In a liquidity crunch banks issue few loans (in terms of value) whilst when the economy is doing well banks issue more loans. In both scenarios we banks tend to either under issue or over issue loans. Borrowing from the Economic Order Quantity idea in inventory management, banks should be able to identify an optimum level in their loan portfolios. Given such model, each bank will be able to issue loans up its level of minimum loan costs and maximum loan returns. My question therefore is, what variables should we take into account in order to establish or to come up with a model that helps establish that optimum level of loan portfolio.
an optimal loan portfolio size model could consider the following variables: interest charged on loans, bank earnings rates, interest rates on government securities (treasury bills and treasury bonds, effective household buying income, and probably consumer effective expenditures on durable goods.
demand is also an important variable followed by cost of fund (holding cost), and non-perfroming loans ratio as ordering cost.
Banks optimisation of loan portfolios is probably easier discovered by a Production frontier , Stochastic Frontier Analysis or Data Envelopment Analysis
Optimum loan for a commercial banks rests on both endogenous as well as exogeneous variables. Reserve requirements determine loanable funds availability. At the same time credit policy of the bank coupled with absorption rate of risk measurement techniques applicable are contributing variables. Then consider amount of non performing loans with a view to reducing the same.
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