Excess Credit Risk and Bank's Default Risk: An Application of Default Prediction's Models to Banks from Emerging Market Economies

Abstract

The purpose of this paper is to investigate the regulatory and institutional factors which may increase excessive risk taking in banks. Few studies deal with the impact of these external factors on bank’s risk taking and probability of default, despite the fact that empirical investigation is crucial for understanding the relationship between the regulatory, legal and institutional environement and bank’s health, especially in emerging market economies. We apply a two step logit model to a database of banks from emerging market economies. Our results confirm the role of the institutional and regulatory environment as a source of excess credit risk, which increases bank failure risk. The integration of these environmental variables significantly contributes to the explanatory and discriminatory power of our model of bank default prediction.