Early warning indicators of bank distress in Danish banks

Specialeforsvar ved Cristina Silkjær Nielsen

Titel: Early warning indicators of bank distress in Danish banks

Abstract: The financial crisis in 2008 caused distress in several Danish banks, mainly small and medium-sized banks. A bank failure not only lead to extensive consequences for employees, depositors, shareholders and the management. The failure of a bank failure is more threatening for the entire economy than the failure of other business firms, due to the strong interconnection among banks and their crucial role in financing the economy. The bankruptcy of one bank often causes a knock-on effect that spreads rapidly and has a negative influence on other banks (systemic risk). Therefore, this master’s thesis will find and analyze the main leading indicators for Danish banks in distress. These indicators can be used by the supervisory authority to detect Danish banks before they are distressed. Since the late 1960s, different studies have looked at both leading indicators of distress and compared different statistical methods, and although highly complex forecast methods already exist, an improvement in the ability to predict bankruptcies can potentially lead to substantial savings for the economy as a whole. In this master’s thesis a logistic regression model is used with financial ratios as input. Data will be drawn from 149 Danish banks’ financial statements during the period 2004-2016. Furthermore, this paper will examine if the problems that caused the financial crisis in Denmark in 2008 have been handled adequately by the Danish regulation. This is done by considering three out of the five pointers in the supervisory diamond. This thesis demonstrates that capital adequacy, liquidity and sensitivity to market risk were not the leading indicators of distress in Danish banks during the period 2004-2016. On the other hand, a bank can prevent distress if they ensure a high asset quality while keeping their earnings high. Moreover, the results of this master’s thesis show, that only one (the sum of large exposures) out of three pointers considered is a statistically significant leading indicator of distress.

Vejleder: Rolf Poulsen
Censor: Mads Gydesen