Economic and financial determinants of bankrupcy: evidence from Ecuador's private banks and the impact of dollarization on financial fragility

Adriana Uquillas,Francis Flores

doi:10.7819/rbgn.v22i4.4080

Abstract

Purpose – An econometric model is established to explain bankruptcy in Ecuadorian banks. The utility of combining macroeconomic, financial, and idiosyncratic determinants to explain bankruptcy is empirically demonstrated. Design/methodology/approach – The cross-sectional analysis includes 24 banks between 1996 and 2016. Bankruptcy is considered as a rare event. Findings – Even in adverse macroeconomic conditions, the main factor explaining bankruptcy is lax administration. Also, those banks with higher levels of indebtedness with respect to their capital levels are more susceptible to bankruptcy. Higher levels of spread and lower inflation are associated with lower levels of bankruptcy. Ceteris paribus, after dollarization the bankruptcy probability decreases and the effective management of each bank becomes a relevant factor to explain bankruptcy. Originality/value – Different determinants are combined in order to produce predictive models with practical value and macro-dependent dynamics that are relevant for stress tests. There is empirical evidence that the change in the monetary system has helped to stabilize the financial system. The problem of having a small sample and rare events is evident and adequately addressed.

Highlights

Banking crises have resulted in costly losses for the countries that have faced them; the effects of a systemic failure in the financial sector are multiple, generally affecting the country’s economy and the banks’ credibility
Where: X is the model’s independent variables vector, that is, X = (Dollarization, Delinquency, ROE, Leverage, Spread, Inflation); Z = −0.478 − 2.289*Dollarization + 5.179*delinquency* dollarization − 3.500*Roe*dollarization + 0.107*difappeasement − 32.623*Spread + 10.729*Inflation; Dollarization: Binary control variable that takes the value 0 before dollarization and 1 after dollarization; delinquency*dollarization: Idiosyncratic variable that measures the individual effect of dollarization on the portfolio’s delinquency rate; ROE*dollarization: Idiosyncratic variable that measures the individual effect of dollarization on the return on equity; difappeasement : Systemic variable of first-differentiation leveraging; Spread: Systemic variable of financial spread; Inflation: Macroeconomic variable of monthly inflation
Dummy variable used to measure the precise impact of dollarization on the probability of bankruptcy of a financial institution

Summary

Introduction

Banking crises have resulted in costly losses for the countries that have faced them; the effects of a systemic failure in the financial sector are multiple, generally affecting the country’s economy and the banks’ credibility. According to Naranjo (2003), the 19981999 recession culminated in general bankruptcy of the country’s financial system and resulted in 15 of the 40 existing banks, two financial companies, and one mutual entity disappearing or being taken over by the state; the economic crisis represented a cost of more than 80% of that year’s GDP. According to figures from the Central Bank of Ecuador (BCE, 2008), between August 1998 and August 1999, the banks’ liquidity decreased from US$ 1.6 billion to US$ 860 million and the pastdue portfolio increased by 300%, from US$ 300 million to US$ 1.1 billion. The way out of this crisis was a change in the monetary system and the official dollarization of the economy was the viable alternative found to establish stability and growth in the country

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Conclusion