The role of capital in bank failures across EU-15 countries: backward LR approach

Abstract

Resolving the puzzle which financial indicators do persistently indicate severe disruptions in the business of banking, is of the utmost importance for prudential authorities. Thus, the intent of this paper was to outline microeconomic determinants of bankruptcies within the banking sectors of the EU-15 countries, and to clarify the role of bank capital in it. Namely, the bank capital regulation was designed as both, ex-ante (bankruptcy prevention), and ex-post (bankruptcy costs reducer) regulatory instrument. Backward stepwise logistic regression was applied on the Bankscope data sample of around 60 commercial banks in the period that preceded the global financial crisis. Estimations were obtained for the year in which certain bank bankrupted as well as for each year over the five-year period prior the bankruptcy. The research findings confirm that a number of financial indicators, such as asset quality and liquidity indicators could serve as early warning signals of bank failures even five years before the bankruptcy. The results for bank capital ratios were non-persistent regarding their sign and significance in the year preceding the bankruptcy and several years prior to bankruptcy. Finally, the most convincing results speak in favor of the too-big-to-fail phenomenon, as bank size explains the most its survival odds.