Małgorzata Iwanicz-Drozdowska

Financial Distress Prediction in an International Context: A Review and Empirical Analysis of Altman's Z-Score Model

This paper assesses the classification performance of the Z-Score model in predicting bankruptcy and other types of firm distress, with the goal of examining the models usefulness for all parties, especially banks that operate internationally and need to assess the failure risk of firms. We analyze the performance of the Z-Score model for firms from 31 European and three non-European countries using different modifications of the original model. This study is the first to offer such a comprehensive international analysis. Except for the United States and China, the firms in the sample are primarily private, and include non-financial companies across all industrial sectors. We use the original Z-Score model developed by Altman, Corporate Financial Distress: A Complete Guide to Predicting, Avoiding, and Dealing with Bankruptcy (1983) for private and public manufacturing and non-manufacturing firms. While there is some evidence that Z-Score models of bankruptcy prediction have been outperformed by competing market-based or hazard models, in other studies, Z-Score models perform very well. Without a comprehensive international comparison, however, the results of competing models are difficult to generalize. This study offers evidence that the general Z-Score model works reasonably well for most countries (the prediction accuracy is approximately 0.75) and classification accuracy can be improved further (above 0.90) by using country-specific estimation that incorporates additional variables.

Capital Regulation of G-SIBS: Does One Size Fit All ?

The ongoing global financial crisis has enhanced the interest in the effective regulation and supervision of internationally active and large financial institutions, named as global systematically important financial institutions or banks (G-SIFIs or G-SIBs). The literature on G-SIBs has started to develop, although it is still infrequent. In this paper, we address a new question: is the quite uniform Basel Committee on Banking Supervision’s (BCBS) methodology adequate to regulate a diverse group of institutions? We use a panel data set covering 31 G-SIBs and the time range of 2006-2012 that demonstrates remarkable differences among the analyzed institutions. We find for example, that the relationships between risk and profitability differ strongly between ‘globally’ and ‘not so globally’ acting G-SIBs, meaning that the ‘one size fits all’ solution may be questioned.

Financial and Non-Financial Variables as Long-Horizon Predictors of Bankruptcy

Reviews on financial distress prediction models indicate that these techniques give highly reliable estimates of probabilities of default (PDs) and loss given default (LGD) only for relatively short horizons, rarely beyond two years. Major stakeholders, e.g. investors and bank risk and capital analysts, therefore, have such models sanctioned by portfolio managers and regulators for the same short horizons; for example, the Basel Committee on Banking Supervision recommends PD and LGD estimates for one year. This is especially the case when financial variables make up the sole or primary estimates, and only a bit longer reliable estimators when these models include non-financial variables as additional early warning signals. Beyond three years, such models, regardless of their structure, rarely give reliable estimates, perhaps not much better than flipping a coin. The objective of this study is to assess the predictive ability of both financial and non-financial variable constructs for longer term horizons of up to ten years based on rigorous post-development distress and non-distress financial events in the Finnish environment. Our model, built with cross-section data from 2003, analyses results for 2004-2013. Results show that measures of solvency, turnover, industry risk, payment behaviour, and board member characteristics can be significant predictors of bankruptcies for as long as ten years. The most accurate long-range prediction results combine financial and non-financial variables. Subsequent tests should attempt to extend such models in a multi-country setting, whether or not bankruptcy regimes are similar across national borders.

State Aid and Fiscal Costs

This chapter presents overall rules for the provision of state aid and the fiscal burden related to that aid. Soon after the collapse of Lehman Brothers, in October 2008, the European Commission issued the so-called ‘first banking communication’ to facilitate the financial support for banks. In 2010, it became necessary to provide financial support to countries. In 2012, the European Stability Mechanism was established. All in all, the net state aid (state aid less repayments) provided to banks in the form of recapitalization and capital provided for asset management companies from 2008 to 2013 equalled EUR 535.6 billion. The state aid imposed a heavy burden on public finance in some EU countries, with Ireland presenting the heaviest.

Restructuring Tools and Their Costs

This chapter describes the restructuring tools applied during the recent crisis to the EU banks and the costs associated with them. The most typical tool was recapitalization, combined also with deep restructuring of a bank or a merger, or a bailout, in other words. Liquidation and nationalization were used rather rarely, mostly in the case of small and medium-sized banks. A new tool, bail-in, was used in Cyprus and Slovenia. This chapter is complemented by a comprehensive Appendix, offering descriptions of case studies of bank restructuring, presented together with ‘bad’ asset management companies and resolution processes applied in several EU countries.

Landscape after the Lessons of the Crisis

This chapter characterizes the changes caused by the recent global financial crisis (GFC). The starting point is the macroeconomic situation combined with the situation in the EU banking sectors. Because the GFC forced the decision-makers to rebuild the financial safety net, the most significant changes for the EU banking sectors have been also elaborated. These include more restrictive capital regulations, liquidity regulations, responsibilities of the financial safety net players and the resolution authority and tools. The chapter also emphasizes the banking union, which is a new concept implemented gradually for the Eurozone. On 4 November 2014, the Single Supervisory Mechanism (SSM) started to operate as the first pillar of the banking union.

Determinants of Banks’ Performance: The Case of ROE of G-SIBs in Central, Eastern and South-Eastern Europe

Abstract Purpose: The goal of the paper is to analyse the determinants of the level of ROE (return on equity) for two groups of banks, interrelated by capital links, and their banking sectors. Methodology: For the case study, we chose companies that, in 2011-2013, were designated by the Financial Stability Board as global systemically important banks (G-SIBs) and their subsidiaries operating in Central, Eastern and Southeastern Europe (CESEE) as well as their banking sectors. We sought to identify differences in the performance drivers, taking into account bank-specific and country- (or sector-) specific factors. Findings: We found no significant differences in the level of ROE among the analysed groups; however, we identified a different set of determinants and their impact on ROE.