Discrete Dynamics in Nature and Society
Volume 2008 (2008), Article ID 740845, 44 pages
doi:10.1155/2008/740845
Research Article

Bank Valuation and Its Connections with the Subprime Mortgage Crisis and Basel II Capital Accord

C. H. Fouche,1 J. Mukuddem-Petersen,2 M. A. Petersen,2 and M. C. Senosi2

1Absa Bank, Division of Retail Banking Business Performance, 2000 Johannesburg, South Africa
2Department of Mathematics and Applied Mathematics, North-West University, 2520 Potchefstroom, South Africa

Received 17 June 2008; Revised 15 October 2008; Accepted 17 November 2008

Academic Editor: Masahiro Yabuta

Copyright © 2008 C. H. Fouche et al. 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.

Abstract

The ongoing subprime mortgage crisis (SMC) and implementation of Basel II Capital Accord regulation have resulted in issues related to bank valuation and profitability becoming more topical. Profit is a major indicator of financial crises for households, companies, and financial institutions. An SMC-related example of this is the U.S. bank, Wachovia Corp., which reported major losses in the first quarter of 2007 and eventually was bought by Citigroup in September 2008. A first objective of this paper is to value a bank subject to Basel II based on premiums for market, credit, and operational risk. In this case, we investigate the discrete-time dynamics of banking assets, capital, and profit when loan losses and macroeconomic conditions are explicitly considered. These models enable us to formulate an optimal bank valuation problem subject to cash flow, loan demand, financing, and balance sheet constraints. The main achievement of this paper is bank value maximization via optimal choices of loan rate and supply which leads to maximal deposits, provisions for deposit withdrawals, and bank profitability. The aforementioned loan rates and capital provide connections with the SMC. Finally, OECD data confirms that loan loss provisioning and profitability are strongly correlated with the business cycle.