Optimization on loan-to-value ratios in inventory financing under price fluctuation

Abstract

In inventory financing business, the collaterals' value may deteriorate due to poor supervision of Third Party Logistics Providers (3PLs), which can influence the default probability of financing enterprises and further the commercial banks' profits. Considering the supervision effort level of 3PLs, this paper studied the issue of optimizing loan-to-value (LTV) ratios of banks with underside risk aversion in static pledge when the fluctuant ending price of collaterals followed three different distribution functions. An LTV ratio optimization model was developed and the objective was to maximize the bank's expected profit at the end of the loan. To solve this model, the risk assessment method of “subject + debt” was applied. Finally, by conducting numerical studies, results derived from this model were compared with those obtained without considering the supervision effort level of 3PLs. Comparison results prove that a high supervision effort level can help to reduce the financing enterprises' default risks facing banks and improve the optimal LTV ratios. Sensitivity analysis indicates that optimal LTV ratios have a positive correlation with loan interest rates and supervision effort levels, and have a negative correlation with price volatility and default probabilities. The results shed light on LTV ratios decisions for commercial banks with the market price of collaterals fluctuating.