Page 25 - Monocle Quarterly Journal Vol 1 Issue 1 Q4

the ARt of fAIluRe: pRedIctING fINANcIAl dIStReSS pRe-cRISIS
Ratios with Predictive Power for Financial Distress
We found that of all the ratios we examined – in excess of nine ratios – by far the strongest was customer loans to deposits. is, of course, makes perfect sense because the ratio e ectively demonstrates the concept of reliance on the interbank market. Recall that a bank in its liability structure to meet its asset demand will depend on either deposits made by corporate or individual customers or on the interbank market. We can therefore deduce that the higher the percentage of total loans to customer deposits the more reliant banks are in their liability structure on the interbank market.
Based on the limited sample size, we are able to conclude that had the extent to which banks were funded by interbank loans versus customer deposits been known pre-crisis it would have been a powerful indicator of future nancial distress with an accuracy level of 80 percent as at 31st of December 2007.
e ultimate nding of the study is that 10.6 percent of banks failed. is is an extremely high proportion and one that we have not found any primary research for. Secondly we found that customer loans to deposits is signi cantly indicative of risk and would have been a very useful indicator prior to the Financial Crisis.
It goes without saying that the constructions of the LCR and NSFR, the latter in particular, are extremely di cult for banks to comply with. To a large degree these ratios con ict with the original notion underlining the business of banking – that is to use an upward sloping convex yield curve to arbitrage on tenor to achieve interest rate di erentials to make pro t.
Given the current environment of very low interest rates in advanced economies, we believe that this study indicates that a more simplistic ratio could have been used by policy makers as early as 2008/9 instead of LCR and NSFR. e use of such a ratio might have had a less deleterious e ect on funding structures for banks. Ultimately a combination of the NSFR as well as the radical levels of monetary intervention – which have led to very low interest rates – have had extreme e ects on the pro tability of banks. If these conditions perpetuate for another 5 to 10 years, it is questionable whether banks will be able to attract su cient equity to remain attractive to investors. A simplistic ratio such as customer loans to customer deposits could be a potential solution to avoid banking ultimately becoming a utility.
“We can therefore deduce that
the higher the percentage of total loans to customer deposits the more reliant banks are in their liability structure on the interbank market.”
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