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Achieving a balance between the avoidance of banking problems and their resolution—can financial cycle dynamics predict bank distress?

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Abstract

The global financial crisis has emphasised the importance of the financial cycle in contributing to bank failures. In this paper, we consider how far it is possible to anticipate problems in banks by using early warning indicators available from published information on the financial cycle in the economy. We use a traditional z-score model that incorporates bank-specific, banking structure and macroeconomic variables to which we add financial cycle indicators. We test these models on an unbalanced panel of 2239 European banks over the period 1999–2014. We find that the financial cycle adds noticeably to the ability to predict bank distress up to 2 years into the future.

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Notes

  1. While the GFC may have been particularly horrific, all banking crises are associated with significant reduction in GDP and consequently welfare loss [13, 17, 33, 36].

  2. In common with the literature we also explore a three-year window but this tends to be unstable.

  3. Yucel [54] and Mayes and Stremmel [41] provide an extensive literature review on early warning models.

  4. We are grateful to Leone Leonidas for suggesting that the square of concentration should also be added as in his work he found that relationship was curvilinear and indeed the effect varied from negative to positive depending on the level of concentration.

  5. Part of the problem is simply to distinguish cyclical from structural factors [51].

  6. i.e it is the EU as it stood in 1999 at the start of our sample, so Austria, Finland and Sweden are included but Cyprus, Malta and central and eastern European countries which have joined since then are not.

  7. http://www.bis.org/bcbs/publ/d300.pdf.

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Author information

Authors and Affiliations

  1. University of Auckland, Auckland, New Zealand

    Giannoula Karamichailidou & David G. Mayes

  2. ARENA, University of Oslo, Oslo, Norway

    David G. Mayes

  3. WHC – Otto Beisheim School of Management, Vallendar, Germany

    Hanno Stremmel

Authors
  1. Giannoula Karamichailidou
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  2. David G. Mayes
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  3. Hanno Stremmel
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Corresponding author

Correspondence to David G. Mayes.

Appendix

Appendix

See Table 7.

Table 7 Allocation of banks by country
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Karamichailidou, G., Mayes, D.G. & Stremmel, H. Achieving a balance between the avoidance of banking problems and their resolution—can financial cycle dynamics predict bank distress?. J Bank Regul 19, 18–32 (2018). https://doi.org/10.1057/s41261-017-0054-z

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