Establishing On-Site Bank Examination Priorities: An Early-Warning System Using Accounting and Market Information

An important tool of bank supervision in the US is the on-site examination. Priority is given to banks with known supervisory or financial problems, with historical examination and accounting reports serving as the basis of priority. A more efficient method of scheduling bank examinations, an early...

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Bibliographic Details
Published in:The Journal of finance (New York) 1980-03, Vol.35 (1), p.137-150
Main Authors: PETTWAY, RICHARD H., SINKEY JR, JOSEPH F.
Format: Article
Language:English
Subjects:
Accounting
Bank examinations
Bank examiners
Bank failures
Bank loans
Bank markets
Bank portfolios
Banking industry
Banking regulation
Banks
Classification
Commercial banks
Financial accounting
Information
Markets
Predictions
Priorities
Systems
Techniques
Trends
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Summary:An important tool of bank supervision in the US is the on-site examination. Priority is given to banks with known supervisory or financial problems, with historical examination and accounting reports serving as the basis of priority. A more efficient method of scheduling bank examinations, an early warning system, is suggested. The proposed method utilizes a screening model with 2 bases: a classification model using accounting data, and a system based upon the market model using market data.The accounting screen is a 2-variable model using total operating expenses as a percentage of total operating income, and investments as a percentage of total assets. A bank is considered a failure risk if, in comparison with historical data, the bank is more similar to the average failed bank than to the average non-failed bank. The market screen relies upon 2 measurements of significant trends in bank residuals, a run test and a statistical t-test. Significant downward trends indicate problem banks. Examination priority is given to banks that are classified as problem banks by both screens.
ISSN:0022-1082
1540-6261
DOI:10.1111/j.1540-6261.1980.tb03476.x