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Bank insolvency risk and Z-score measures: caveats and best practice

Author

Listed:
  • Vincent Bouvatier

    (EconomiX - EconomiX - UPN - Université Paris Nanterre - CNRS - Centre National de la Recherche Scientifique)

  • Laetitia Lepetit

    (LAPE - Laboratoire d'Analyse et de Prospective Economique - GIO - Gouvernance des Institutions et des Organisations - UNILIM - Université de Limoges)

  • Pierre-Nicolas Rehault

    (LAPE - Laboratoire d'Analyse et de Prospective Economique - GIO - Gouvernance des Institutions et des Organisations - UNILIM - Université de Limoges)

  • Frank Strobel

    (University of Birmingham [Birmingham])

Abstract

We highlight caveats arising in the application of traditional ROA-based Z-scores for the measurement of bank insolvency risk, develop alternative Z-score measures to resolve these issues , and make recommendations for best practice for the US/Europe based on the experience of the …nancial crisis of 2007-2008. Using a probabilistic approach (i) our novel regulatory capital Z-score dominates traditional Z-score measures for both US/Europe; (ii) Z-scores computed with exponentially weighted moments dominate those with moving moments for the US sample, but not for Europe. For both US/Europe, using a multivariate logit approach (i) allows computation of augmented Z-scores that provide probabilities of distress that better discriminate between distressed/surviving banks than the probabilistic approach; (ii) suggests that the ROA-based Z-score using current values of the capital-asset ratio is best, calculated either with moving or exponentially weighted moments.

Suggested Citation

  • Vincent Bouvatier & Laetitia Lepetit & Pierre-Nicolas Rehault & Frank Strobel, 2018. "Bank insolvency risk and Z-score measures: caveats and best practice," Working Papers hal-01937929, HAL.
    • Handle: RePEc:hal:wpaper:hal-01937929
    Note: View the original document on HAL open archive server: https://unilim.hal.science/hal-01937929
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    References listed on IDEAS

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    3. Hafeez, Bilal & Li, Xiping & Kabir, M. Humayun & Tripe, David, 2022. "Measuring bank risk: Forward-looking z-score," International Review of Financial Analysis, Elsevier, vol. 80(C).
    4. Guo, Lin & Prezas, Alexandros P., 2019. "Market monitoring and influence: evidence from deposit pricing and liability composition from 1986 to 2013," Journal of Financial Stability, Elsevier, vol. 43(C), pages 146-166.

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    Keywords

    Z-score; bank; insolvency risk; risk measure;
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