Optimal borrowing and bank lending policies. An interactive approach

In recent years, the literature on bank lending has greatly expanded to cover such issues as the role of different lending systems, alternative funding environments and interest rate polities. In this paper we consider these issues from an interactive borrower-bank perspective. The borrower makes his borrowing decisions as a function of interest rates, given his credit requirements which are assumed to vary over time, and the available lending systems. The bank determines its funding, lending and investment polities which are dynamic (determined over time) and, assuming optimal behavior on behalf of its borrowers, determines interest rates on loans, credit balances and other deposits. The analysis of the bank's model provides interesting insights into lending and funding policies and shows that fixed term lending arrangements may generate additional costs to the financial system while the overdraft system does not and therefore is more efficient in this environment.