Comparative predictability of Failure of Financial Institutions Using Multiple Models

Abstract

The impact of failure of financial institutions is beyond just the failure of a public corporation. The failure of financial institutions in the USA, is a clear evidence that the greater macro impact is beyond just the failure of few financial institutions. It can bring down the entire economy and can have global devastating impact. By realizing the grave systemic risk of the failure, US government is forced to intervene and bail out many institutions for greater macroeconomic reasons. It raises the view that perhaps the current regulating policies and methods are lacking efficiency in predicting the possibility of failure beforehand and hence are not effective in preventing that to happen. This research applies several existing methods of institutional failure and test the signaling ability of each method in predicting the bankruptcy beforehand. The authors apply Moody's financial ratios, Standard and Poor's financial ratio, Vaziri's financial ratio, Altman's Z score and then applying logit model and discriminant analysis, the authors test each of these model's predictive ability for future use. The paper analyzes the reasons like changes in market, policy, economy, and political influence which have led to bankruptcy. Banks or financial institutions from Europe, the United States and Asia are considered as samples. Samples are taken from the same period to analyze the effect of different methods. The results from this analysis should help us find the most significant method that could be used to identify the risk, so that necessary action could be taken to prevent the effect or reject the project which could lead to bankruptcy in the future. This research would also offer policy recommendations for regulating agencies as to which factors should be analyzed deeply and how to implement a preventive measure ahead of any potential problems. © Mo Vaziri, Rafiqul Bhuyan, Ponkala Anand Vaseekhar Manuel, 2012.