We assess the extent to which stock market information can be used to estimate leading indicators of bank financial distress. We specify a logit early warning model, designed for European banks, which tests if market based indicators add predictive value to models relying on accounting data. We also study the robustness of the link between market information and financial downgrading in the light of the safety net and asymmetric information hypotheses. Some of our results support the use of market-related indicators. Other results show that the accuracy of the predictive power depends on the extent to which bank liabilities are market traded.

/pdf/market-discipline-and-the-use-of-stock-market-data-to-3d2chzfmp0.pdf

Market Discipline and the Use of Stock Market Data to Predict Bank Financial Distress

This article illustrates various ways in which the supervisors of depository institutions currently use market information; the article also highlights some potential applications of market data that the FDIC is considering in its insurance functions. The first section reviews the literature on the application of market data to supervisory risk assessments. The second section briefly reviews the supervisory process, setting the context for the current use of market information within that process. The third section illustrates how market information is currently applied in assessments of both industry risk trends and institution-specific risk conditions. The fourth section discusses research and other activities being conducted at the FDIC with a view to using market information more broadly. The final section summarizes and discusses a few of the challenges for wider incorporation of market information into the supervisory process.

A Survey of Current and Potential Uses of Market Data by the FDIC

Market discipline: a theoretical framework for regulatory policy development

The effects of ratings disclosure by bank regulators

I examine how banks change their risk management practices in response to the private disclosure of regulatory ratings that summarize bank risk-taking. Upon ratings disclosure, affected banks increase the timeliness of their loan loss provisioning. These effects are concentrated among banks that lie below key rating thresholds and those headquartered in states with low competition. After ratings disclosure, deficient banks decrease commercial lending while shifting assets into cash. Overall, my findings highlight how performance measures produced and privately disclosed by a third party can influence actions within a firm.

The Effects of Ratings Disclosure by Bank Regulators

Market data and bank supervision: the transition to practical use

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Market data and bank supervision: the transition to practical use