Ability of Accounting and Audit Quality Variables to Predict Bank Failure During the Financial Crisis

29 Pages Posted: 2 Mar 2011 Last revised: 1 Feb 2012

Justin Yiqiang Jin

McMaster University - DeGroote School of Business

Kiridaran (Giri) Kanagaretnam

York University - Schulich School of Business

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Date Written: January 1, 2011

Abstract

We examine the ability of selected accounting and audit quality variables measured in a period prior to the financial crisis (i.e., the four quarters of 2006), to predict banks that subsequently failed during the financial crisis. These predictor variables include balance sheet strength, loan characteristics, financial reporting discretion, and auditor type and auditor industry specialization. We employ two sets of samples from the US: a troubled banks sample that includes banks that failed in or after 2007 as well as banks classified as being troubled based on profitability, loan quality, and balance sheet position in 2007, and a full sample that includes all banks with available required data. Using the troubled banks sample, we identify five reliable predictors of bank failure: auditor type, Tier 1 capital ratio, proportion of securitized loans, growth in loans, and loan mix. For the larger full sample of banks, we identify ten predictors of bank failure: auditor type, Tier 1 capital ratio, proportion of securitized loans, nonperforming loans, loan loss provisions, growth in commercial loans, growth in real estate loans, growth in overall loans, loan mix, and whether the bank is a public bank.

Keywords: Bank Failure, Troubled Banks, Loan Quality, Loan Loss Provisions, Auditor Reputation, Financial Crisis

JEL Classification: G14, G21, M41, M42

Suggested Citation

Jin, Justin Yiqiang and Kanagaretnam, Kiridaran (Giri) and Lobo, Gerald J., Ability of Accounting and Audit Quality Variables to Predict Bank Failure During the Financial Crisis (January 1, 2011). Journal of Banking and Finance, Vol. 35, No. 11, 2011. Available at SSRN: https://ssrn.com/abstract=1773031 or http://dx.doi.org/10.2139/ssrn.1773031

Justin Y. Jin

McMaster University - DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada
905-525-9140 ext. 26194 (Phone)
905-521-8995 (Fax)

Kiridaran Kanagaretnam (Contact Author)

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

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