What Happens to Problem Banks? Evidence from the 1980s and Guidance for the 2010s

Abstract

In this study, we analyze factors determining the ultimate outcomes of banks classified as “problems” by the FDIC: failure or recovery. Using data for banks that were first classified as problems during 1984-1989 as inputs into a competing hazards model, we find that traditional proxies for the CAMELS components do an excellent job in explaining which problem banks failed and which problem banks recovered. We then use the model based upon 1984-1989 data to classify banks that first became problems during 2007-2009 period. We find that the model is reasonably accurate in classifying the failures and recoveries that took place during this period, in spite of the fact that it was estimated using data from the 1980s. We interpret these results as evidence that the CAMELS model continues to explain the financial outcomes of banks, even during the ongoing financial crisis, when most attribute the crisis to investments in residential mortgages and residential-mortgage-backed securities.

Keywords: bank, problem bank, bank failure, CAMELS, FDIC, financial crisis,

JEL Classification: G17, G21, G28, P51