Financial distress in Brazilian banks: an early warning model,

Paulo Sérgio Rosa,Ivan Ricardo Gartner

doi:10.1590/1808-057x201803910

Paulo Sérgio Rosa, Ivan Ricardo Gartner

Open Access

https://doi.org/10.1590/1808-057x201803910

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Abstract

ABSTRACT This study aims to propose an early warning model for predicting financial distress events in Brazilian banking institutions. Initially, a set of economic-financial indicators is evaluated, suggested by the risk management literature for identifying situations of bank insolvency and exclusively taking public information into account. For this, multivariate logistic regressions are performed, using as independent variables financial indicators involving capital adequacy, asset quality, management quality, earnings, and liquidity. The empirical analysis was based on a sample of 142 financial institutions, including privately and publicly held and state-owned companies, using monthly data from 2006 to 2014, which resulted in panel data with 12,136 observations. In the sample window there were nine cases of Brazilian Central Bank intervention or mergers and acquisitions motivated by financial distress. The results were evaluated based on the estimation of the in-sample parameters, out-of-sample tests, and the early warning model signs for a 12-month forecast horizon. These obtained true positive rates of 81%, 94%, and 89%, respectively. We conclude that typical balance-sheet indicators are relevant for the early warning signs of financial distress in Brazilian banks, which contributes to the literature on financial intermediary credit risk, especially from the perspective of bank supervisory agencies acting towards financial stability.

Highlights

In periods following nancial crises – such as the 2007-2008 subprimes crisis, in which the fall of Lehman Brothers showed the systemic risk of a series of bankruptcies and the high cost for society resulting from government interventions in the nancial sector, such as in the United States and other European countries – the relevance of the issue of nancial stability comes under focus, with the leadership of important multilateral organizations, such as the Basel Committee for Banking Supervision, of which Brazilian companies (Brazil) has been a member since 2009, and the Financial Stability Board, linked to the Group of 20 biggest economies in the world
As a result of this nding, which is consistent with Brito, Assaf Neto, and Corrar (2009) with regards to the potential to explore this area of knowledge – of interest to both supervisory bodies and market investors, this study’s main aim is to propose an early warning model for predicting nancial distress events in Brazilian banking institutions
A matter of key importance for macroprudential decision making – such as systemic risk analysis focused on financial stability and interfinancial contagion among market participants, company solvency studies have been present in the financial literature since Altman (1968), with the Z-score model

Summary

Introduction

E Basel recommendations involve three pillars: minimum levels of capital requirement (Basel ratio), in which financial institutions must have adequate levels of own capital in relation to the risks of their assets; supervision processes, which concern banking supervision practices for nancial institutions; and market discipline. For this last pillar, nancial institutions should maintain e ective processes for disclosing information and displaying transparency to the market. Context of early warning systems, with bankruptcies occurring between 1988 and 1990 in the treatment group and another 1,000 banks in the control group.

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