How early can non-performance loan predict bank failure? Evidence from US Bank failure during 2008-2010

Abstract

Probit model was applied on the non-performance loans (NPL) of eight quarters, quarter 1-quarter 8, in determining the significant quarter before the bank was declared failure. The result of the Probit estimates found that as early as one-year ahead (4th quarter-ahead) bank-failure can be alerted and predicted. The NPL of the 4th quarter was a significant predictor of bank failure. The estimates of the model correctly predicts 89.6 percent of the U.S. banks that failed and 97.6 percent of the banks that survived during 2008-2010. Overall, the estimated model correctly predicts 95.5 percent of the observations (89.6 percent of the failure =0 and 97.6 percent of the survival=1 observations). The paper provides policy prescription that bank managements and bank regulators should pay attention to the early quarter(s) that are significant factor (s) for bank failure.