A New Methodology for Estimating Internal Credit Risk and Bankruptcy Prediction under Basel II Regime
Abstract
Credit estimation and bankruptcy prediction methods have been utilizing Altman's
z
score method for the last several years. It is reported in many studies that
z
score is sensitive to changes in accounting figures. Researches have proposed different variations to conventional
z
score that can improve the prediction accuracy. In this paper we develop a new multivariate non-linear model for computing the
z
score. In addition we develop a new credit risk index by fitting a Pearson type-III distribution to the transformed financial ratios. The results from our study have shown that the new
z
score can predict the bankruptcy with an accuracy of
98.6%
as compared to
93.5%
by the Altman's
z
score. Also, the discriminate analysis revealed that the new transformed financial ratios could predict the bankruptcy probability with an accuracy of
93.0%
as compared to
87.4%
using the weights of Altman's
z
score.