Good management or good finances? An agent-based study on the causes of bank failure

Abstract

The recent series of banking crises in the United States and in the Eurozone has resulted in numerous bank failures. In this paper, an agent-based model is employed to test for factors that determine bank viability in times of distress, focusing mainly on the endogenous risk of financial institutions. The authors test for the effects of both management and financial factors on the institutions’ ability to weather the storm during times when the banking system experiences distress. The agent-based simulation process is split into a setup period, when the simulation builds the structural characteristics of each bank, and a testing period, where these characteristics are tested against the final result, which is the bank’s viability. A risk estimation model is built and it is found that the proposed model is successful in predicting whether a particular bank can endure a stress testing situation. The empirical results confirm the relevant literature and put further emphasis on the policy implications regarding banking supervision and regulation, particularly in context of the Eurozone banking union.