Z-Altman’s Model Effectiveness in Bank Failure Prediction

Z-Altman’s model effectiveness
in bank failure prediction -
The case of European banks
Charalampos-Orestis Manousaridis
Master thesis
MSc programme in Finance
Supervisor: Prof. Anders Vilhelmsson
July 2017, Lund, Sweden

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Contents
Abstract ..................................................................................................................................... 1
Acknowledgements ................................................................................................................... 2
Introduction............................................................................................................................... 3
Research objectives and tasks................................................................................................... 4
Literature review ....................................................................................................................... 5
Risks faced by financial institutions....................................................................................... 5
Financial Distress and Corporate Bankruptcy ....................................................................... 8
MDA analysis ....................................................................................................................... 10
Altman’s prediction models ................................................................................................ 11
Z‐score formula ................................................................................................................... 13
Grover’s model .................................................................................................................... 15
Grover's formula.................................................................................................................. 16
Springate’s model................................................................................................................ 16
Springate's formula ............................................................................................................. 16
Ohlson’s model.................................................................................................................... 17
Ohlson's formula ................................................................................................................. 17
Zmijewski's Model ............................................................................................................... 18
Zmijewski’s formula............................................................................................................. 18
Empirical Study ........................................................................................................................ 19
Sample and data.................................................................................................................. 20
Methodology ....................................................................................................................... 23
Financial data analysis and results ...................................................................................... 24
Limitations of the empirical study....................................................................................... 29
Conclusions.............................................................................................................................. 31
References ............................................................................................................................... 33
Digital references .................................................................................................................... 35

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Appendix I Processed data and ratios of failed banks............................................................. 37
Appendix II Processed data and ratios of non‐failed banks .................................................... 40

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Abstract
The corporate bankruptcy is a significant problem for economy since it is considered
as a limiting factor for economic growth. The financial crisis that broke out in USA
on 2007 as a result of miscalculated subprime mortgage strategies turn into a full
international banking crisis affecting successively the European banks, especially
those of South European countries. Given that the role and the impact of the banks in
the national and international economies are significant , it is vital for all interested
economy stakeholders to constantly assess and measure the financial health of banks
by use of reliable bankruptcy prediction models.
This work includes a literature review of known prediction models for firm
bankruptcy which are based on multivariate discriminant analysis. Additionally, it
presents the findings of the empirical study implemented by use of Altman’s Z-score
model specialized for firms from emerging markets. The main tasks carried out were:
 Financial data analysis for “failed” banks located mostly in South European
countries (GIIPS group)
 Application of the above analysis outcome to benchmark the financial status
of Central European banks that are still active
The aim of this work was to examine the effectiveness and accuracy of Altman's Z-
score model for measuring the financial health of banking sector organizations and
answer the research question whether Altman’s specialized formula, for firms from
emerging markets, could be used for banking sector organizations too.
The findings of the empirical study, allows someone to claim that the accuracy and
predictability of the tested Altman Z-score model, specialized for firms from
emerging markets, is questionable as regards predictions for private firms operating
with high leverage.
Keywords: European banks, financial health, prediction models, multivariate
discriminant analysis, Z- score model , Altman

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Acknowledgements
From this step, I would like to express my deep appreciation for the admission in the
very demanding and of high quality MSc programme in Finance of Lund University.
It was very significant and emotional event for me as I returned after 23 years into my
birthplace. Moreover, I ‘d like to express my sincere gratitude to my supervisor prof.
Anders Vilhelmsson and the MSc programme director prof. Hossein Asgharian
although their summer days-off during my working procedure on the thesis, they were
there to help me by providing valuable feedback and instructions. Finally, special
thanks are given to my family which supported me in order to realize my dream to
become a financial expert, without them this would not be achievable.
Lund, July 2017
Charalampos-Orestis Manousaridis

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Introduction
The financial crisis that broke out in USA on 2007 as a result of miscalculated
subprime mortgage strategies turn into a full international banking crisis affecting
successively the banks in Europe as well. Some European banks with high exposure
on the American banking system were directly affected and brought to the brink of
collapse. However, this was not the only reason for bank collapsing. A plethora of
additional reasons contributed in this as well i.e. inefficient fiscal policies of European
countries for consecutive years, overloaded public sector that did not correspond to
the real country’s needs etc. In Greece, a sovereign national debt in conjunction to the
impact of the international financial crisis put in troubles many banks.
Several Greek banks were exposed to the threat of a "disorderly bankruptcy" as a bi-
effect of the policies of non-cautious lending activity and the over-investment in the
past years. The lack of crucial funds for these banks imposed the need of an urgent
recapitalization of them. The Greek government was surprised and reacted gradually
to this by taking a series of measures (bail-out programme) in order to avoid a
collapse of the Greek banking system that could lead to chaotic situation with
tremendous economic and social consequences for the country.
Undoubtedly, the role and the impact of banks in the social-economic life of any
country are of great significance and this applies for Greece too. Therefore their
financial health is matter of great concern for all involved to financial activities and
finance researchers as well.
This work aimed to check if it is possible to measure and predict the financial health
of banks in an efficient and reliable way.
Inspiration about choosing this research topic was the collapse threat that Greek banks
faced when the Eurozone crisis broke out. According to my point of view, if there
were effective predicting tools for corporate default which could also be used in the
banking sector too, it would be a significant tool for European governments in their
decision making. These would be able to immediately react and take appropriate
mitigation measures for their economies which in combination with assistance from
the European Central Bank and the International Monetary Fund could keep off

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upcoming default of European banks and consequently avoid their catastrophic effects
on the social-economic life of the European countries affected.
Research objectives and tasks
Based on the fact that the banking sector could be considered as a service sector
organisation which plays a crucial role in development of the economy, both on
national and international level, it is always challenging and valuable to measure the
financial health of banks, especially on economic recession time.
First objective of this work is to present known prediction models for the
measurement of firm financial health. Special focus is given on those of multivariate
discriminant analysis which are commonly used by many finance researchers and
professionals. The second objective, the main one, was to test and evaluate the
strength and accuracy of Altman’s Z- score model and its suitability to be used for
predicting imminent threats of financial distress in banking sector. For that, a data
sample of European banks was selected which was divided in two target groups.
In the first group were included banks mainly from countries of South Europe, namely
Greece, Italy, Ireland, Portugal, Spain plus Cyprus. Further on, this group will be
referred to as GIIPS banks or “failed” group. The second was consisted of banks from
countries of Central Europe, namely Germany, France, Belgium, Netherlands and
Switzerland which will be called as CE banks or “active” group.
The main tasks of the second objective were:
 Analysis of financial data of failed banks of GIIPS group by use of the
Altman’s Z-score specialized for firms from emerging markets
 Application of the analysis outcome in benchmarking of the financial status of
CE banks
in order to examine the effectiveness and accuracy of Altman's Z-score in measuring
the financial health of banking sector organizations and answer the research question
whether Altman’s specialized formula for emerging markets could be used for
banking sector organizations too.