We study the stochastic dynamics of banking items such as assets, capital,
liabilities and profit. A consideration of these items leads to the formulation of
a maximization problem that involves endogenous variables such as depository
consumption, the value of the bank's investment in loans, and provisions for loan
losses as control variates. A solution to the aforementioned problem enables us
to maximize the expected utility of discounted depository consumption over a
random time interval, [t,τ], and profit at terminal time
τ. Here, the term depository consumption refers to the
consumption of the bank's profits by the taking and holding of deposits. In particular, we determine an analytic solution for the associated Hamilton-Jacobi-Bellman (HJB) equation in the case where the utility functions are either
of power, logarithmic, or exponential type. Furthermore, we analyze certain aspects of the banking model and optimization against the regulatory backdrop offered by the latest banking regulation in the form of the Basel II capital accord. In keeping with the main theme of our
contribution, we simulate the financial indices return on equity and return on assets that are two measures of bank profitability.
