Probability Of Bank Failure Research Articles

Macroeconomic Stress Test on the Probability of Default Banking in Indonesia (Study on Conventional Banks 2007-2021)

The role of the Bank in mobilizing is a necessity, especially related to the provision of financing facilities to economic actors in the form of loans or credit. Usually, when an economy expands, it will be followed by a procyclical trend of credit growth, which will cause banking vigilance. And cause banks to have more expectations and are too optimistic about the ability to pay customers, thus making banks less careful. Furthermore, this condition will result in excessive delays which will eventually become a nightmare during the boom or expansion of the economy. This situation will lead to the failure of the debtor in dealing with his credit, causing a nonperforming ratio, and eventually becoming a probability of default. Meanwhile, to measure the risk of a bank failure, it can use the macroeconomic stress testing method and sensitivity analysis. This study aims to measure how big the impact of macroeconomic shocks on the probability of default that will be borne by banks, as well as to see the sensitivity of the probability of default of banking to macroeconomic variable shocks. To measure the impact of macroeconomic shocks on the probability of default, the study uses regression analysis. And to determine the sensitivity of macroeconomic variables to the probability of default using the stress test method by calculating macroeconomic variable shocks. The results showed that there was a significant effect of macroeconomic variables (Real GDP, exchange rates, inflation, interest rates, and world oil prices) on the probability of bank failure. Furthermore, after calculating the stress test, the result is that of the three bank samples, only BCA Bank has the lowest stress value. Meanwhile, to see how big the Probability of Default is, when there is a shock or session on macroeconomic variables, it shows that Mandiri Bank is very sensitive to macroeconomic variable shocks compared to others.

“The Crooked Smile of TCR”: Banks’ Solvency and Restructuring Costs in the European Banking Industry

In this study, we analyze the probability of bank failure, the expected losses, and the costs of bank restructuring with the application of a lognormal distribution probability function for three categories of European banks, that is, small, medium, and large, over the post-crisis period from 2012 to 2016. Our goal was to determine whether the total capital ratio (TCR) properly reflects banks’ solvency under stress conditions. We identified a phenomenon that one can call the “crooked smile of TCR”. Medium-sized banks with relatively high TCRs performed poorly in stress tests; however, the probability of bank failure increases slightly with the size of the bank, while the TCR decreases. We claim that the focus on capital adequacy measures is not sufficient to achieve the goal of improving banks’ stability and reducing their restructuring costs. Our results are of special importance for medium-sized banks, as these banks are not regularly subjected to publicly available stress tests.

How dark is the dark side of diversification?

PurposeThis paper aims to illustrate, within the context of a well-known linear diversification model, that risk management as exerted by banks and regulators ultimately depends on how risk is assessed and conceptualized. The two risk metrics used are the probability of bank failure and value at risk (VaR). The paper also extends the results of the model by incorporating an explicit analysis of correlation of the bank's portfolios.Design/methodology/approachThe paper is based on a well-known model of linear diversification of two banking institutions developed by Wagner (2010) in the Journal of Financial Intermediation. The authors added considerations that were unexplored by Wagner and derived the corresponding logical and practical implications.FindingsThe authors found that depending on which of the two risk metrics being used, the way diversification is perceived and risk is managed may differ. This situation may very well end-up generating different incentives for banks and regulators. The authors suggest a general rationale for considering how to think about the apparent dilemma and the challenges faced by regulators. The authors also offer an explicit analysis of correlation for the bank's portfolios.Research limitations/implicationsThe results are dependent on the particular aspects of the model, so the research results may lack generality in other contexts.Practical implicationsDespite the limitations already mentioned, the paper illustrates some relevant points within the open debate about risk measurement and diversification.Originality/valueThis paper contributes to the open discussion of diversification, risk perception and systemic crisis.

Reserve requirements and financial stability

This study assesses the effects of reserve requirements on the probability of bank failure and compares them to those of capital requirements. While both requirements affect banks’ balance sheets and lending rates similarly, their effects on financial stability can differ markedly. When adjustment in deposit rates is constrained, the cost effect arising from higher reserve requirements may incentivise banks to choose riskier assets rendering worse financial conditions. Borrowers’ moral hazard problem augments these adverse effects. They are mitigated when considering imperfectly correlated loan-default as higher interest revenues from non-defaulting loans curb losses from defaulting loans.

The Effect of Cash Injections: Evidence from the 1980s Farm Debt Crisis

AbstractWhat is the effect of cash injections during financial crises? Exploiting county-level variation arising from random weather shocks during the 1980s Farm Debt Crisis, we analyze and measure the effect of local weather-driven cash flow shocks on the real and financial sectors. We show that such cash flow shocks significantly affect a host of economic outcomes, including land values, loan delinquency rates, the probability of bank failure, employment, and wages. Estimates of the effect of local cash flow shocks on county income levels during the financial crisis yield a multiplier of 1.63.

Optimal screening capacity and perceived risk of mortgage banks across countries

In this paper, we investigate the optimal combination of the levels of perceived risk and screening capacity that maximizes the fair value of a mortgage bank, while considering the probability of bank failure and the distribution borrower's wealth across emerging and developed countries. This is a novel contribution to the current literature that does not address that optimal combination and its dependency on the distribution borrower's wealth.We show that in countries where both levels of inequality of borrowers' wealth and the amount of the maximum wealth are high, the bank prefers to adopt a very severe level of perceived risk and cut down the screening capacity to the lowest level that enables the bank to be successful in lending its allotted funds. In countries where the level of wealth inequality decreases, the bank prefers to keep the severe level of perceived risk while increasing its screening capacity. Only when the level of screening capacity is bounded, the bank freezes its level of screening capacity while adopting a medium level of perceived risk.

Evaluation of Factors Aff ecting the Probability of Bank Failure

Evaluation of Factors Aff ecting the Probability of Bank Failure

(A Study on the Ownership Structure and Insolvencies of Savings Bank)

Korean Abstract: 2011년 발생한 저축은행 사태의 주요한 원인 중의 하나로 최대주주의 전횡적인 부실경영을 가능하게 한 소유구조의 문제점이 제기되었다. 본고에서는 당시 파산한 30개 부실저축은행들의 소유구조 현황을 살펴보고, 지배주주와 대표이사의 겸직 여부, 지분율 정도 등 소유지배구조가 저축은행 부실가능성과 어떠한 관계가 있는지 분석하였다. 분석결과 최대주주 지분율이 낮은 수준에서 높아질수록 저축은행의 부실가능성이 하락하다가 지분율이 일정 수준이상을 넘어서면 부실가능성이 높아지는 U자형 비선형관계를 가지는 것으로 나타났다. 또한 최대주주가 대표이사로서 직접 경영에 참여할 경우 최대주주 지분율과 부실의 정( )의 관계는 더욱 강하게 나타났다. 이러한 분석결과는 향후 저축은행 부실가능성을 낮추기 위해서는 최대주주의 지분율에 적정한도를 설정하고, 연기금이나 공제회 등 공적인 투자기관의 저축은행 지분참여확대를 통해 견제시스템을 강화해야 한다는 정책적 시사점을 제시한다. English Abstract: Problems with ownership structure that allowed the largest shareholders to make decisions that decrease firm value are pointed out as one of main causes of the massive failures of savings banks in 2011. In this paper, we examine 30 failed savings banks to explore the determinants of the failures by analyzing the impact of ownership structure and the role of the outside directors. We find that the higher the ownership by the largest shareholders, the lower the likelihood of failure of the savings bank up to a certain level. And at one point, the likelihood of savings bank failure increases as the ownership level of the largest shareholders become concentrated. Thus, we confirm a U-shaped nonlinear relationship between the probability of bank failure and the ownership structure by largest shareholders. We further show that if the largest shareholder participates in direct management as a representative director, the probability of failure increases. Our results suggest important policy implications that an governance system can be strengthened through the shareholder activism of large institutional investors such as pension and trust funds.

BANK FAILURES UNDER MANAGERIAL AND REGULATORY INEFFICIENCY: THREE DECADES OF EVIDENCE FROM TURKEY

AbstractDrawing on a comprehensive data set from Turkey (1970–2003) and using both nonparametric (data envelopment analysis) and parametric (stochastic frontier analysis) frontier methods, we estimate 16 alternative efficiency measures to study their associations with the probability of bank failures in an emerging market setting. We find that failed banks severely underperform survived banks in all forms of efficiency and that their subpar performance deteriorates closer to failure, prosperous times and bloated scales tend to precede eventual banking fatalities, managerially induced (technical) inefficiencies dominate politically induced (allocative) inefficiencies in failed banks, and banks with new ownership and affiliation with other businesses are more likely to fail. The results also caution that liquidity, capital, and currency risks combined with poor management are a lethal mix ahead of crises.

Drivers of US Bank Failures during the Financial Crisis

Hundreds of banks failed during the financial crisis of 2008 to 2010 causing significant social cost and enfeebling economic growth for years following. In the aftermath of the crisis, regulators responded, as always, with new regulations, the efficacy of which is debatable. For policy makers to enact effective regulation, they must understand the true cause of bank failures during crisis periods. We study the effects of 31 variables using univariate t-tests and probit regression to determine their influence on the probability of bank failure. We find that banks failed during the 2008 to 2010 financial crisis because of choices management made to accept more risk, specifically by having higher financial leverage, investing in higher risk loans in real estate and construction and by holding less liquid assets and fewer low risk loans like single family real estate loans. That is, the cause of US bank failures during the finance crisis was poor management.

The Effect of Cash Injections: Evidence from the 1980s Farm Debt Crisis

What is the effect of cash injections during financial crises? Exploiting county-level variation arising from random weather shocks during the 1980s Farm Debt Crisis, we analyze and measure the effect of local cash flow shocks on the real and financial sector. We show that such cash flow shocks have significant impact on a host of economic outcomes, including land values, loan delinquency rates, the probability of bank failure, employment, and wages. Estimates of the effect of local cash flow shocks on county income levels during the financial crisis yield a multiplier of 1.63.

The back side of banking in Russia: forecasting bank failures with negative capital

Since 2013, we have observed an increasing number of failed Russian banks with negative capital and falsified financial reporting. We use previously unavailable data for the period 2010-1H2015 to develop a logit model predicting the probability of bank failure with negative capital. In order to do so, we suggest solutions for the class imbalance and variable selection problems. The models chosen are confirmed to be robust and have longer forecasting horizons compared to previous research. Also, we implement a novel probability-based approach to the out-of-sample forecasting evaluation which confirms a good fit of the selected models to data. The model predicts bank failures in three quarters and finds 33% of actual failures among 5% of banks with the highest predicted probability to fail (out-of-sample). In addition, we make available previously unpublished banking data for Russia.

Dynamic Interpretation of Emerging Systemic Risks

We use computational linguistics of bank's risk disclosures in the 10-K to develop an empirical model of dynamic, interpretable emerging risks that successfully predicts the emergence of financial instability. The model detects risks as early as late 2005, well in advance of the 2008 financial crisis. Risks related to interest rates, mortgages, real estate, capital requirements, rating agencies and marketable securities became highly elevated during this pre-crisis period, with individual bank risk exposures strongly predicting returns, the probability of bank failure and future stock return volatility. Tests using very recent data indicate a rise in market instability since 2014 related to risks associated with sources of funding, marketable securities, regulation risk, and credit default. Overall, our model reliably assesses both the build-up of systemic risk in the financial system and bank-specific exposures in a timely fashion.

Does Basel Save Our Banks? The Effect of Basel I Capital Requirements on Bank Failures

We develop an empirical model to test the relation between compliance with Basel I capital requirements and the probability of bank failure during ‘normal’ economic conditions and times of financial crises. We also seek to determine whether increased capital requirements would further reduce the rate of bank failure. Specific bank data, as well as some macro-economic data, for the periods 1996-2007 and 2000-2007 are analyzed and multi-period logistic models are fitted to this data. Robust standard errors are used to ameliorate the issue of dependent observations. The results from the 1996-2007 sample should be taken with caution, given that the number of events for that period is relatively low.Banks that complied with the tier 1 and total capital requirements of the Basel I agreement saw their probability of failure drop significantly. The results also suggested that the Basel I capital requirements did not manifest procyclicality; to the contrary, they reduced failure rates even further in financial crises. In addition, the regression models indicate that increasing the tier 1 capital requirements would likely not be beneficial, although banks whose tier 1 capital ratio declined rapidly from one quarter to the next experienced increased risks of failure. A potential limitation of the models is that they utilize only data from US banks; whether the findings apply also to other developed nations is a question that requires further analysis.We conclude that the Basel I capital adequacy requirements achieve the objective of increasing banks’ financial stability and reducing bank failure rates. Importantly, the Basel I capital ratios appear to protect banks particularly well against insolvency in times of financial crises. Thus, our results do not support the argument that Basel’s requirements are procyclical. We find also that a rapid decrease in Basel capital ratios is a good indicator of a bank’s impending failure. Banking supervisors should therefore pay extra attention to these banks.

Bank Capital Regulation and Soft Budget Constraints

This paper presents a model of soft budget constraints on firms where refinancing of poor projects is ex post inefficient when viewed in isolation, and analyzes how bank capital regulation affects the softness of firms’ budget constraints. A firm is said to have a soft budget constraint if a bank allows the firm to continue to operate even when continuation is ex post inefficient. It is shown that bank capital regulation may induce soft budget constraints on firms because banks have an incentive to roll over loans made to poor firms in order to comply with the regulation. It is also shown that soft budget constraints are more likely to arise when the regulation is less strict, that is, when banks’ minimum required capital ratios are lower. This paper also demonstrates that soft budget constraints may be more likely to arise under Basel III, that bank capital regulation may increase the probability of bank failures by inducing the soft budget constraint problem, and that the bank capital regulation of Basel I was one of the causes of soft budget constraints in the post-bubble period of Japan.

Systemic Risk and Bank Failure

We investigate the impact of systemic risk on bank failure. All systemic risk measures investigated in this paper are significantly related to the probability of bank failure during the latest financial crisis. The predictive power of systemic risk is strong in the one-year forecast horizon, suggesting that systemic risk has substantial impact on bank failure. Its impact weakens in the one-quarter forecast horizon, so immediately before the failure, the influence from systemic risk seems to be largely channeled through and reflected in the worsening balance sheet. Further, systemic risk is not a new phenomenon during the latest banking crisis, as it also contributes to bank failures before 2005; but the influence of systemic risk is much stronger after 2005. Finally, there is evidence that firms with higher capital ratios are more affected by systemic risk.

Competition vs. Financial Stability in the Aftermath of the Crisis in the UK

The article addresses the status quo of competition enforcement during financial crises and presents the balance between competition law and financial stability during the recent crisis. The debate of the balance between competition and financial stability remains at the forefront. On the one hand, it seems plausible to expect that, once a certain threshold is reached, an increase in the level of competition will tend to increase risk-taking incentives and the probability of bank failure. On the other hand, competition cannot be eliminated in the financial services sector because it ensures efficiency, a broader range and higher quality of products to final consumers, innovation, and lower prices.

What Problem Banks Reveal About Future Financial Distress: Evidence from the Late 2000s Financial Crisis

In this paper, we contribute to a better understanding of the factors related to the operation of the banking system that led to the late 2000s crisis through the development of an early warning model of bank distress. Contrary to all other relevant studies which exclusively focus on bank failures, the current study assumes that bank fragility can result either in a bankruptcy or in a bailout. We employ the dynamic hazard model of Shumway (2001) to develop such an early warning system. Special attention is paid on the relevance of modern financial activities like asset securitisation and derivatives trading in the probability of bank failure and that of bailout. Our empirical findings provide strong evidence that banking firms with illiquid and risky assets, inadequate equity capital, poor management, and low level of earnings have higher probability of failure. However, not all the aforementioned factors are related to the probability of a bank to receive financial assistance in case of a financial debacle. Importantly, we show that banking institutions which rely more on off-balance-sheet activities to finance their operations are more likely to go bankrupt. However, it is easier for these institutions to receive financial aid from authorities. We also provide evidence for the ‘Too-Big-To-Fail’ strategy of banks, as it is found to be less likely for a larger bank to go bankrupt but more likely to obtain financial support from authorities. Overall, our application of the Shumway model is found to be capable of providing bank regulators and supervisors with some of the necessary tools to distinguish healthy from distressed institutions and to work as an effective mechanism for preventing future crises, since its out-of-sample prediction accuracy is found to be very high.

Using Accounting Proxies of Proprietary FDIC Ratings to Predict Bank Failures and Enforcement Actions During the Recent Financial Crisis

Focusing on the recent banking crisis, our article examines whether accounting-based proxies for the Federal Deposit Insurance Corporation’s proprietary CAMELS measurement system effectively predict the likelihood of failure for most regulated, depository institutions with U.S. operations (in and out of sample testing). This article also utilizes regulatory enforcement actions as both an explanatory and predicted variable. The CAMELS ratings from bank examinations are not released to the public because of regulatory concerns over potential bank runs. To the extent that such ratings provide timely information to banks, our lagged proxies are less likely to be effective predictors of bank failure. However, we find that proxies for each of the six categories of CAMELS—capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to interest rates—are significantly associated with the probability of bank failure when examined individually. Nearly all measures maintain their significance when examined collectively. These results should aid investors, customers of commercial banks, and also regulators to better assess the risk of bank distress in the future.

The Effect of Reliance on International Funding on Banking Fragility: Evidence from East Asia

The East Asian crisis highlights the importance of liquidity for smooth functioning of the banking system. It also shows the vulnerabilities that arise as a result of high dependence on international liquidity. This article empirically analyses the influx of liquidity before the crisis and illiquidity during the crisis in finding out whether banks in East Asia held ‘too little’ or ‘too much’ liquidity before and during a crisis and how their vulnerabilities to failure changed as a result of that. Instrumental Variable estimation is used to dissociate the effect of international illiquidity on banks’ liquidity risk during a crisis year. The study finds that the effect of liquidity on the probability of bank failure varies before and during a crisis. The findings also highlight the vulnerabilities of banks to failure as a result of international illiquidity and high reliance on external funding. These findings bring forward the case for stronger regulation of banks’ liquidity, which can be brought forward by better liquidity management.