DISTRESS CLASSIFICATION MEASURES IN THE BANKING SECTOR

Download This Article

Maria Carapeto, Scott Moeller, Anna Faelten, Valeriya Vitkova, Leonardo Bortolotto

DOI:10.22495/rgcv1i4art2

Abstract

This paper investigates distress classification measures in the banking sector. The power of ten different accounting measures is tested using media coverage as the benchmark for a sample of 1,175 banks which participated in merger and acquisitions or divestiture deals over the past 22 calendar
years. According to the results of the study, a bank should be defined as distressed if the ratio of its non-performing loans to total loans is in the two highest deciles of the industry, using a three-year moving average. This measure is typically favored by practitioners, who maintain that other common measures, e.g., those involving provisions for loan losses, are not as accurate as they express only a managerial forecast. Interestingly, measures that capture capital adequacy too often depict the bank as healthy even if it is de facto distressed, while measures of asset quality, though highly correlated with each other, tend to overestimate the number of distressed banks.

Keywords: Distress Classification Models; Banking Sector; Mergers and Acquisitions; Divestitures.

How to cite this paper: Carapeto, M., Moeller, S., Faelten, A., Vitkova, V., & Bortolotto, L. (2011). Distress classification measures in the banking sector. Risk Governance and Control: Financial Markets & Institutions, 1(4), 19-30. http://dx.doi.org/10.22495/rgcv1i4art2