte Carlo Based Estimation of the Value-at-Risk for Operational Risk Measurement
Previous Article in Special Issue
Peer-To-Peer Lending: Classification in the Loan Application Process
Open AccessFeature PaperArticle

The Optimum Leverage Level of the Banking Sector

by Sagara Dewasurendra 1,†, Pedro Judice 2,† and Qiji Zhu 1,*,†
1
Department of Mathematics, Western Michigan University, Kalamazoo, MI 49008, USA
2
ISCTE Business Research Unit, Lisbon 1649-026, Portugal
*
Author to whom correspondence should be addressed.
These authors contributed equally to this work.
Risks 2019, 7(2), 51; https://doi.org/10.3390/risks7020051
Received: 28 March 2019 / Revised: 26 April 2019 / Accepted: 27 April 2019 / Published: 1 May 2019
Banks make profits from the difference between short-term and long-term loan interest rates. To issue loans, banks raise funds from capital markets. Since the long-term loan rate is relatively stable, but short-term interest is usually variable, there is an interest rate risk. Therefore, banks need information about the optimal leverage strategies based on the current economic situation. Recent studies on the economic crisis by many economists showed that the crisis was due to too much leveraging by “big banks”. This leveraging turns out to be close to Kelly’s optimal point. It is known that Kelly’s strategy does not address risk adequately. We used the return–drawdown ratio and inflection point of Kelly’s cumulative return curve in a finite investment horizon to derive more conservative leverage levels. Moreover, we carried out a sensitivity analysis to determine strategies during a period of interest rates increase, which is the most important and risky period to leverage. Thus, we brought theoretical results closer to practical applications. Furthermore, by using the sensitivity analysis method, banks can change the allocation sizes to loans with different maturities to mediate the risks corresponding to different monetary policy environments. This provides bank managers flexible tools in mitigating risk. View Full-Text
Keywords: leverage level; growth optimal portfolio; balance sheet management; asset-liability management; long-term risk; interest rate risk; credit risk leverage level; growth optimal portfolio; balance sheet management; asset-liability management; long-term risk; interest rate risk; credit risk
Show Figures

Figure 1

MDPI and ACS Style

Dewasurendra, S.; Judice, P.; Zhu, Q. The Optimum Leverage Level of the Banking Sector. Risks 2019, 7, 51.

Show more citation formats Show less citations formats
Note that from the first issue of 2016, MDPI journals use article numbers instead of page numbers. See further details here.

Article Access Map by Country/Region

1
Back to TopTop