Predicting Rating Changes for Banks: How Accurate Are Accounting and Stock Market Indicators?

Abstract

We aim to assess the accuracy of accounting and stock market indicators to predict rating changes of banks. We conduct a stepwise process to determine the optimal set of early indicators by tracing upgrades and downgrades by rating agencies as well as other relevant factors. Our results indicate that both accounting and market indicators are useful leading indicators but more effective in predicting upgrades than downgrades, especially for large banks. For small banks, only market indicators contribute to the early detection of downgrades. Moreover, early indicators are only significant in predicting rating changes for banks, more focused on traditional banking activities e.g., deposits and loans activities. Finally, a higher reliance of banks on subordinated debt is associated with better accuracy of early indicators.

Keywords: Bank Failure, Bank Risk, Ratings, Emerging Market

JEL Classification: G21, G28