Athematical Modeling and Optimal Control of Bank Balance Sheet Dynamics

Enterprise, Research and Development Forum
(EREDEF-2020)
Artificial Intelligence, Digital Economy and African Transformation
U NIVERSITY OF Algebra • Analysis • Computer Science
D SCHANG mailto://dept.math-info@univ-dschang.org
M ATHEMATICAL MODELING AND OPTIMAL CONTROL OF BANK

BALANCE SHEET DYNAMICS
Tadmon Calvin1,* and Njike Tchaptchet Eric Rostand1
1 URMA, Department of Mathematics and Computer Science, University of Dschang, Cameroon
* Corresponding author : tadmonc@yahoo.fr
A BSTRACT: In this paper, we propose and analyze a model of the dynamic of a bank balance sheet
and derive first and second order optimality conditions of an constrained optimal control problem of a
bank balance sheet. The proposed model can be used to perform stress testing under different scenar-
ios which can help to improve the bank balance sheet management in long term context and portfolio
optimization.
K EYWORDS : balance sheet, assets, Liabilities, optimal control
1. Introduction
The origins of bank go back to antiquity. Historians discovered proof of banking activities dating from
3000 before Christ in Mesopotamia. The banking industry grew up exponentially during the century.
Today, in every country, banks (public and private) play an important role in the financial system and
the economy. They provide payment system used by almost all economic agents. Bank also act as
intermediary between economic agent with excess fund and investors seeking fund to pull advantages
of the opportunities. Bank collects fund from savers and borrows them to investors. Collected funds
or deposits represent liabilities and loans are assets. All of these constitute elements of bank balance
sheet. Since the profit of the bank comes, among others, from the difference between interest charged
on loans and other assets and those payed on deposits and others liabilities, bank manager must
perfectly manage its portfolio to maximize profit and the same time to reduce risk bearing by loans.
In financial markets language, this process is called assets and liabilities management (ALM). The
ALM process took place after the 1980’s financial crisis. Because of the central role played by bank
in the entire economy, there exists authority regulation to reduce the risk of economic contagion
coming from the failure of banks. The Basel regulation framework was a result of the 1980’s crisis
experience. One of the main challenge in ALM is the problem of balance sheet modeling. In the
literature, there exists many approaches of this modeling. Amongst others Birge and Judice [1],
Liang et al. [2], Grzegorz [3], Hasman et al. [4], Mankart et al. [5] and Behn et al. [6]. Which is
common to these authors is the use of discrete time models. Continuous time models has been firstly
proposed by Selyutin and Kharuzhnaya [7]. In this chapter we propose a continuous time model of
balance sheet in the form of deterministic dynamical system. Our model differs from which proposed
by Selyutin and Kharuzhnaya [7] in the sense that we took into account eventual losses coming
from earlier selling of securities and made mathematical analysis with simulations. We obtained
conditions on parameters which insure in one hand durability without expansion and on the other
E NTERPRISE , R ESEARCH AND D EVELOPMENT F ORUM (EREDEF-2020) 1

hand durability with expansion of the banking business. We also underline the negative impact of
excess vault cash in the banking process. Our model can be used for educational purposes to simulate
a variety of scenarios of cash flows including stress testing and to study response of the balance sheet
to changes of controlled parameters values. We also consider a more simple bank balance sheet’s
model and derive first and second order optimality conditions of an associated constrained optimal
control problem.
The rest of this chapter is organized as follows. In Section 2, after a brief presentation of bank
balance sheet and basic banking principle, we propose a mathematical model. The Section 3 deals
with the mathematical analysis of the model. Section 4 deals with simulation. In Section 5, we
consider another model of bank balance sheet and derive first and second order optimality conditions
of an associated constrained optimal control problem. We conclude and give perspectives pertaining
this work in Section 6.
2. The model
2.1. The bank balance sheet
One of the main role played by bank in the economy is that of intermediary. They collect funds from
economic agents with excess and borrow them to economic agents seeking additional funds to invest.
Collected funds represent liabilities for bank and assets for depositors or lenders. Funds borrowed to
investors are assets for bank and liabilities for borrowers. The bank balance sheet can then be divided
into two parts: assets and liabilities. Liabilities can be divided into two components: borrowed funds
and capital. Borrowed funds contain deposits made by bank’s clients also called demand deposits
and funds borrowed in interbank market. Capital is the bank’s net worth. It is raised by selling
new equity or from retained earnings and constitutes a cushion against a drop in the value of assets
which can force bank into insolvency. The assets side of balance sheet can be divided into four mains
components: reserves, securities, loans and others assets. There are two types of reserves, required
reserves and excess reserves. Required reserves are held because of reserve requirements imposed by
regulatory authority. Required reserves is a ratio of demand deposit funds. Excess reserves are held
in order to use them when funds are withdrawn. Securities are an important income-earning asset
and they are made up entirely of debt instruments, because banks are not allowed to hold stock. The
loans constitute the main sources of income of the bank. They often possess a higher probability of
default than other assets. The large categories of loans for commercial banks are commercial and
industrial loans made to businesses and real estate loans. Commercial banks also make consumer
loans and lend to each other. In other assets, we have cash in process of collection, deposits at other
banks, bank buildings, computers and so on. The bank balance sheet has the following characteristic
Total assets = total liabilities + capital.
The bank manager has four primary concerns [8]. The first is to make sure that bank possesses
enough ready cash to pay its depositors in case of withdrawals. That is liquidity management. The
second is that the bank manager must pursue an acceptably low level of risk by the acquisition of
assets with low rate of default and by diversification of asset holdings. That is asset management.
The third responsibility is the acquisition of funds at low cost. That is liability management. The
last concern is that the bank manager must decide the amount of capital the bank should maintain
and then defines the capital needs. That is capital adequacy management. All these concerns can

be embedded in ALM. For a prospective management, a model of bank balance sheet can be of an
important help.
2.2. The basic banking principle

Here, we describe the basic operation of a bank inspired on the book of Frederic S. Mishkin and
Stanley G. Eakins [8]. We saw above that the bank balance sheet can be decomposed into two parts:
assets and liabilities. In general terms, banks make profits by selling liabilities (borrowing funds)
with their specifics characteristics and using the proceeds to buy assets with different characteristics.
This process is referred to as asset transformation. For example, demand deposits provided by a set of
persons can provide the funds that enable the bank to make a mortgage loan to another set of persons.
The bank has, in effect, transformed the demand deposits (assets for holders) into a mortgage loan
( assets held by the bank). Another way this process of asset transformation is described is to say
that the bank borrows short and lends long because it makes long-term loans and funds them by
issuing short-dated deposits. The process of assets’ transformation and provision of a set of services
(check clearing, record keeping, credit analysis, and so forth) is like in any other firm. If the bank
produces services at low cost and earns substantial income on its assets, it earns profits; if not, the
bank suffers losses. When a bank receives a deposit (liability), a fraction of this deposit must be kept
in the central bank account. These deposits constitute what is called required reserves. The rest of
deposits can be held into vault cash (excess reserves), but holding deposit requires some expenses.
Interest rate make on deposits and general loads of working. Hence the bank takes a loss by holding
this money in vault. Bank manager must put it into a productive use as buying securities or making
loans after evaluating potential borrowers using the following criteria character, capacity (ability to
repay), collateral, conditions (in the local and national economies), and capital (net worth). If the
bank manager chooses not to hold excess reserves, but to make loans instead, then the asset side
should increase of this amount. For example, if a bank A receives a deposit of 1000 and make a loans
after removing required reserves, its balance sheet should look like follows if we suppose that ten
percent of deposit are retained as required reserves.
Assets Liabilities
Required reserves: 100 Demand deposits:+1000
Loans:900
The bank is now making a profit because it holds liabilities such as demand deposits and uses the
proceeds to buy assets such as loans with higher interest rates. Liabilities are often short-term (less
than one year) whereas assets are long-term (more than one year). if the loans have an interest rate
of ten percent per year, the bank earns 90 in incomes from its loans over the year. If the interest rate
on demand deposits is six percent per year and it costs 10 per year to service the account, then the
bank earns 20 on the new deposits plus any interest that is paid on required reserves.
Let us now present the role of reserves. It serves as rescue to funds outflow. For example, let
us consider the bank A with required reserves equal to ten percent of deposits. We suppose that its
balance sheet looks as follows
Assets Liabilities
Required reserves: 100 Demand deposits:1000
Loans:800 Bank capital : 100
Securities 100
Vault cash 100

If there is a withdraw of 150 in the demand deposits account, then the bank balance sheet should look
like follow
Assets Liabilities
Required reserves: 50 Demand deposits:850
Loans:800 Bank capital : 100
Securities 100
Vault cash 0
There is gap of 35 in required reserves account. The bank manager has three main possibilities:
1. The first one is to borrow this amount of money in interbank market. In this case, the bank
should support the cost of this loan.
2. A second alternative is for the bank to sell some of its securities to help cover this deposit
outflow. But the bank incurs some brokerage and other transaction costs when it sells these
securities.
3. Finally, a bank can acquire this amount 35 of reserves to meet the deposit outflow by reducing
its loans by this amount and depositing the amount in required reserves account. But in this
case, the process of reducing its loans is the bank’s costliest way of acquiring reserves when a
deposit outflow occurs. In fact, if the Bank has numerous short-term loans renewed at fairly
short intervals, it can reduce its total amount of loans outstanding fairly quickly by calling in
loans. That is, by not renewing some loans when they come due. Unfortunately for the bank,
this is likely to antagonize the customers whose loans are not being renewed because they have
not done anything to deserve such treatment. Indeed, they are likely to take their business
elsewhere in the future, a very costly consequence for the bank.
All of the above decisions have a cost. The amount of excess reserves is of main importance in the
reduction of liquidity cost. But holding more cash can reduce the rentability of the bank because on
these cash, bank receives nothing as interest but should pay on it the interest asked by depositors.
The manager should therefore manage it liquidity in order to reduce the cost of eventual shortfall.
This management is efficient if the manager has a suitable tool to understood the mechanism of
bank balance sheet not only in static case but also in dynamic case in order to made a good tradeoff
between decisions which could have impact on bank efficiency in the future.
2.3. The model

Here, we propose the model. For a given bank, we make the following assumptions on its balance
sheet:
1. Its liabilities side contains demand deposits, borrowed funds in interbank market and the capi-
tal.
• Demand deposits: denoted by F , the bank pays on a continuous interest with rate ρF . Its
rate of change depends on supply of funds and withdrawal of depositors. The rate of funds
supply is modeled by a continuous function uF and the withdrawal is proportional to F
with coefficient µ which is a continuous function with value in (0, 1).

• Borrowed funds from interbank market: denoted by M , its rate of change depends on the
maturity profile and the difference between needed funds to satisfy withdrawal and funds
coming from earlier selling of securities. They are solicited as ultimate rescue to satisfy
cash withdrawal. The bank pays on them interests with constant rate ρ3 ∈ (0, 1). The
maturity profile is a constant real number ε4 ∈ (0, 1).
• Capital: denoted by C, it is also the difference between total assets and total liabilities. As
the net worth of the bank, its rate of change depends on earnings and losses coming from
assets, interests payed on demand deposit account and on borrowing from interbank mar-
ket and the amount of money needs to cover operating expenses. In operating expenses we
include taxes, cost of capital, salaries and others expenses. We assume that the operating
expenses are proportional to the current capital with coefficient β ∈ (0, 1).
2. The assets side contains required reserves, private loans( or risky loans), securities, loans to
other banks and vault cash( or excess reserves).
• Reserves: denoted by R, it is a fraction θ ∈ (0, 1) of the demand deposit funds and the bank
receives on them interest with constant rate ρ0 ∈ (0, 1).
• Private loans: denoted by L, its rate of change depends on demand of loans per unit of
time, its maturity profile. The demand per unit of time is modeled by a continuous function
uL . Loans are payed in fine with associated interests. The maturity profile, the interest rate
and the rate of default are the positive real numbers in (0, 1), ε1 , ρ1 and δ respectively.
• Securities: denoted by S, it is formed by one class of free of risk debt instrument (gov-
ernment bonds). Its rate of change depends on the supply of new securities issued by
government or sold by other bank to solve liquidity problem (a continuous function uS ),
its maturity profile and on the rate of haircut due to earlier selling when vault cash are
insufficient to satisfy funds withdrawal. Bank earns on them interests with constant rate
ρ2 ∈ (0, 1). The maturity profile and the rate of haircut are the constant real numbers in
(0, 1), ε2 and δ ∗ respectively. We also suppose that price process of securities is determinis-
tic.
• Loans to other banks (free of risk loans): denoted by N , its rate of change depends on
demand of loans on interbank market and and its maturity profile. The demand of loans
is a continuous functions uN and the maturity profile is a constant real number ε3 ∈ (0, 1).
The bank earns on them interests with constant rate ρ2 ∈ (0, 1).
• Vault cash (or excess reserves): denoted by V , they are funds hold by bank as first rescue
to face funds withdrawal. Its rate of change depends on residual funds after satisfaction of
private loans, securities supply and interbank loans demand.
3. Funds are invested in the following order: assets, private loans, securities, loans to interbank
market and vault cash. Funds invested in private loans is the minimum between demand of
loans and available cash. Those invested in securities is the minimum between residual funds
after investment in private loans and securities supply. The amount of money lend to inter-
bank market is the minimum between residual funds after investment in securities and loans
demand (on interbank market). The vault cash is residual funds after investment in private
loans, securities and loans to interbank market.
4. The model is studied in a finite interval of time [0, T ] where T is a strictly positive real number.

5. We assume that debts are payed in fine with interests.
6. We suppose that ρ1 > ρ2 > ρ3 > ρF . That is, interest rate on private loans is greater than that of
securities which is greater than that of loans to interbank market and all these rates are greater
than rate on demand deposit account.
From the banking principle described above, we propose the following model

 L̇(t) = ψ1 (t, X) min Q(t) − µ(t)F (t) + V (t), uL (t) − ε1 L(t)








 Ḟ (t) = uF (t) − µ(t)F(t)


Ṡ(t) = ψ2 (t, X) min uS (t), Q(t) − µ(t)F (t) + V (t) − uL (t) +







∗

ψ3 (t, X) (1 + δ )(Q(t) − µ(t)F (t) + V (t)) − ψ4 (t, X) 1 − ε2 S(t) − ε2 S(t)








Ṅ (t) = ψ5 (t, X) min uN (t), Q(t) − µ(t)F (t) + V (t) − uL (t) − uS (t) − ε3 N (t)

(1)
Ṙ(t) = θ u (t) − µ(t)F (t)

F





V̇ (t) = ψ6 (t, X) Q(t) − µ(t)F (t) − uL (t) − uS (t) − uN (t) − ψ7 (t, X)V (t)








∗
Ṁ (t) = ψ4 (t, X) µ(t)F (t) − Q(t) − V (t) − (1 − δ )(1 − ε2 )S(t) − ε4 M (t)






Ċ(t) = (ρ1 − ρ1 δ − δ)ε1 L(t) + ρ2 ε2 S(t) + ψ3 (t, X)δ ∗ Q(t) − µ(t)F (t) + V (t) −




 ψ (t, X)δ ∗ (1 − ε )S(t) + (θρ − ρ )F (t) + ε ρ N (t) − ε ρ M (t) − βC(t),

 4 2 0 F 3 3 3 4


C(t) = L(t) + R(t) + V (t) + S(t) + N (t) − F (t) − M (t)
where for all t ∈ [0, T ]

Q(t) = (1 + ρ1 )(1 − δ)ε1 L(t) + ρ0 θ − ρF + θµ(t) F (t) + (1 − θ)uF (t)
+(1 + ρ2 )ε2 S(t) + (1 + ρ3 )ε3 N (t) − (1 + ρ3 )ε4 M (t) − βC(t) (2)
is the available funds except vault cash at time t,

ψ1 (t, X(t)) = χ{Q(t)−µ(t)F (t)+V (t)≥0} ,
ψ2 (t, X(t)) = χ{Q(t)−µ(t)F (t)+V (t)≥uL (t)} ,
ψ3 (t, X(t)) = χ{Q(t)−µ(t)F (t)+V (t)<0} χ{−(Q(t)−µ(t)F (t)+V (t))≤(1−δ∗ )(1−ε2 )S(t)} ,
ψ4 (t, X(t)) = χ{Q(t)−µ(t)F (t)+V (t)<0} χ{−(Q(t)−µ(t)F (t)+V (t))>(1−δ∗ )(1−ε2 )S(t)} ,
ψ5 (t, X(t)) = χ{Q(t)−µ(t)F (t)+V (t)−uL (t)≥uS (t)} ,
ψ6 (t, X(t)) = χ{Q(t)−µ(t)F (t)+V (t)−uL (t)−uS (t)≥uN (t)} ,
ψ7 (t, X(t)) = χ{Q(t)−µ(t)F (t)+V (t)−uL (t)−uS (t)−uN (t)<0} ,
χ is the characteristics function and
X(t) = L(t), F (t), S(t), N (t), R(t), V (t), M (t), C(t)).
Remark 2.1. • The variables C and R in the system 1 can be deducted from others.
• For a given bank, the value of capital C is of great interest. It is the net worth of the bank. It can
be divided into equity and retained earning. Since all retaining earnings and eventual losses are

recorded in C, it reflects the quality of the bank management. The return on equity (ROE) at the
end of a given period defined by
net of prof it af ter taxes C − C0 − taxes
ROE = =
equity C0
is a measure of performance of the bank manager. Here C0 is the total amount of equity at the
beginning of the period. The main objective of the bank manager is to maximize the ROE.
3. Mathematical analysis of the model

3.1. Positivity and boundedness of potential solutions
Variables F and R are linked. That is the positivity of one entails the positivity of the other. For
positive initial values L(0), F (0), S(0), N (0), V (0), M (0), C(0) , to study the positivity of potential
solution of the system (1), we will proceed as follows. Firstly, we prove the positivity of L(t), F (t),
S(t), N (t), V (t) and M (t) for t > 0. Secondly, under additional conditions we prove the positivity
of C(t) for t > 0. In fact, for a given bank, the capital C is its net worth. The first time for which it
reaches zero is the end of the banking process or the bankruptcy. To ensure the positivity of C and
the durability of the bank, there are some hypothesis to be fulfilled.
The following theorem sets the positivity of L(t), F (t), S(t), N (t), R(t), V (t) and M (t) for t > 0 if
initial values are positive.

Theorem 3.1. If the initial conditions L(0), F (0), S(0), N (0), V (0), M (0), C(0) for the system (1) are
positive real numbers, then for all t > 0,
L(t) ≥ 0, F (t) ≥ 0, S(t) ≥ 0, N (t) ≥ 0, R(t) ≥ 0, V (t) ≥ 0 and M (t) ≥ 0
.
Proof. We assume that (L(0), F (0), S(0), N (0), V (0), M (0) and C(0) are positive real numbers. Let
t > 0.
1. For L(t), we have

L̇(t) = ψ1 (t, X) min Q(t) − µ(t)F (t) + V (t), uL (t) − ε1 L(t).
The function ψ1 assumes only two values 0 and 1. If it is equal to 0, then L̇(t) = −ε1 L(t) and
the positivity is obvious. Otherwise, if it is equal to 1, then

ε1 t ε1 t
d(e L(t)) = e min Q(t) − µ(t)F (t) + V (t), uL (t) ≥ 0
from the definition of ψ1 . Which implies the positivity of L(t) for t > 0.
2. The dynamics of F (t) is given by
Ḟ (t) = uF (t) − µ(t)F (t),
that is Rt Rt
µ(s)ds µ(s)ds
d(e 0 F (t)) = e 0 uF (t) ≥ 0
and the positivity of F (t) follows. The positivity of F (t) entails that of R(t) since R(t) = θF (t).

3. Concerning S(t), its dynamics is given by the relation

Ṡ(t) = ψ2 (t, X) min uS (t), Q(t) − µ(t)F (t) + V (t) − uL (t) + ψ3 (t, X) (1 + δ ∗ )(Q(t) − µ(t)F (t) +

V (t)) − ψ4 (t, X) 1 − ε2 S(t) − ε2 S(t)
The functions ψ2 , ψ3 and ψ4 can only take two values 0 and 1 and both of them can not assume
the value 1 at the same time. The possible combinations for theses functions are
• ψ2 = 1, ψ3 = 0 and ψ4 = 0,
• ψ2 = 0, ψ3 = 1 and ψ4 = 0,
• ψ2 = 0, ψ3 = 0 and ψ4 = 1 and
• ψ2 = 0, ψ3 = 0 and ψ4 = 0
In the case ψ2 = 1, ψ3 = 0 and ψ4 = 0, we have

Ṡ(t) = min uS (t), Q(t) − µ(t)F (t) + V (t) − uL (t) − ε2 S(t),
that is
ε2 t ε2 t
d(e S(t)) = e min uS (t), Q(t) − µ(t)F (t) + V (t) − uL (t) ≥0
from the definition of ψ2 . The positivity of S(t) follows.

If ψ2 = 0, ψ3 = 1 and ψ4 = 0, we have

∗
Ṡ(t) = − (1 + δ )(Q(t) − µ(t)F (t) + V (t)) − ε2 S(t),
that is
ε2 t ∗ε2 t
d(e S(t)) = −e (1 + δ )(Q(t) − µ(t)F (t) + V (t)) ≥ 0
from the definition of ψ3 and we obtain the positivity of S(t).

When ψ2 = 0, ψ3 = 0 and ψ4 = 1, we have
Ṡ(t) = −S(t)
and the positivity is obvious.

If ψ2 = 0, ψ3 = 0 and ψ4 = 0, we have
Ṡ(t) = −ε2 S(t)
4. The dynamics of N (t) is given by

Ṅ (t) = ψ5 (t, X) min uN (t), Q(t) − µ(t)F (t) + V (t) − uL (t) − uS (t) − ε3 N (t)

where the function ψ5 assume only two values 1 and 0. If it is equal to 1, then

Ṅ (t) = min uN (t), Q(t) − µ(t)F (t) + V (t) − uL (t) − uS (t) − ε3 N (t),
that is

ε3 t ε3 t
d(e N (t)) = e min uN (t), Q(t) − µ(t)F (t) + V (t) − uL (t) − uS (t) ≥ 0
from the definition of ψ5 and the positivity of N (t) follows. If ψ5 (t, X) = 0 then
Ṅ (t) = −ε3 N (t)
and the positivity of N (t) follows.
5. The dynamics of V (t) is given by the relation

V̇ (t) = ψ6 (t, X) Q(t) − µ(t)F (t) − uL (t) − uS (t) − uN (t) − ψ7 (t, X)V (t)
where ψ6 and ψ7 assume only two values 1 and 0 and can not be equal to 1 at the same time.
The possible configurations are
• ψ6 = 0 and ψ7 = 1,
• ψ6 = 1 and ψ7 = 0 and
For ψ6 = 0 and ψ7 = 1, we have

V̇ (t) = −V (t)
If ψ6 = 1 and ψ7 = 0, the dynamics of V (t) becomes

V̇ (t) = Q(t) − µ(t)F (t) − uL (t) − uS (t) − uN (t) ≥ 0
by definition of ψ6 = 1. In this case V (t) is an increasing function and assume only positive
values.
The positivity of C(t) is given in the following lemma

Lemma 3.1. Let us consider a bank with balance sheet dynamics given by the system (1). Under the
hypothesis (H)
1. For all t > 0, L(t), S(t) or N (t) is strictly positive,
V (t)
2. ∀t > 0, L(t)+S(t)+N (t)+R(t)+V (t)
≈ 0,

3. δ(1 + ρ1 )ε1 < min ρ1 ε1 − ρF , ρ1 ε1 − ρ3 ε4 ,
4. δ ∗ (1 − ε2 ) < min ρ2 ε2 − ρF , ρ2 ε2 − ρ3 ε4 and


5. ρ3 ε3 > max ρF , ρ3 ε4 .
if the initial value of the bank capital C(0) is positive, then C(t) remains positive for all t > 0.
Before the proof of Lemma 3.1, let us give interpretations of the hypothesis (H).
1. The bank manager can act only on L(t), S(t) and N (t). The amount of required reserves is set-
tled by authority regulation. The positivity of L(t), S(t) or N (t) means that bank manager must
hold continuously in his balance sheet at least one interest earning asset other than required
reserves.
V (t)
2. ≈ 0 means that for all t > 0, the vault cash as compared to the total assets
L(t)+S(t)+N (t)+R(t)+V (t)
are too small. This assumption is realistic because for a bank, it is costly to hold cash, since on
the one side, there is no interest earned on them and on the other side, interest has to be paid
on them. Taking into account other financial means to cover up expenditures, excess availability
of vault cash is prejudicious for a bank.

3. δ(1 + ρ1 )ε1 < min ρ1 ε1 − ρF , ρ1 ε1 − ρ3 ε4 means that if a given amount of money received as
deposit or borrowed in interbank market is invested in private loan, then per unit of time, the
loss in this portfolio is less than which is earned after the payment of interest on deposit and on
interbank loan.
4. δ ∗ (1 − ε2 ) < min ρ2 ε2 − ρF , ρ2 ε2 − ρ3 ε4 means that if a given amount of money received as

deposit or borrowed in interbank market is invested in securities, then per unit of time, the
worst loss in this portfolio due to earlier selling is less than which is earned after the payment
of interest on deposit and on interbank loan.

5. ρ3 ε3 > max ρF , ρ3 ε4 means that if a given amount of money received as deposit or borrowed
from interbank market is entirely invested in interbank loans, then per unit of time, the interest
receive from loans to interbank bank market is greater which to be pay on deposit of interbank
borrowing.
Proof. We suppose that (L(0), F (0), S(0), N (0), V (0), M (0) and C(0) are positive real numbers. Let
t > 0. The dynamics of C(t) is given by the relation
Ċ(t) = (ρ1 − ρ1 δ − δ)ε1 L(t) + ρ2 ε2 S(t) + ψ3 (t, X)δ ∗ Q(t) − µ(t)F (t) + V (t)

−ψ4 (t, X)δ ∗ (1 − ε2 )S(t) + (θρ0 − ρF )F (t) + ε3 ρ3 N (t) − ε3 ρ4 M (t) − βC(t) (3)
.
The functions ψ3 and ψ4 assume only two values 1 and 0. Both of them can not simultaneously
assume the value 1. The different possibilities are
1. ψ3 = 1 and ψ4 = 0,
2. ψ3 = 0 and ψ4 = 1 and
3. ψ3 = 0 and ψ4 = 0.

If (ψ3 , ψ4 ) are successively (1, 0), (0, 1) and (0, 0) the dynamics of C(t) are given by the relations
Ċ(t) = (ρ1 − ρ1 δ − δ)ε1 L(t) + ρ2 ε2 S(t) + δ ∗ Q(t) + V (t) + (θρ0 − ρF − δ ∗ µ(t))F (t)

+ε3 ρ3 N (t) − ε3 ρ4 M (t) − βC(t), (4)
Ċ(t) = (ρ1 − ρ1 δ − δ)ε1 L(t) + ρ2 ε2 − δ ∗ (1 − ε2 ) S(t) + (θρ0 − ρF )F (t) + ε3 ρ3 N (t) − ε3 ρ4 M (t) − βC(t)

and
Ċ(t) = (ρ1 − ρ1 δ − δ)ε1 L(t) + ρ2 ε2 S(t) + (θρ0 − ρF )F (t) + ε3 ρ3 N (t) − ε3 ρ4 M (t) − βC(t)
respectively.
The worst variation of C(t) is registered when ψ4 (t, X) = 1, that is when the bank manager have
to sell early all its unmatured securities. In this case the variation of C(t) is given by the relation
Ċ(t) = (ρ1 −ρ1 δ −δ)ε1 L(t)+ ρ2 ε2 −δ ∗ (1−ε2 ) S(t)+(θρ0 −ρF )F (t)+ε3 ρ3 N (t)−ε3 ρ4 M (t)−βC(t). (5)

From Theorem 3.1, L(t), S(t), N (t), R(t), M (t) and F (t) are positive. Using the relation (5) we
have
Ċ(t) ≥ γ1 L(t) + R(t) + N (t) + S(t) − γ0 M (t) + F (t) − βC(t) (6)
where
∗

γ1 = min ρ1 − ρ1 δ − δ ε1 , ρ2 ε2 − δ (1 − ε2 ) , ε3 ρ3 and

γ0 = max ε3 ρ4 , ρF
The relation (6) can also be written as

Ċ(t) ≥ γ1 L(t) + R(t) + N (t) + S(t) − γ0 M (t) + F (t) + C(t) + (γ0 − β)C(t) (7)
that is

Ċ(t) − (γ0 − β)C(t) ≥ γ1 L(t) + R(t) + N (t) + S(t) − γ0 M (t) + F (t) + C(t) (8)
But from the definition of the bank balance sheet we have
M (t) + F (t) + C(t) = L(t) + R(t) + N (t) + S(t) + V (t)
and the relation (8) becomes

Ċ(t) − (γ0 − β)C(t) ≥ γ1 L(t) + R(t) + N (t) + S(t) − γ0 L(t) + R(t) + N (t) + S(t) + V (t) . (9)
The second member of (9) can be written as

γ1 V (t)
L(t) + R(t) + N (t) + S(t) + V (t) γ1 − γ0 − .
L(t) + R(t) + N (t) + S(t) + V (t)

V (t)
If L(t)+S(t)+N (t)+R(t)+V (t)
≈ 0, then, from the fact that γ1 < 1, we have
γ1 V (t)
≈0
L(t) + R(t) + N (t) + S(t) + V (t)
and the second member of (9) is equal to

γ1 − γ0 L(t) + R(t) + N (t) + S(t) + V (t) .
Furthermore, using the positivity of L(t) + S(t) + N (t) + R(t) + V (t), that of C(t) is acquired if
γ1 − γ0 > 0,
which is obtained if the conditions of hypothesis (H) are fulfilled. This end the proof.
The following theorem state about the boundedness of potential solutions of the system (1).
Theorem 3.2. Let T be a strictly positive real number. Under the hypothesis (H), a solution of (1) is such
that for all t ∈ [0, T ],
X(t) ∈ Ω = (X1 , . . . , X8 ) ∈ R8 such that ∀i = 1, . . . , 8 0 ≤ Xi ≤ A(T )

where
A(T ) = max A1 (T ), A2 (T ), A3 (T )
RT
with A1 (T ) =P (0) + 0
uF (s)ds,
RT ∗
RT
A2 (T ) = P (0) + 0 1 + δ (1 − θ) uF (s)ds exp 0 γ4 (s)ds and

RT RT
A3 (T ) = P (0) + 0 uF (s)ds exp 0 γ5 (s)ds .

(1 + δ ∗ )(ρ1 − ρ1 δ − δ) − δ ∗ ε1 , ρ2 + δ ∗ (1 + ρ2 ) ε2 ,

∀t ∈ [0, T ] γ4 (t) = max

∗ ∗
∗
ρ3 + δ (1 + ρ3 ) ε3 , ρ0 + δ (ρ0 + µ(t)) , δ , (10)

∀t ∈ [0, T ] γ5 (t) = max (ρ1 − ρ1 δ − δ)ε1 , ρ2 ε2 , ρ3 ε3 , ρ0

− min (1 + ρ3 )ε4 , ρF + µ(t), β ,
P (0) = L(0) + S(0) + R(0) + N (0) + V (0) = M (0) + F (0) + C(0) and
X(t) = L(t), F (t), S(t), N (t), R(t), V (t), M (t), C(t) .
To prove Theorem 3.2, we need the following lemma

Lemma 3.2. [9] Let f be a nonnegative absolutely continuous function on [0, T ] which satisfies for
almost all t the differential inequality
f˙(t) ≤ g(t)f (t) + h(t),
where g and h are nonnegative, integrable functions on [0, T ]. Then

Z t Z t
f (t) ≤ f (0) + h(s)ds exp( g(s)ds)
0 0
for all 0 ≤ t ≤ T .
We give the proof of Theorem 3.2.

Proof. Let t > 0, from the system (1) we have

∗
Ṁ (t) + Ḟ (t) + Ċ(t) = ψ4 (t, X) µ(t)F (t) − Q(t) − V (t) − (1 − δ )(1 − ε2 )S(t)
−(1 + ρ3 )ε4 M (t) + (ρ1 − ρ1 δ − δ)ε1 L(t) + ρ2 ε2 S(t)

+ψ3 (t, X)δ ∗ Q(t) − µ(t)F (t) + V (t)

−ψ4 (t, X)δ ∗ (1 − ε2 )S(t) + (θρ0 − ρF )F (t)

+ε3 ρ3 N (t) − βC(t) + uF (t) − µ(t)F (t), (11)
where ψ3 and ψ4 can assume only two values 0 and 1 and both of them can not be simultaneously
equal to 1. There and three possibilities
1. ψ3 = 1 and ψ4 = 0,
2. ψ3 = 0 and ψ4 = 1 and
3. ψ3 = 0 and ψ4 = 0.
In the case ψ3 = 0 and ψ4 = 1, using the hypothesis (H), we deduce from (11) that
Ṗ (t) ≤ −γ3 P (t) + uF (t) (12)
where
P (t) = L(t) + R(t) + S(t) + N (t) + V (t) = M (t) + F (t) + C(t) and
γ3 = min(ε1 , ε3 , ρ0 ).
From Lemma 3.2 we have
Z t
P (t) ≤ P (0) + uF (s)ds e−γ3 t , ∀t ∈ [0, T ] (13)
0
Since γ3 is positive and the function uF assume only positive values, the relation (13) becomes
Z T
P (t) ≤ P (0) + uF (s)ds, ∀t ∈ [0, T ]. (14)
0

In the case that ψ3 = 1 and ψ4 = 0, the relation (11) becomes

∗ ∗ ∗
Ṁ (t) + Ḟ (t) + Ċ(t) = (1 + δ )(ρ1 − ρ1 δ − δ) − δ ε1 L(t) + 1 + δ (1 − θ) uF (t)

∗ ∗
+ ρ2 + δ (1 + ρ2 ) ε2 S(t) + ρ3 + δ (1 + ρ3 ) ε3 N (t)
−(1 + δ ∗ )(1 + ρ3 )ε4 M (t) − (1 + δ ∗ )(µ(t) + ρF )F (t) (15)

+ ρ0 + δ (ρ0 + µ(t)) R(t) + δ ∗ V (t) − β(1 + δ ∗ )C(t).
∗
Using the hypothesis (H), the relation (15) becomes

∗
Ṗ (t) ≤ γ4 (t)P (t) + 1 + δ (1 − θ) uF (t), ∀t ∈ [0, T ], (16)
where γ4 is given by the relation (??).

Z t Z t
∗

P (t) ≤ P (0) + 1 + δ (1 − θ) uF (s)ds exp γ4 (s)ds , ∀t ∈ [0, T ]. (17)
0 0
Since the functions γ4 (t) and uF (t) assume only positive values, the relation (17) becomes
Z T Z T
∗

P (t) ≤ P (0) + 1 + δ (1 − θ) uF (s)ds exp γ4 (s)ds , ∀t ∈ [0, T ]. (18)
0 0
In the case ψ3 = 0 and ψ4 = 0, that is there is not loss due to earlier selling of securities, the relation
(11) becomes
Ṁ (t) + Ḟ (t) + Ċ(t) = uF (t) − µ(t)F (t) − (1 + ρ3 )ε4 M (t) + (ρ1 − ρ1 δ − δ)ε1 L(t)
+ρ2 ε2 S(t) + (θρ0 − ρF )F (t) + ε3 ρ3 N (t) − βC(t)
Using the hypothesis (H), the relation (15) becomes
Ṗ (t) ≤ γ5 (t)P (t) + uF (t), ∀t ∈ [0, T ], (19)
where
γ5 (t) = max (ρ1 − ρ1 δ − δ)ε1 , ρ2 ε2 , ρ3 ε3 , ρ0 − min (1 + ρ3 )ε4 , ρF + µ(t), β .
Z t Z t

P (t) ≤ P (0) + uF (s)ds exp γ5 (s)ds , ∀t ∈ [0, T ]. (20)
0 0
Since the functions γ5 (t) and uF (t) assume only positive values, the relation (20) becomes
Z T Z T

P (t) ≤ P (0) + uF (s)ds exp γ5 (s)ds , ∀t ∈ [0, T ]. (21)
0 0

3.2. Existence and uniqueness of the solution
In the system (1), the variable F is independent of the others and the variable C(t) is a linear combi-
nation of the others.
The equation
Ḟ (t) = uF (t) − µ(t)F (t) (22)
can be solve independently to others and the value of R immediately obtained using the relation
R(t) = θF (t) for all t in [0, T ]. Given an initial condition F0 at time 0, let us solve Cauchy problem

Ḟ (t) = uF (t) − µ(t)F (t), (t, F ) ∈ (0, T ] × R
(23)
F (0) = F0
The problem (23) can also be written as

Ḟ (t) = h(t, F ), (t, F ) ∈ [0, T ] × R
(24)
F (0) = F0
where
h is the function defined on [0, T ] × R by
h(t, x) = uF (t) − µ(t)x, ∀(t, x) ∈ (0, T ] × R
The function h is a continuous function of both variables t and x.
Lemma 3.3. The unique solution of the problem (24) is given by the relation
Z t Z t Z t

F (t) = F0 exp − µ(s)ds + uF (s) exp − µ(σ)dσ ds, ∀t ∈ [0, T ].
0 0 s
Proof. The function h is clearly Lipschitz with respect to the variable x. In fact, for all x1 , x2 ∈ R, for
all t ∈ [0, T ], we have
|h(t, x1 ) − h(t, x2 )| ≤ µ(t)|x1 − x2 | ≤ |x1 − x2 |.
From Cauchy-Lipschitz Theorem [9], the problem (24) admits a unique solution defined on [0, T ].
Using integrant factor we obtain the result.
Hence, the system (1) is restricted to the following
∗

 L̇(t) = ψ 1 (t, Y (t)) min Q (t), uL (t) − ε1 L(t)
 Ṡ(t) = ψ (t, Y (t)) min u (t), Q∗ (t) − u (t)+

2 S L


∗ ∗

ψ3 (t, Y (t)) (1 + δ )Q (t) − ψ4 (t, X) 1 − ε2 S(t) − ε2 S(t)

(25)
 Ṅ (t) = ψ5 (t, Y (t)) min uN (t), Q∗ (t) − uL (t) − uS(t) − ε3 N (t)

V̇ (t) = ψ6 (t, Y (t)) Q∗ (t) − uL (t) − uS (t) − uN (t) −

ψ7 (t, X)V (t)



∗ ∗

Ṁ (t) = ψ4 (t, Y (t)) − Q (t) − (1 − δ )(1 − ε2 )S(t) − ε4 M (t)

Y (t) = L(t), S(t), N (t), V (t), M (t) ,
Q∗ (t) = (1 + ρ1 )(1 − δ)ε1 − β L(t) + (1 + ρ2 )ε2 − β S(t) + (1 + ρ3 )ε3 − β N (t)

− (1 + ρ3 )ε4 − β M (t) + (1 − β)V (t) + ρ0 θ − ρF + (1 − θ)(β − µ(t)) F (t) + (1 − θ)uF (t),

ψ1 (t, Y (t)) = χ{Q∗ (t)≥0} ,
ψ2 (t, Y (t)) = χ{Q∗ (t)≥uL (t)} ,
ψ3 (t, Y (t)) = χ{Q∗ (t)<0} χ{−{Q∗ (t)≤(1−δ∗ )(1−ε2 )S(t)} ,
ψ4 (t, Y (t)) = χ{Q∗ (t)<0} χ{−{Q∗ (t)>(1−δ∗ )(1−ε2 )S(t)} ,
ψ5 (t, Y (t)) = χ{Q∗ (t)−uL (t)≥uS (t)} ,
ψ6 (t, Y (t)) = χ{Q∗ (t)−uL (t)−uS (t)≥uN (t)} ,
ψ7 (t, Y (t)) = χ{Q∗ (t)−uL (t)−uS (t)−uN (t)<0} and
χ is the characteristics function.
The following Theorem states about the existence and uniqueness of solution of the problem (25).
Theorem 3.3. Given initial condition Y0 = (L0 , S0 , N0 , V0 , M0 ), the problem (25) admits a unique solu-
tion.
Proof. Let define the function G : [0, T ] × R5 → R5 by
∀(t, Y ) ∈ R5

G(t, Y ) = G1 (t, Y ), G2 (t, Y ), G3 (t, Y ), G4 (t, Y ), G5 (t, Y )
where
0
G1 (t, Y ) = ψ1 (t, Y ) min Q (Y ) + w(t), uL (t) − ε1 L,

0
G2 (t, Y ) = ψ2 (t, Y ) min uS (t), Q (Y ) − uL (t) + w(t)

∗ 0

+ ψ3 (t, Y ) (1 + δ )(Q (Y ) + w(t)) − ψ4 (t, Y ) 1 − ε2 S − ε2 S,

0
G3 (t, Y ) = ψ5 (t, Y ) min uN (t), Q (Y ) + w(t) − uL (t) − uS (t) − ε3 N ,

0
G4 (t, Y ) = ψ6 (t, Y ) Q (Y ) + w(t) − uL (t) − uS (t) − uN (t) − ψ7 (t, Y )V ,

0 ∗
G5 (t, Y ) = ψ4 (t, Y ) − Q (Y ) − w(t) − (1 − δ )(1 − ε2 )S − ε4 M ,

0
Q (Y ) = (1 + ρ1 )(1 − δ)ε1 − β L + (1 + ρ2 )ε2 − β S + (1 + ρ3 )ε3 − β N

− (1 + ρ3 )ε4 − β M + (1 − β)V
and
w(t) = ρ0 θ − ρF + (1 − θ)(β − µ(t)) F (t) + (1 − θ)uF (t).
Let (t, Y1 ), (t, Y2 ) ∈ [0, T ] × R5 , we have
kG(t, Y1 ) − G(t, Y2 )k ≤ ζkY1 − Y2 k
where

ζ = max (5 + δ ∗ ) (1 + ρ1 )(1 − δ)ε1 − β ; (5 + δ ∗ ) (1 + ρ2 )ε2 − β

+ (1 − δ ∗ )(1 − ε2 ); (5 + δ ∗ ) (1 + ρ3 )ε4 − β ; (5 + δ ∗ ) (1 + ρ3 )ε3 − β

∗ ∗
; (5 + δ )(1 − β); (4 + δ )(1 − β) − 1 .

From Cauchy-Lipschitz Theorem [9], the problem (25) admits a unique solution for given initial
condition L(0), S(0), N (0), M (0), V (0) .
3.3. Stability
Let’s define
the following sets
0

Ω1 = Y ∈ Ω, Q (Y ) ≤ mint∈[0,T ] w(t) + uL (t) ,

0

Ω2 = Y ∈ Ω, max w(t) + uL (t) < Q (Y ) ≤ min w(t) + uL (t) + uS (t) ,
t∈[0,T ] t∈[0,T ]

0

Ω3 = Y ∈ Ω, max w(t) + uL (t) + uS (t) < Q (Y ) ≤ min w(t) + uL (t) + uS (t) + uN (t) ,
t∈[0,T ] t∈[0,T ]

Q0 (Y

Ω4 = Y ∈ Ω, maxt∈[0,T ] w(t) + uL (t) + uS (t) + uN (t) < ) ,

Ω5 = Y ∈ Ω, Q0 (Y
) + (1 − δ ∗ )(1
− ε2 )S ≥ maxt∈[0,T ] w(t) and

0 ∗
Ω6 = Y ∈ Ω, Q (Y ) + (1 − δ )(1 − ε2 )S < maxt∈[0,T ] w(t) .
We have the following Lemma
Lemma 3.4. The sets Ωi (i = 1, . . . , 6) are mutually disjoints.
Proof. It is straightforward.
For a given initial condition Y0 , the system (25) can be decomposed into six subsystems given in the follow-
ing lemma
Lemma 3.5. We assume that for all i = 1, . . . , 6, Ωi is non-empty. For a given initial condition Y0 , the problem
(25) can be written as 

 A1 Y + g1 (t), (t, Y ) ∈ I1 × Ω1



 A2 Y + g2 (t), (t, Y ) ∈ I2 × Ω2
A3 Y + g3 (t), (t, Y ) ∈ I3 × Ω3

Ẏ (t) = (26)

 A4 Y + g4 (t), (t, Y ) ∈ I4 × Ω4
A Y + g5 (t), (t, Y ) ∈ I5 × Ω5

 5



A6 Y + g6 (t), (t, Y ) ∈ I6 × Ω6
where
Ii (i = 1, . . . , 6) are closed intervals (as finite union of closed intervals) such that
∪6i=1 Ii = [0, T ],
   
a11 a12 a13 a15 −ε1 0 0 0 0

 0 −ε2 0 0 0 


 a21 a22 a23 a24 a25 

A1 = 
 0 0 −ε3 0 0  , A2 = 
  0 0 −ε3 0 0 ,

 0 0 0 −1 0   0 0 0 −1 0 
0 0 0 0 −ε4 0 0 0 0 −ε4
with

a11 = (ρ1 − ρ1 δ − δ)ε1 − β
a12 = (1 + ρ2 )ε2 − β
a13 = (1 + ρ3 )ε3 − β
a14 =1−β
a15 = −(1 + ρ3 )ε4 + β,
a21 = (1 + ρ1 )(1 − δ)ε1 − β
a22 = ρ2 ε2 − β
a23 = (1 + ρ3 )ε3 − β
a24 =1−β
a25 = −(1 + ρ3 )ε4 + β
   
−ε1 0 0 0 0 −ε1 0 0 0 0
 0
 −ε 2 0 0 0 


 0 −ε2 0 0 0 

A3 =  a 31 a32 a33 a34 a35  , A4 = 
  0 0 −ε3 0 0 ,

 0 0 0 −1 0   a41 a42 a43 a44 a45 
0 0 0 0 −ε4 0 0 0 0 −ε4
with
a31 = (1 + ρ1 )(1 − δ)ε1 − β
a32 = (1 + ρ2 )ε2 − β
a33 = ρ3 ε3 − β
a34 = 1 − β
a35 = −(1 + ρ3 )ε4 + β
a41 = (1 + ρ1 )(1 − δ)ε1 − β
a42 = (1 + ρ2 )ε2 − β
a43 = (1 + ρ3 )ε3 − β
a44 = −β
a45 = −(1 + ρ3 )ε4 + β
   
−ε1 0 0 0 0 −ε1 0 0 0 0
 a51 a52 a53 a54 a55




 0 −1 0 0 0 

A5 =  0 0 −ε3 0 0  , A6 = 
  0 0 −ε3 0 0 

 0 0 0 −1 0   0 0 0 −1 0 
0 0 0 0 −ε4 a61 a62 a63 a64 a65
with
a51 = (1 + δ ∗ ) (1 + ρ1 )(1 − δ)ε

1 − β ,
a52 = 1 + δ ∗ (1 + ρ2 )ε2 − β − ε2 ,

a53 = 1 + δ ∗ (1 + ρ3 )ε3 − β ,

a54 = 1 − β 1 + δ ∗ ,
a55 = − 1 + δ ∗ (1 + ρ3 )ε4 − β

a61 = −(1 + ρ1 )(1 − δ)ε1 + β,

a62 = −(1 + ρ2 )ε2 + β + (1 − δ ∗ )(1 − ε2 ),
a63 = −(1 + ρ3 )ε3 + β,
a64 = −1 + β and
a65 = ρ3 ε4 − β.

   
w(t) uL (t)

 0 


 w(t) − uL (t) 

g1 (t) = 
 0  , g2 (t) = 
  0 ,

 0   0 
0 0
   
uL (t) uL (t)

 uS (t) 


 uS (t) 

g3 (t) = 
 w(t) − uL (t) − uS (t)  , g4 (t) = 
  uN (t) .

 0   w(t) − uL (t) − uS (t) − uN (t) 
0 0
   
0 0

 (1 + δ ∗ )w(t) 


 0 

g5 (t) = 
 0  , g6 (t) = 
  0 .

 0   0 
0 −w(t)
Proof. For each t ∈ [0, T ], the functions ψi (i = 1, . . . , 7) can assume only two values 1 and 0, a meticulous
analysis of all possibilities leads to the fact that only one of the equations Ẏ (t) = Ai Y (t) + gi (t) (i = 1, . . . , 6)
is active. Each equation Ẏ (t) = Ai Y (t) + gi (t) in Ii × Ωi (i = 1, . . . , 6) is a mode in which the system (25) can
evolve. Transitions between these modes depend on the values of ψj (j = 1, . . . , 7) at every time. The set of
different transitions contains all couple (i, j) ⊂ {1, 2, 3, 4, 5, 6}2 with (i 6= j). Initial values in successor modes
are final values in the predecessor modes.
We will study the stability of the system in each mode. For each i ∈ {1, 2, 3, 4, 5, 6}, the model in mode i is
nonhomogeneous and the stability can be studied by using the following theorem.
Theorem 3.4. [9] Let consider the following nonhomogeneous time-varying linear differential equation
Ẋ(t) = A(t)X + f (t) (27)
and the corresponding homogeneous time-varying linear differential equation
Ẋ(t) = A(t)X (28)
where
f = (f1 , . . . , fn ) ∈ C[I, Rn ] and A(t) = (aij (t))n×n ∈ C[I, Rn×n ].
The system (27) has certain class of stability if and only if the zero solution of (28) has the same type of stability.
The following theorem gives the stability condition in all mode.
Theorem 3.5. The system (25) is locally asymptotically stable in Ii for each mode i ∈ {1, 2, 3, 4, 5, 6} if and only if
1. (ρ1 − ρ1 δ − δ)ε1 < β,

δ ∗ ε2
2. ρ2 ε2 < β − 1+δ ∗ ,
3. ρ3 ε3 < β and
4. ρ3 ε4 < β.

Proof. From Theorem 3.4, the stability of each mode in system (25) is equivalent to the stability of the systems
Ẏ (t) = Ai Y (t), i = 1, . . . , 6.
The vector (0, 0, 0, 0, 0) is an equilibrium of all these systems and the eigenvalues of matrix Ai are given as
follows
1. For i = 1, they are (ρ1 − ρ1 δ − δ)ε1 − β, −ε2 , −ε3 , −1 and −ε4 .
2. For i = 2, they are −ε1 , ρ2 ε2 − β, −ε3 , −1 and −ε4 .
3. For i = 3, they are −ε1 , −ε2 , ρ3 ε3 − β, −1 and −ε4 .
4. For i = 4, they are −ε1 , −ε2 , −ε3 , −β and −ε4 .
5. For i = 5, they are −ε1 , 1 + δ ∗ (1 + ρ2 )ε2 − β) − ε2 , −ε3 , −1 and −ε4 .

6. For i = 6, they are −ε1 , −1, −ε3 , −1 and ρ3 ε4 − β.
The equilibrium (0, 0, 0, 0, 0) is locally asymptotically stable if and only if all these eigenvalues are negative.
The proof is completed.
We give some interpretations of local asymptotic stability in Theorem 3.5.
1. (ρ1 − ρ1 δ − δ)ε1 < β means that if the entire capital was invested in private loans, the amount of money
in each inflow of interest payment is less than that of outflow for capital remuneration.
∗
δ ε2
2. ρ2 ε2 < β − 1+δ ∗ means that if the entire capital was invested in securities portfolio, the amount of money
in each inflow of interest payment is less than that of outflow for capital remuneration taking into account
the eventual loss coming from earlier selling of securities.
3. ρ3 ε3 < β means that if the entire capital was invested in interbank market, the amount of money in each
inflow of interest payment is less than that of outflow for capital remuneration.
4. ρ3 ε4 < β means that if the entire capital has been borrowed in interbank market, then after the invest-
ment, the outflow for remuneration of capital must be greater than that of interest payment on loans.
That is the equity holders earn money after the repayment of their loan.
Remark 3.1. • The stabilities conditions in Theorem 3.5, in addition with hypothesis (H) in Lemma 3.1 ensure
the durability of the bank business but not it expansion. In fact the cost of capital is high in such away that
the retained earnings are small and in these conditions the expansion is just impossible.
• If we suppose that the aims of equity holders is to expand the bank activities, then additionally to hypothesis
(H), at least one of the following relations (H’) must be satisfied
1. (ρ1 − ρ1 δ − δ)ε1 ≥ β,
δ ∗ ε2
2. ρ2 ε2 ≥ β − 1+δ ∗ ,
3. ρ3 ε3 ≥ β and
4. ρ3 ε4 ≥ β.
Summing up these relations, we conclude that the rate of capital remuneration must be low if equity holders
need to expand the bank business.

We suppose that the aims of equity holders is to expand the bank activities. The problem is how to act on
parameters to achieve this goal? One possibility is the maturity profile that the bank manager can control. In
our model they are ε1 , ε2 and ε3 . The maturity profile of borrowing in interbank market is external to the bank.
The following theorem states about the maturity profiles of private loans, securities portfolio and interbank
loans for a bank with expansion as principal aims.
Theorem 3.6. For a bank with balance sheet governed by the system (25), we suppose that interest rate are
constant numbers. The bankruptcy is precluded and the business expansion is insured if and only if the maturity
profiles of private loans, securities portfolio and interbank loans ε1 , ε2 and ε3 respectively satisfy the relations
1. ε1 ∈ (ν, 1],
2. ε2 ∈ (ν1 , 1] and
3. ε3 ∈ [0, ν2 )
ν+δ ∗ ν
where ν = max(ρ3 ε4 , ρF , β), ν1 = ρ2 +δ ∗ and ν2 = ρ3 .
Proof. Direct consequence of Lemma 3.1 and Theorem 3.5.
4. Simulations
This section is devoted to simulations of results obtained in Section 3. The profile of uL , uS , uN , uF and µ are
given in Figure 4.1. Initial conditions are L(0) = 400, F (0) = 600, S(0) = 200, N (0) = 150, V (0) = 190,
2.5 0.03
Demand of private loans
Supply of securities 0.028
Demand of loans in interbank market
Amount of money per unit of time
2 0.026
Supply of funds in demand deposit account
0.024
1.5 0.022
0.02
1 0.018
0.016
0.5 0.014
0.012
0 0.01
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000
Time Time
Figure 1: The left hand graphics is for the functions uL , uS , uN and uF , the right hand is for the
function µ
M (0) = 100 and C(0) = 300. The parameters values are ε1 = 0.0027, ε2 = 0.0083, ε3 = 0.016, ε4 = 0.0165,
δ ∗ = 0.000083, ρ0 = 6.944 × 10− 5, β = 0.002, ρ1 = 0.11, ρ2 = 0.05, ρF = 0.035/360, ρ3 = 0.035, δ = 0.03 and
θ = 0.1. The parameter β will assume two values. In Figure 2 and 3 the value of β is 0.002 which is such that
the condition of Theorem 3.5 are fulfilled. In Figure 4 and 5, the value of β is 0.0002 which is such that the
hypothesis (H’) of Remark 3.1 are fulfilled.
In Figure 4.2, the durability of bank is insured even if there is no expansion. In Figure 4.3, we assure that
the functions uL , uS , uN , uF are all equal to 0. That is there is no new investment in assets and no supply of
funds in demand deposit account. The observation suggests that the bankruptcy doesn’t occur immediately but
when all assets are equal to 0. In this case equity holders receive nothing.
In Figure 4.4, the durability and expansion are insured. We can observe that the net wealth of the bank
does’t decrease. When the vault cash increase, the net worth decrease since there is no interest earned on
them. In Figure 4.5 we assume that the functions uL , uS , uN , uS and uF are all equal to 0. That is there is

400 600
Private loans Demand deposits
350 Securities Borrowing from interbank market
500 Net worth of the bank
Loans to interbank market
300 Vault cash
400
250
Amount of money
Amount of money
200 300
150 200
100
100
50
0
0
-50 -100
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Time Time
δ ∗ ε2
Figure 2: The value β is such that (ρ1 − ρ1 δ − δ)ε1 < β, ρ2 ε2 < β − 1+δ ∗
, ρ3 ε3 < β and ρ3 ε4 < β.
400 600
300 Vault cash
400
250
Amount of money
Amount of money
200 300
150 200
100
100
50
0
0
-50 -100
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Time Time
δ ∗ ε2
Figure 3: The value of β is such that (ρ1 − ρ1 δ − δ)ε1 < β, ρ2 ε2 < β − 1+δ ∗
, ρ3 ε3 < β and ρ3 ε4 < β,
ρ3 ε3 ≥ β
no new investment in assets and no supply of funds in demand deposit account. The observation suggest that
even if there is no investment, the speed of decreasing of net worth is slow compared to that in Figure 4.3. The
bankruptcy occurs when all assets except vault cash are equal to 0. After the bankruptcy, the remaining funds
in vault cash can help to pay equity holders.
In Figure 4.6 and Figure 4.7, we have most undesirable scenarios for a bank manager. Here the rate of
liabilities transformation into assets is weak and an important amount of money stay as vault cash. In this
case, since interest rate on securities and interbank loans are fixed exogenously to the bank, in order to avoid
bankruptcy due not to default of assets’ holders but to excess cash, the bank manager can choose to charge more
interest on private loans. But this option can reduce the private loans demand and exacerbate the situation via
the reduction of earning’s sources. As illustrated in the graphics, the net worth can be less than 0 equivalent
to bankruptcy. The profile of uL , uS , uN , uS and uF that entail the observation of Figure 4.6 and Figure 4.7
are depicted in Figure 4.8. From these figures, we deduce the negative impact of excess value of vault cash in
banking business.

400 600
Loans to interbank market 500 Net worth of the bank
300 Vault cash
250 400
Amount of money
Amount of money
200
300
150
100 200
50
100
0
-50 0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Time Time
Figure 4: The value of β satisfies at least one of the following relations (ρ1 − ρ1 δ − δ)ε1 ≥ β, ρ2 ε2 ≥
δ ∗ ε2
β − 1+δ ∗ and ρ3 ε4 ≥ β.
400 600
300 Vault cash
400
250
Amount of money
Amount of money
200 300
150 200
100
100
50
0
0
-50 -100
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Time Time
δ ∗ ε2
β − 1+δ ∗ and ρ3 ε4 ≥ β.
4000 4500
Private loans
Demand deposits
Securities 4000
3500 Borrowing from interbank market
Net worth of the bank
Vault cash
3500
3000
3000
Amount of money
Amount of money
2500
2500
2000 2000
1500
1500
1000
1000
500
500
0
0 -500
0 1000 2000 3000 4000 5000 6000 7000 0 1000 2000 3000 4000 5000 6000 7000
Time Time
δ ∗ ε2
β − 1+δ ∗ and ρ3 ε4 ≥ β.

4000 4500
Private loans
4000 Demand deposits
3500 Securities
Borrowing from interbank market
Net worth of the bank
Vault cash 3500
3000
3000
Amount of money
Amount of money
2500
2500
2000 2000
1500
1500
1000
1000
500
500
0
0 -500
0 1000 2000 3000 4000 5000 6000 7000 0 1000 2000 3000 4000 5000 6000 7000
Time Time
δ ∗ ε2
Figure 7: The value of β is such that (ρ1 − ρ1 δ − δ)ε1 < β, ρ2 ε2 < β − 1+δ ∗
, ρ3 ε3 < β and ρ3 ε4 < β,
ρ3 ε3 ≥ β
9 0.02
Demand of private loans
8 Supply of securities 0.018
Demand of loans on interbank market
Supply of funds in demand deposits account 0.016
0.014
6
0.012
5
0.01
4
0.008
3
0.006
2
0.004
1 0.002
0 0
0 1000 2000 3000 4000 5000 6000 7000 0 1000 2000 3000 4000 5000 6000 7000
Time Time
Figure 8: The left hand graphics is for the functions uL , uS , uN and uF , the right hand is for the
function µ

5. The control of a model of the bank balance sheet
In this section, we consider a simple model of bank balance sheet and solve a constrained optimal control
problem that allows to study the impact of loan’s interest rate on the behavior of the asset side of a bank
balance sheet.
5.1. The problem

In the sequel, we made the following assumptions
1. Time horizon is a constant real number T > 0.
2. Assets’ side of the balance sheet is constituted only by loans and required reserves denoted by L and
R respectively. In liabilities side, there are demand deposit funds and capital denoted by F and C
respectively.
3. The rate of change of Loans depends on new issued loans and the maturity rate of outstanding debt. New
issued loans depend on the interest rate charged on them ρ in [0, 1]. We assume that they are decreasing
functions of the interest rate, that is, investors are more willing to borrow when interest rate is low. We
also assume that loans are repayed in fine with associated interests at the maturity date and matured
loans are proportional to outstanding debt with average constant rate equals to γ ∈ (0, 1). There is a
default on loans repayment proportional to matured loans with an average constant rate δ ∈ (0, 1).
We will assume that new issued loans are given by the function
ρ → (1 − ρ2 )K
where K > 0 is the maximum average amount of money that can be issued as loans per unit of time.
4. Required reserves are a fraction θ ∈ (0, 1) of the demand deposit funds and the bank receives on them
interests with constant rate ρ0 ∈ (0, 1).
5. The bank pays on demand deposit funds a continuous interests with rate ρF ∈ (0, 1). Its rate of change
depends on supply of funds and withdrawal of depositors. The rate of funds supply is modeled by
a continuous function uF assuming positive value in R and the withdrawal is proportional to F with
coefficient µ which is a continuous function with value in [0, 1].
6. Capital is also the difference between total assets and total liabilities. As the net worth of the bank,
its rate of change depends on earnings and losses coming from assets, interests payed on demand de-
posits account and the amount of money needs to cover operating expenses. In operating expenses we
include taxes, cost of capital, salaries and others expenses. We assume that the operating expenses are
proportional to the current capital with coefficient β ∈ (0, 1).
7. ρ > ρF , that is, interest rate on loans is greater than that on demand deposit account.
Under the above assumptions, a model of the bank balance sheet is given by the relation
L̇ = (1 − ρ2 )K − γL



Ḟ = uF (t) − µ(t)F

(29)

 Ṙ = θ(uF (t) − µ(t)F )

Ċ = (ρ − δρ − δ)γL + (θρ0 − ρF )F − βC
Theorem 5.1. Under the hypothesis

1. (ρ − ρδ − δ) > 0 and (ρ − ρδ − δ)γ ≥ ρF ,

2. ρ0 ≥ ρF ,
if L(0), C(0) and F (0) are strictly positive real numbers, then L(t), C(t) and F (t) remain strictly positive for all
t ∈ [0, T ].
Proof. Proceed as in the proof of Lemma 3.1.
Remark 5.1. 1. The condition (ρ − ρδ − δ)γ ≥ ρF , means that if the demand deposit funds are entirely invested
in loans, then the amount of money received per unit of time as repayment of matured loans is greater than
the interest to be payed on demand deposit account.
2. The condition ρ0 ≥ ρF means that if the demand deposit funds are entirely put in the in required reserves,
then the amount of interests received per unit of time is greater than that to be payed on demand deposit
account.
Existence and uniqueness of solution of (29) is straightforward. In what follows, we propose an optimal
control problem and set first and second order optimality conditions. The control is the interest rate on loans,
because the bank’s manager can avoid the liquidity risk coming from the lack of sufficient cash consecutive
to excess demand of loan. Since F (t) is independent of other variables and R(t) can be deduced from it, the
optimal control problem can be stated as follows
 R T −rt


 min − 0 e (ρ(t) − δρ(t) − δ)γL + (θρ0 − ρF )F (t) − βC(t) dt



 subject to
 L̇(t) = (1 − ρ2 (t))K − γL(t)


Ċ(t) = (ρ(t) − δρ(t) − δ)γL + (θρ0 − ρF )F (t) − βC(t) (30)
δ

ρ(t) ∈ max( 1−δ , ρF ), 1 ∀t ∈ [0, T ],








 φ(t, L(t), C(t), ρ(t)) = 0 ∀t ∈ [0, T ],
L(0) = L0 , C(0) = C0 , L(T ) = LT , C(T ) = CT

where
φ(t, L(t), C(t), ρ(t)) = (1+ρ(t))(1−δ)γL(t)+(θρ0 −ρF +µ(t)(θ−1))F (t)+(1−θ)uF (t)−βC(t)−(1−ρ2 (t))K
for all t ∈ [0, T ],
L0 , C0 , LT , CT and r are given real numbers. LT and CT are objectives defined by equity holders of the
bank and r is the interest rate payed on risk free bond issued by the local government.
Remark 5.2. 1. The objective function
Z T
e−rt (ρ(t) − δρ(t) − δ)γL(t) + (θρ0 − ρF )F (t) − βC(t) dt

0
is the sum of actualized profits of the bank during the period [0, T ].
2. The constraint (1+ρ(t))(1−δ)γL(t)+(θρ0 −ρF +µ(t)(θ −1))F (t)+(1−θ)uF (t)−βC(t)−(1−ρ2 (t))K = 0
for all t ∈ [0, T ] states that there is no risk of liquidity due to the insufficiency of cash.
δ

3. The constraint on the control ρ(t) ∈ max( 1−δ , ρF ), 1 for all t ∈ [0, T ] comes from assumptions and the
Theorem 5.1.
4. Since the quantity (θρ0 − ρF )F (t) in the objective function does not depend on the control ρ, then it is
equivalent to consider the following function
Z T
e−rt (ρ(t) − δρ(t) − δ)γL(t) − βC(t) dt

0
as the objective function in problem (30).

5. We assume that δ < 12 . That is, the losses coming from default of matured loans is smaller than fifty per cent
of the total amount due.

5.2. Preliminaries
To solve the problem (30), we will use the approach proposed par Pinho and Rosenblueth [10] in 2007 to solve
constrained optimal control problem. We need the following lemmas.
Lemma 5.1. [11] Let φ be a C 1 function mapping Rn × Rm into Rq . Let
V = {(y, u) ∈ Rn × Rm |φ(y, u) = 0}
and suppose that the matrix ∇u f (y, u) has rank q on V . Then there exists a neighborhood Ve of V and a continuous
function U : Ve → Rm such that
• (y, U (y, u)) ∈ V for all (y, u) ∈ Ve .
• U (y, u) = u for all (y, u) ∈ V .
If φ is of class C ν then U can be chosen to be of class C ν on Ve . Moreover

−1
∇x U (x, u) = −∇⊥ ⊥
u φ(x, u) ∇u φ(x, u)∇u φ(x, u) ∇x φ(x, u) and
⊥ ⊥
−1
∇u U (x, u) = I − ∇u φ(x, u) ∇φ(x, u)∇u φ(x, u) ∇u φ(x, u)
where I is the matrix identity.
The above Lemma based on implicit function theorem will allow us to transform the constrained problem
(30) into an unconstrained one. The following Lemma gives necessary conditions for optimization problems
involving equality constraint which are based on the corresponding results for finite dimensional case.
Suppose we are given an interval I = [a, b] in R and functions f and g mapping I × Rm to R and Rq ,
respectively, with f , g continuous and having continuous partial derivatives with respect to u. Let
e = {(t, u) ∈ I × Rm |g(t, u) = 0}
C
and suppose the matrix ∇u g(t, u) has rank q on C.

e Denote by U the space of piecewise continuous functions
m
mapping I to R and let
U(C)e = {u ∈ U | (t, u(t)) ∈ C
e ∀t ∈ I}.
Lemma 5.2. [11] Suppose u0 ∈ U(C) e and f (t, u0 (t)) ≤ f (t, u(t)) for all t ∈ I such that (t, u) ∈ C.
e Then there
q
exists a unique µ : I → R such that, if
F (t, u) = f (t, u)+ < µ, g(t, u) > ∀(t, u) ∈ I × Rm ,
then ∇u F (t, u0 (t)) = 0 for all t ∈ I. Moreover,
< h, ∇uu F (t, u0 (t))h >≥ 0 for all h ∈ Rm such that ∇u g(t, u0 (t))h = 0.
The function µ is piecewise continuous on I and continuous at each point of continuity of u0 . ∇uu F the Hessian of
F with respect to to u.
The next Lemma is the maximum principle result proved in [11] for the following problem
 Rt

 min t01 L0 (t, x(t), u(t))dt
 subject to


ẋ = f0 (t, x(t), u(t)), ∀t ∈ [t0 , t1 ] (31)



 x(t0 ) = ξ0 , x(t1 ) = ξ1 ,

(t, x(t), u(t)) ∈ A0 , ∀t ∈ [t0 , t1 ]
where A0 is an open set of [t0 , t1 ] × Rn × Rm , L0 : [t0 , t1 ] × Rn × Rm → R and f0 : [t0 , t1 ] × Rn × Rm → Rn are

given functions.

Lemma 5.3. [11] Assume that the functions L0 , f0 in (31) and their partial derivatives with respect to x are
continuous on A0 , and the set A0 is admissible in the sense that, for each (s, y, v) ∈ A0 , there exist δ0 and
u : [s − δ0 , s + δ0 ] → Rm continuous such that u(s) = v and (t, u(t)) ∈ A0 for all (t, x) ∈ [t0 , t1 ] → Rn with
|(t, x) − (s, y)| < δ0 . If (x0 , u0 ) solves (31), then there exist λ0 ≥ 0 and a function p ∈ X the set of piecewise C 1
functions mapping [t0 , t1 ] to Rn , not both zero, such that
• ṗ(t) = −∇x H(t, x0 (t), u0 (t), p(t), λ0 ) on every interval of continuity of u0 .
• H(t, x0 (t), u, p(t), λ0 ) ≤ H(t, x0 (t), u0 (t), p(t), λ0 ) for all (t, u) ∈ [t0 , t1 ] × Rm with (t, x0 (t), u) ∈ A0 .
where H(t, x, u, p, λ) =< p, f0 (t, x, p) > −λL0 (t, x, u). Moreover, If A0 is open and L0 and f0 are continuous on
A0 and C 1 on A0 with respect to u, then ∇u H(t, x0 (t), u0 (t), p(t), λ0 ) = 0. If also L0 and f0 are C 2 on A0 with
respect to u then ∇uu H(t, x0 (t), u0 (t), p(t), λ0 ) ≤ 0 for all t ∈ [t0 , t1 ] with ∇uu H the Hessian of H with respect to
to u.
To derive second order condition of optimality, we need to define some concepts. Let us consider the
following constrained problem  Rt

 min t01 L0 (t, x(t), u(t))dt
 subject to


ẋ = f0 (t, x(t), u(t)), ∀t ∈ [t0 , t1 ] (32)



 x(t0 ) = ξ0 , x(t1 ) = ξ1 ,

(t, x(t), u(t)) ∈ A0 , ∀t ∈ [t0 , t1 ]
where
A0 = {(t, x, u) ∈ [t0 , t1 ] × Rn × Rm | φ(t, x, u) = 0}
and φ : [t0 , t1 ] × Rn × Rm → Rq is of class C 2 and the matrix ∇u φ(t, x, u) has rank q on A0 .
Definition 5.1. [10]
1. Admissible variations.
Given (x, u) ∈ X × U let A(t) = ∇x f0 (t, x(t), u(t)), B(t) = ∇u f0 (t, x(t), u(t)), and define the set Y(X, ρ)
of A0 -admissible variations along (x, u) as the set of all (y, v) ∈ X × U satisfying
i) y(t0 ) = y(t1 ) = 0.
ii) ẏ(t) = A(t)y(t) + B(t)v(t) ∀t ∈ [0, T ].
iii) ∇x φ(t, x(t), u(t))y(t) + ∇u φ(t, x(t), u(t))v(t) = 0 ∀t ∈ [t0 , t1 ].
2. The sets M, E and H.

For all (x, u) ∈ X × U let
M(x, u) = {(λ0 , p, µ) ∈ R × X × U | λ0 ≥ 0, λ0 + kpk =
6 0, ṗ(t) = −∇x H(t, λ0 ), ∇u H(t, λ0 ) = 0},
where H(t, λ0 ) =< p, f0 (t, x, u) > −λ0 L0 (t, x, u)− < µ, φ(t, x, u) > and k.k is the euclidian norm on Rn .
E = {(x, u, p, µ) ∈ X × U × X × U | ẋ(t) = f0 (t, x(t), u(t)) ∀t ∈ [t0 , t1 ] and (1, p, µ) ∈ M(x, u)},

H = {(x, u, p, µ) ∈ X × U × X × U | W (x, u), (y, v) ≥ 0 ∀(y, v) ∈ Y(x, u)},
where

Z T
W (x, u), (y, v) = 2Ω(t, y(t), v(t))dt ∀(y, v) ∈ X × U
0
and for all (t, y, v) ∈ [t0 , t1 ] × Rn × Rm ,
2Ω(t, y, v) = −[< y, ∇xx H(t, 1)y > +2 < y, ∇xu H(t, 1)v > + < v, ∇uu H(t, 1)v >]
where ∇xx H(t, 1), ∇xu H(t, 1) and ∇uu H(t, 1) are second order derivatives.

3. Normality
A couple (x, u) ∈ X × U will be said to be normal to the problem (32) if, given (p, µ) ∈ X × U such that, for
all t ∈ [t0 , t1 ],
ṗ(t) = −A⊥ (t)p(t) + ∇⊥

x φ(t, x(t), u(t))µ(t),
B ⊥ (t)p(t) − ∇u φ(t, x(t), u(t))µ(t) = 0,
Then p ≡ 0. In this case , also µ ≡ 0. We also note that, if (x, u) is normal to the problem (32) and
(λ0 , p, µ) ∈ M(x, u), then λ0 6= 0.
The following definition of normality for equality constraints generalizes those given in [12], [13] and [14].
Definition 5.2. Let (x, u) ∈ X × U and suppose that, given (p, µ) ∈ X × U such that, for all t ∈ [t0 , t1 ]
ṗ(t) = −A⊥ (t)p(t) + ∇⊥

x φ(t, x(t), u(t))µ(t),
p⊥ (t)B(t)h = 0 for all h ∈ Rm satisfying ∇u φ(t, x(t), u(t))h = 0
necessarily p ≡ 0 and hence (x, u) is normal to the problem (32).
5.3. First and second order condition of optimality

We give here the main results of this section. The first and second order optimality condition of the problem
(30) are stated.
The problem (30) can be written as follows
 RT

 min 0 L0 (t, X(t), ρ(t))dt
 subject to


Ẋ = f0 (t, X(t), ρ(t)) ∀t ∈ [0, T ], (33)



 X(0) = X0 , X(T ) = XT ,

(t, X(t), ρ(t)) ∈ A0 ∀t ∈ [0, T ].
where
X = (L, C), X0 = (L0 , C0 ) (L0 , C0 > 0), XT = (LT , CT ),
For all (t, X, ρ) ∈ [0, T ] × R2 × R,
L0 (t, X, ρ) = −e−rt (ρ − δρ − δ)γL − βC ,

f0 (t, X, ρ) = (1 − ρ2 )K − γL, (ρ − δρ − δ)γL + (θρ0 − ρF )F (t) − βC and

δ

A0 = {(t, X, ρ) ∈ [0, T ] × (0, ∞) × max( 1−δ , ρF ), 1 | φ(t, X, ρ) = 0}.
The following theorem provides the first order optimality condition of the problem (33).
Theorem 5.2. Suppose (X ∗ , ρ∗ ) = (L∗ , C ∗ , ρ∗ ) solves the problem (33). Then there exist λ0 ≥ 0, a function
q = (q1 , q2 ) ∈ X and η ∈ U1 continuous on each interval of continuity of ρ∗ , not vanishing simultaneously on
[0, T ], such that
1. On every interval of continuity of ρ∗ ,

q̇1 (t) = q1 (t)α1 (t) + q2 (t)α2 (t) + α3 (t)
q̇2 (t) = q1 (t)α4 (t) + q2 (t)α5 (t) + α6 (t)
−2ρ∗ (t)Kq1 +(1−δ)γL∗ (t))(q2 (t)+λ0 )

2. η(t) = 2ρ∗ (t)K+(1−δ)γL∗ (t) on every interval of continuity of ρ∗ .
3. H(t, X ∗ (t), ρ, q(t), η(t), λ0 ) ≤ H(t, X ∗ (t), ρ∗ (t), q(t), η(t), λ0 ) for all (t, ρ) in [0, T ] × R with (t, X ∗ (t), ρ) ∈
A0 .

Where
H(t, X, ρ, p, η, λ0 ) =< q, f0 (t, X, ρ) > −λ0 ert L0 (t, X, ρ) − ηφ(t, X, ρ) (34)

−2ρ∗ (t)K(1+ρ∗ (t))(1−δ)γ
α1 (t) = r + γ + 2ρ∗ (t)K+(1−δ)γL∗ (t) ,
(1−δ)γ 2 L∗ (t)−2γρ∗ (t)K(ρ∗ (t)−ρ∗ (t)δ−δ)
α2 (t) = 2ρ∗ (t)K+(1−δ)γL∗ (t) ,
∗ ∗ (1+ρ∗ (t))(1−δ)γ
α3 (t) = λ0 (ρ (t) − ρ (t)δ − δ)γ + 2ρ∗ (t)K+(1−δ)γL∗ (t) ,
2ρ∗ (t)Kβ
α4 (t) = 2ρ∗ (t)K+(1−δ)γL ∗ (t) ,
2ρ∗ (t)Kβ
α5 (t) = r + 2ρ∗ (t)K+(1−δ)γL∗ (t) ,
2λ0 ρ∗ (t)Kβ
α6 (t) = 2ρ∗ (t)K+(1−δ)γL ∗ (t) ,
<, > is the scalar product in R2 .

X is the set of piecewise C 1 functions mapping [0, T ] to R2 and
U1 is the space of piecewise continuous functions mapping [0, T ] to R.
Proof. L0 , f0 and φ are C 2 functions on [0, T ] × R2 × R. Furthermore,
∂φ
= (1 − δ)γL + 2ρK
∂ρ
which is different to zero on A0 .

By Lemma 5.1, there exists a neighborhood B0 of A0 and a C 2 function
U : B0 → R
such that
• (t, X, U (t, X, ρ)) ∈ A0 for all (t, X, ρ) ∈ B0 ,
• U (t, X, ρ) = ρ for all (t, X, ρ) ∈ A0 .
Now, set
fb0 (t, X, ρ) = f0 (t, X, U (t, X, ρ)), Lb0 (t, X, ρ) = L0 (t, X, U (t, X, ρ)) ∀(t, X, ρ) ∈ B0 .
Let us prove that (X ∗ , ρ∗) solves the problem
 RT
min 0 L0 (t, X(t), ρ(t))dt

 b

 subject to


Ẋ = fb0 (t, X(t), ρ(t)) ∀t ∈ [0, T ], (35)




 X(0) = X0 , X(T ) = XT ,
 (t, X(t), ρ(t)) ∈ B ∀t ∈ [0, T ].
0
Since (X ∗ , ρ∗ ) solves (33) we have for all (t, X, ρ) ∈ A0 ,

 RT RT
 0 L0 (t, X ∗ (t), ρ∗ (t))dt ≤ 0 L0 (t, X(t), ρ(t))dt
Ẋ ∗ = f0 (t, X ∗ (t), ρ∗ (t))
 ∗
X (0) = X0 , X ∗ (T ) = XT
Hence , (t, X ∗ (t), ρ∗ (t)) ∈ A0 ⊂ B0 for all t ∈ [0, T ] and

∗
Ẋ (t) = fb0 (t, X ∗ (t), ρ∗ (t)) ∀t ∈ [0, T ]
(36)
X ∗ (0) = X0 , X ∗ (T ) = XT

It remains to prove that for all (X,
b ρb) solving the problem

 Ẋ = fb0 (t, X(t), ρ(t)) ∀t ∈ [0, T ],
X(0) = X0 , X(T ) = XT , , (37)
(t, X(t), ρ(t)) ∈ B0 ∀t ∈ [0, T ].

we have Z T Z T
Lb0 (t, X ∗ (t), ρ∗ (t))dt ≤ Lb0 (t, X(t),
b ρb(t))dt. (38)
0 0
Let (X,
b ρb) solving (37) and define
X(t) = X(t),
b ρ(t) = U (t, X(t),
b ρb(t)) ∀t ∈ [0, T ].
Then (t, X(t), ρ(t)) ∈ A0 and Ẋ(t) = f0 (t, X(t), ρ(t)) and so (X, ρ) solves

 Ẋ(t) = f0 (t, X(t), ρ(t)) ∀t ∈ [0, T ]
X(0) = X0 , X(T ) = XT
(t, X(t), ρ(t)) ∈ A0 ∀t ∈ [0, T ]

Also, Z T Z T
L0 (t, X(t), ρ(t))dt = Lb0 (t, X(t),
b ρb(t))dt
0 0
and Z T Z T
Lb0 (t, X ∗ (t), ρ∗ (t))dt = L0 (t, X ∗ (t), ρ∗ (t))dt
0 0
which implies inequality (38).
Now by Lemma 5.3 applied to (X ∗ , ρ∗ ) with respect to problem (35), there exist λ0 ≥ 0 and p = (p1 , p2 ) ∈ X ,
not both zero such that if
b X, ρ) = p1 (1 − U 2 (t, X, ρ))K − γL

H(t,

+ p2 (U (t, X, ρ) − U (t, X, ρ)δ − δ)γL + (θρ0 − ρF )F (t) − βC
+ λ0 e−rt (U (t, X, ρ) − U (t, X, ρ)δ − δ)γL − βC

∀(t, X, ρ) ∈ B0
then
b X ∗ (t), ρ∗ (t)) on every interval of continuity of ρ∗ .
a. ṗ(t) = −∇X H(t,
b X ∗ (t), ρ) ≤ H(t,
b. H(t, b X ∗ (t), ρ∗ (t)) for all (t, ρ) in [0, T ] × R with (t, X ∗ (t), ρ) ∈ B0 .
Let us denote by q = (q1 , q2 ) the vector ert p and define
G(t, X, ρ) = q1 (1 − U 2 (t, X, ρ))K − γL + q2 (ρ − ρδ − δ)γL + (θρ0 − ρF )F (t) − βC

+ λ0 (ρ − ρδ − δ)γL − βC
b X, ρ) = e−rt G(t, X, U (t, X, ρ)) for all (t, X, ρ) ∈ B0 .

so that H(t,
Since U (t, X, ρ) = ρ for all (t, X, ρ) ∈ A0 , it follows from b. that
G(t, X ∗ (t), ρ) ≤ G(t, X ∗ (t), ρ∗ (t)) ∀(t, ρ) ∈ [0, T ] × R with (t, X, ρ) ∈ A0 .
Let g(t, ρ) = φ(t, X ∗ (t), ρ) and h(t, ρ) = −G(t, X ∗ (t), ρ) for all (t, ρ) ∈ [0, T ] × min( 1−δ
δ

, ρF ), 1 and set
δ
Se = {(t, ρ) ∈ [0, T ] × max( , ρF ), 1 | g(t, ρ) = 0}.
1−δ

Since h(t, ρ∗ (t)) ≤ h(t, ρ) for all (t, ρ) ∈ S,
e by Lemma 5.2 there exists a unique η ∈ U1 such that, if we set
F (t, ρ) = h(t, ρ) + η(t)g(t, ρ),

∂F (t,ρ∗ (t))
then ∂ρ = 0. In other words, if
b X, ρ) = G(t, X, ρ) − η(t)φ(t, X, ρ),

G(t,
b X ∗ (t), ρ) = −F (t, ρ), then
so that G(t,
∂G
b ∂G ∂φ
(t, X ∗ (t), ρ∗ (t)) = (t, X ∗ (t), ρ∗ (t)) − η(t) (t, X ∗ (t), ρ∗ (t)) = 0 ∀t ∈ [0, T ].
∂ρ ∂ρ ∂ρ
∗ ∗
That is, η(t) = −2ρ (t)Kq 1 +(1−δ)γL (t))(q2 (t)+λ0 )
2ρ∗ (t)K+(1−δ)γL∗ (t) and the point 2. of Theorem is obtained.
The function η is continuous on each interval of continuity of ρ∗ . Since, for all (t, X, ρ) ∈ B0 , we have
b X, ρ) = e−rt G(t, X, U (t, X, ρ)), it follows that
(t, X, U (t, X, ρ)) ∈ A0 and H(t,
b X, ρ) = e−rt G(t,
H(t, b X, U (t, X, ρ)) ∀(t, X, ρ) ∈ B0 .
Consequently,
∗ ∗
b X ∗ (t), ρ∗ (t)) + ∂ G(t, X (t), ρ (t)) ∇X U (t, X ∗ (t), ρ∗ (t))
b
b X ∗ (t), ρ∗ (t)) = e−rt ∇X G(t,

∇X H(t,
∂ρ
−rt ∗ ∗
= e ∇X G(t, X (t), ρ (t)).
b
b X, ρ) = ert H(t, X, ρ, p(t), η(t), λ0 ), using the condition a. above, we obtain by derivation the point 1.
Since G(t,
of the Theorem. The condition b. above leads to point 3. of the Theorem.
In what follows we derive second order conditions of optimality of the problem (33).
The following Lemma will be useful in the sequel.
Lemma 5.4. Consider the problem (35) and suppose that (X ∗ , ρ∗ ) is normal to the problem (33). Then (X ∗ , ρ∗ ) is
normal to the problem (35)
Proof. We want to prove that p ≡ 0 is the only solution of

b⊥ p(t),
ṗ(t) = −A b ⊥ (t)p(t) = 0 ∀t ∈ [0, T ],
B (39)
which is the normality condition in the unconstrained case. Here,

!
a11 (t) b
a12 (t) bb1 (t)
A= , B(t) =
b b
ba21 (t) b
a22 (t) bb2 (t)
with
a11 (t) = −γ − 2KU (t) ∂U∂L(t) ,
b
a12 (t) = −2KU (t) ∂U
b (t)
∂C ,
a21 (t) = (U (t) − U (t)δ − δ) + (1 − δ) ∂U∂L(t) L∗ (t) γ,

b
a22 (t) = −2KU (t) ∂U∂ρ(t) ,
b
∂U (t)
bb1 (t) = − K ∂ρ 2 ,
(1+U (t))
bb2 (t) = (1 − δ) ∂U (t) γL∗ (t) and
∂ρ
U (t) ≡ U (t, X ∗ (t), ρ∗ (t)).

From Lemma 5.2, the relation (39) becomes
ṗ(t) = −A⊥ (t)p(t) + ∇X φ(t, X ∗ (t), ρ∗ (t))µ(t)
and
∂φ(t, X ∗ (t), ρ∗ (t))
B ⊥ (t)p(t) − µ(t) = 0 ∀t ∈ [0, T ],
∂ρ
µ(t) = ∂φ(t,X ∗1(t),ρ∗ (t)) B ⊥ (t)p(t),
∂ρ

−γ 0 −2ρ(t)K
A(t) = and B(t) = .
(ρ(t) − ρ(t)δ − δ)γ −β (1 − δ)γL(t)
Thus, the normality of (X ∗ , ρ∗ ) to problem (33) implies that p ≡ 0.
We can now establish first and second order conditions for the problem (33).
Theorem 5.3. Let (X ∗ , ρ∗ ) be a solution of problem (33). Then (X ∗ , ρ∗ ) is normal to the problem (33).
Proof. Let (p, µ) ∈ X × U1 such that
ṗ(t) = −A⊥ (t)p(t) + ∇⊥

X φ(t, X(t), ρ(t))µ(t)
and
p⊥ (t)B(t)h = 0 for all h such that (1 − δ)γL∗ + 2ρ(t)K h = 0.

The only h ∈ R that satisfies (1−δ)γL∗ +2ρ(t)K h = 0 is zero and then p⊥ (t)B(t)h = 0. Thus, from Definition

5.2, p ≡ 0 and (X ∗ , ρ∗ ) is normal to the problem (33).
Theorem 5.4. Let (X ∗ , ρ∗ ) be a solution of problem (33). There exists a unique (p, µ) ∈ X × U1 such that
(X ∗ , ρ∗ , p, µ) ∈ E. Moreover, (X ∗ , ρ∗ , p, µ) ∈ H.
Proof. Since (X ∗ , ρ∗ ) solves the problem (33), then by Theorem 5.2, M(X ∗ , ρ∗ ) 6= ∅. Let (λ0 , p, µ) ∈ M(X ∗ , ρ∗ ),
this implies that λ0 6= 0 and if (λ0 , q, ν) ∈ M(X ∗ , ρ∗ ), then r = p − q satisfies
(
ṙ(t) = −A⊥ (t)r(t) + ∇⊥ X φ(t, X(t), ρ(t))[µ(t) − ν(t)],
⊥ ∂φ(t,X(t),ρ(t))
B (t)p(t) − ∂ρ [µ(t) − ν(t)] = 0,
implying p ≡ q and µ ≡ ν. Let (p, µ) ∈ X × U1 be the unique pair such that (X ∗ , ρ∗ , p, µ) ∈ E and define
Z T
Z(X, ρ) = p1 (T )LT + p2 (T )CT − (p1 (0)L0 + p2 (0)C0 ) + F (t, X(t), ρ(t))dt ∀(X, ρ) ∈ X × U1 ,
0
where , for all (t, X, ρ) ∈ [0, T ] × R2 × R,
F (t, X, ρ) = L0 (t, X, ρ)− < p(t), f0 (t, X, ρ) > +µ(t)φ(t, X, ρ)− < ṗ(t), X > .
We can observe that

F (t, X, ρ) = −H(t, X, ρ, p(t), µ(t), 1)− < ṗ(t), X >
where
H(t, X, ρ, p(t), µ(t), 1) =< p(t), f0 (t, X, ρ) > −L0 (t, X, ρ) − µ(t)φ(t, X, ρ)
and if (X, ρ) satisfies the system 
 Ẋ = f0 (t, X(t), ρ(t)) ∀t ∈ [0, T ],
X(0) = X0 , X(T ) = XT ,
(t, X(t), ρ(t)) ∈ A0 ∀t ∈ [0, T ].


, then Z T
Z(X, ρ) = L0 (t, X(t), ρ(t))dt.
0
Let (Y, ν) ∈ Y(X ∗ , ρ∗ ). By Lemma 5.1 and iii) in Definition 5.1 about A0 -admissible variations, we have
∂U (t, X ∗ (t), ρ∗ (t)

∇X U (t, X ∗ (t), ρ∗ (t))Y (t) + ν(t) = ν(t).
∂ρ
Therefore,
Ẏ (t) = A(t)Y (t) + B(t)ν(t) (40)

∂U (t, X ∗ (t), ρ∗ (t)
= A(t)Y (t) + B(t)[∇X U (t, X ∗ (t), ρ∗ (t))Y (t) + ν(t)]
∂ρ
= A(t)Y
b (t) + B(t)ν(t)
b
where A(t)
b and B(t)
b are defined as in (39). The equality
Y (t) = A(t)Y
b (t) + B(t)ν(t)
b
in (40) means that (X ∗ , ρ∗ ) is B0 -admissible (see [10] for definition of admissible variation in unconstrained
case).
From Lemma 5.4, (X ∗ , ρ∗ ) is normal to the problem (35). Therefore, by Lemma 2.5 in [10], there exist
η > 0 and a one-parameter family (X(., b ), ρb(., )) for all such that || < η solution to the problem

 Ẋ = fb0 (t, X(t), ρ(t)) ∀t ∈ [0, T ],
X(0) = X0 , X(T ) = XT ,
(t, X(t), ρ(t)) ∈ B0 ∀t ∈ [0, T ].

satisfying
b 0) = X ∗ (t), ρb(t, 0) = ρ∗ (t) for all t ∈ [0, T ].
i) X(t,
∂ X(t,0) ∂ ρb(t,0)
ii) = ν(t) for all t ∈ [0, T ].
b
∂ = Y (t), ∂

Let define X(t, ) = X(t,
b ) and ρ(t, ) = U t, X(t,

b ), ρb(t, ) .
Clearly, X(., ), ρ(., ) solves the problem

 Ẋ = f0 (t, X(t), ρ(t)) ∀t ∈ [0, T ],
X(0) = X0 , X(T ) = XT ,
(t, X(t), ρ(t)) ∈ A0 ∀t ∈ [0, T ].

Let

Z T
g() = Z X(., ), ρ(., ) = F t, X(t, ), ρ(t, ) dt ∀ || < η.
0
Thus, g() ≥ g(0) for all such that || < η. We have
T

∂F t, X(t, ), ρ(t, )
Z
0
g () = dt
0 ∂
Z T
∂ H(t, 1)+ < ṗ(t), X(t, ) >
= − dt
0 ∂
Z T
∂X ∂H(t, 1)
= − < ∇X H(t, 1), > +ṗ(t) + dt
0 ∂ ∂ρ

with H(t, 1) ≡ H t, X(t, ), ρ(t, ), p(t), µ(t), 1 . We have g 0 (0) = 0, since

∂ρ(t, 0) ∂U (t, X ∗ (t), ρ∗ (t))

= ∇X U (t, X ∗ (t), ρ∗ (t))Y (t) + ν(t) = ν(t)
∂ ∂ρ
Furthermore,
T
∂ 2 H(t, 1) ∂U (t, 1) ∂L(t, ) ∂ 2 H(t, 1) ∂U (t, 1) 2
Z
g 00 () = 2 + dt
0 ∂ρ∂L ∂ ∂ ∂ρ2 ∂

with U (t, 1) ≡ U t, X(t, ), ρ(t, ), p(t), µ(t),1 .
We have 0 ≤ g 00 (0) = W (X ∗ , ρ∗ ), (Y, ν) with
T
(L∗ (t)ν 2 (t) − 2Y1 (t)ρ∗ (t)ν(t))(p1 (t) + p2 (t) + e−rt )
Z
W (X ∗ , ρ∗ ), (Y, ν) = 2(1 − δ)γK

dt
0 2ρ∗ (t)K + (1 − δ)γL∗ (t)
where p = (p1 , p2 ) is the solution of the system
ṗ(t) = −∇X H(t, X ∗ (t), ρ∗ (t), p(t), ν(t), 1).
6. Conclusion
In this chapter, we proposed and analyzed a mathematical model of a bank balance sheet. The proposed model
can help to best understanding of assets and liabilities management and to visualize different scenarios in the
banking process. It can also be used for optimization and control purposes. We found from the study made in
Section 3 that maturity profile of assets side of the balance sheet and the rate of remuneration of the capital are
of great importance
in the banking process. To insure the durability of a bank business, there are conditions
(H) and (H’) to be fulfilled. The main task of the manager is amongst other to match the asset side of the
balance sheet in such a way that the conditions (H) and (H’) are fulfilled. We also derive first and second order
optimality conditions for a constrained optimal control problem of a bank balance sheet model.
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36

Athematical Modeling and Optimal Control of Bank Balance Sheet Dynamics

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Athematical Modeling and Optimal Control of Bank Balance Sheet Dynamics

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Enterprise, Research and Development Forum

M ATHEMATICAL MODELING AND OPTIMAL CONTROL OF BANK

K EYWORDS : balance sheet, assets, Liabilities, optimal control

E NTERPRISE , R ESEARCH AND D EVELOPMENT F ORUM (EREDEF-2020) 1

Total assets = total liabilities + capital.

E NTERPRISE , R ESEARCH AND D EVELOPMENT F ORUM (EREDEF-2020) 2

2.2. The basic banking principle

E NTERPRISE , R ESEARCH AND D EVELOPMENT F ORUM (EREDEF-2020) 3

2.3. The model

E NTERPRISE , R ESEARCH AND D EVELOPMENT F ORUM (EREDEF-2020) 4

E NTERPRISE , R ESEARCH AND D EVELOPMENT F ORUM (EREDEF-2020) 5

where for all t ∈ [0, T ]

is the available funds except vault cash at time t,

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3. Mathematical analysis of the model

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In the case ψ2 = 1, ψ3 = 0 and ψ4 = 0, we have

from the definition of ψ2 . The positivity of S(t) follows.

from the definition of ψ3 and we obtain the positivity of S(t).

and the positivity is obvious.

Ṡ(t) = −ε2 S(t)

and the positivity is obvious.

4. The dynamics of N (t) is given by

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Ṅ (t) = −ε3 N (t)

and the positivity of N (t) follows.

5. The dynamics of V (t) is given by the relation

For ψ6 = 0 and ψ7 = 1, we have

The positivity of C(t) is given in the following lemma

4. δ ∗ (1 − ε2 ) < min ρ2 ε2 − ρF , ρ2 ε2 − ρ3 ε4 and

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4. δ ∗ (1 − ε2 ) < min ρ2 ε2 − ρF , ρ2 ε2 − ρ3 ε4 means that if a given amount of money received as

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+ε3 ρ3 N (t) − ε3 ρ4 M (t) − βC(t), (4)

But from the definition of the bank balance sheet we have

M (t) + F (t) + C(t) = L(t) + R(t) + N (t) + S(t) + V (t)

and the relation (8) becomes

The second member of (9) can be written as

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and the second member of (9) is equal to

X(t) ∈ Ω = (X1 , . . . , X8 ) ∈ R8 such that ∀i = 1, . . . , 8 0 ≤ Xi ≤ A(T )

To prove Theorem 3.2, we need the following lemma

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f˙(t) ≤ g(t)f (t) + h(t),

where g and h are nonnegative, integrable functions on [0, T ]. Then

We give the proof of Theorem 3.2.

−(1 + ρ3 )ε4 M (t) + (ρ1 − ρ1 δ − δ)ε1 L(t) + ρ2 ε2 S(t)

−ψ4 (t, X)δ ∗ (1 − ε2 )S(t) + (θρ0 − ρF )F (t)

Ṗ (t) ≤ −γ3 P (t) + uF (t) (12)

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−(1 + δ ∗ )(1 + ρ3 )ε4 M (t) − (1 + δ ∗ )(µ(t) + ρF )F (t) (15)

Using the hypothesis (H), the relation (15) becomes

where γ4 is given by the relation (??).

Using the hypothesis (H), the relation (15) becomes

Ṗ (t) ≤ γ5 (t)P (t) + uF (t), ∀t ∈ [0, T ], (19)

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The problem (23) can also be written as

h(t, x) = uF (t) − µ(t)x, ∀(t, x) ∈ (0, T ] × R

The function h is a continuous function of both variables t and x.

where for all t ∈ [0, T ]

Q∗ (t) = (1 + ρ1 )(1 − δ)ε1 − β L(t) + (1 + ρ2 )ε2 − β S(t) + (1 + ρ3 )ε3 − β N (t)

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