Coordinated failure? a cross-country bank failure prediction model

Santoso, Wimboh and Montgomery, Heather and Besar, Dwityapoetra and Hanh, Tran (2005): Coordinated failure? a cross-country bank failure prediction model. Published in: ADB Institute Discussion Paper No. 32

Abstract

This paper empirically investigates the causes of bank failures in Japan and Indonesia. Using logistic regression analysis of financial ratios, we explore the usefulness of domestic bank failure prediction models with a cross-country model that allows for cross-correlation of the error terms.

Our results suggest that loans, both as a ratio to total assets, deposits and in some cases the ratio of non-performing loans, are the most significant predictors of bank failure in both Japan and Indonesia. Regulatory capital ratios, on the contrary, do not seem to be significant indicators of failure. In addition to the domestic models, we explore the usefulness of a cross-country model of bank failure prediction and find that this model outperforms the domestic models on several diagnostic tests.

• Item Type: MPRA Paper
• Language: English
• Keywords: Bankruptcy; logistic regression; early warning; logit; bank failure; bank crisis
• Subjects: G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C25 - Discrete Regression and Qualitative Choice Models ; Discrete Regressors ; Proportions ; Probabilities; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

References

Aldrich and Nelson (1984), Linear Probability, Logit And Probit Models, California: Sage University Paper

Altman, E. (1968), “Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy”, Journal of Finance, Vol. 23, No. 4, pp. 589-609

Beaver, W. (1966), “Financial ratios as predictors of Failure”, Journal of Accounting Research, Vol. 4, Empirical Research in Accounting: Selected Studies, pp. 71-111

Beaver, W. (1968), “Market Prices, Financial Ratios, and the Prediction of Failure”, Journal of Accounting Research, Vol. 6, No. 2, pp. 179-192

Hillegeist, S.A, Keating, E. K., Cram, D. P. and Lundstedt, K. G. (2003), “Assessing the Probability of Bankruptcy”, forthcoming, Review of Accounting Studies.

Hosmer, D. W. Jr. and S. Lemeshow. (1980), “Goodness of Fit Tests for the Multiple Logistic Regression Model.” Communications in Statistics. A9: 1043-1069.

Martin, D. (1977), “Early Warning of Bank Failure: A logit regression approach”, Journal of Banking and Finance, Vol. 1, pp. 259-276.

McFadden, D. (1973), Conditional Logit Analysis Of Qualitative Choice Behavior, In Zarembka, P. (ed), Frontiers in Econometrics, pp.105-142, New York: Academic Press.

Merton, R.C. (1974), “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,” Journal of Finance, Vol. XXIX, pp. 449-470.

Meyer, P. A. and Pifer, H. (1970), “Prediction of bank failures”, Journal of Finance, Vol. 25, No.4, pp. 853-868.

Qurriyani, Tengku Nuzulul (2000), “Potential Indication to Bank Survival Using Financial Ratio Analysis: Three-chotomy Logistic Regression Model,” National Accounting Symposium III, September IAA, pp. 27-44.

Rencher, Alvin C., (1995), Methods of Multivariate Analysis. John Wiley & Sons, Inc. Canada.

Santoso, Wimboh (1996), "The Determinants of Problem Banks in Indonesia," Banking Research and Regulation Paper, Bank Indonesia.

Santoso, Wimboh (2004), “Prediction Model of Bank Bancruptcy in Indonesia,” Banking Research and Regulation Paper, Bank Indonesia.

Shirata, C.Y. (1998), “Financial Ratios as Predictors of Bankruptcy in Japan: An Empirical Research”, online paper