Predicting Banking Distress in European Countries

Abstract

This paper seeks to investigate internal and external factors with relation to regulations in order to predict difficulties which the banks are exposed. The sample consists of 368 banks in 8 European countries for the period 2004-2007. The model was built primarily only on a set of ratios constituting the CAMEL rating system (Capital adequacy, Asset qu ality, Management quality, Earnings ability, Liquidity position). Secondly, we added the variables related to the regulatory environment. The application of the method panel logit shows that financial ratios relating to the rating system (CAMEL) are correlated with the likelihood of problems measured by binary variables. The probability of occurrence of problems in these banks is positively correlated with the presence of an explicit system of deposit insurance and negatively correlated with the presence of auditors who provide information to regulators in the event of illegal activities committed by managers. The ability to prosecute these regulators for their actions has a negative effect on the probability of distress. The role of the Central Bank in monitoring activity is also very important to maintain system’s stability.