Loan portfolio optimization using Genetic Algorithm: A case of credit constraints

Abstract

With the increasing impact of capital regulation on banks financial decisions especially in competing environment with credit constraints, it comes the urge to set an optimal mechanism of bank lending decisions that will maximize the bank profit in a timely manner. In this context, we propose a self-organizing method for dynamically organizing bank lending decision using Genetic Algorithm (GA). Our proposed GA based model provides a framework to optimize bank objective when constructing the loan portfolio, which maximize the bank profit and minimize the probability of bank default in a search for an optimal, dynamic lending decision. Multiple factors related to loan characteristics, creditor ratings are integrated to GA chromosomes and validation is performed to ensure the optimal decision. GA uses random search to suggest the best appropriate design. We use this algorithm in order to obtain the most efficient lending decision. The reason for choosing GA is its convergence and its flexibility in solving multi-objective optimization problems such as credit assessment, portfolio optimization and bank lending decision.