Assessing probabilities offinancial distress of banks in

UAECAGB6101- Accounting for Business Decision Making

Alireza khosroyar

Semester one 11/24/2011

Contents…

1-Introduction & Objectives2-Methodology( specifying a financial distress model)3- Preliminary Statistics4-Marginal effects of Variables 5-Conclusion; Results & Discussion6- Q & A

Introduction

Financial distress :Refers to a period when a borrower (either individual or institutional) is unable to meet a payment obligation to lenders and other creditors.

The period 2000-2008 in UAE is chosen.Using a distress prediction model for 12 commercial banks and 4 Islamic banks in UAE

Objectives1-What were the drivers of financial distress of commercial and Islamic banks in UAE during 2000-2008?2-How much of this financial distress can be attributed to internal bank-specific fundamental factors and how much can be attributed to external factors (macroeconomic developments)?

Methodology : specifying a financial distress model

define variables that are supposed to impact on the future financial distress.The paper used the categories of 5 C’s (except the Character)

Methodology

Hypotheses

5 C’s Probability of Financial Distress

Cash Flow(CF) -

Profitability (ratio of costs to total revenue) +

Liquidity(ratio of current assets to current liabilities) -

Capital () +/- (depends)

Collateral (security represented by total asset growth) +

Credit Risk (non-performing loans to gross loans) +

Market Risk (price to earnings ratio) -

Market Risk (market-to-book value) +/- (dep. PE)

Business Cycle indicators -

Macroeconomic prices -

Preliminary Statistics

Marginal effects of Variables

Marginal effects of Variables cont.

Macro economic variables did not influence the probability of financial distress of the financial

institutions in UAE

Conclusion; Results & Discussion

Previous tables present the marginal effects of each of the independent variable in the model specifications on the probability of financial distress.The Probit model specification has the lowest log-likelihood ration likewise (AIC, BIC, HQIC) models which are all desirable in estimating the probability of financial distress.Fixed Effect Model: Represents the observed quantities in terms of explanatory variables that are treated as if the quantities were non-random. This is in contrast to random effects models in which some of the explanatory variables are treated as if they arise from the random causes

Discussion of fixed effect model results

Capacity: measured by cost to Income Ratio Variable (CIR), was +ve & statistically significant. 1% increase in time t is expected to increase the probability of financial distress by 0.02% in time t+1.Capital: measured by Equity to Total Assets (ETA), high ETA of a financial institutions in time t should lead to reduction in probability of financial distress in time t+1.Collateral: measured Total Asset Growth(TAG),variable increased assets lead to increase loan default. Condition (internal): measured by credit risk variable, higher credit risk in previous year result will increase probability of financial distress in current year.

Limitation and Future Direction of Research

UAE is relatively small economy in MENA region. There were no available data that would made the analysis more region specific.No data loan default experience of banks Panel B of Table V two macro economic variables i.e. real GDP (Gross domestic product refers to market value of all final goods & services produced within a country in a given period) and oil prices didn’t effect the probability of financial distress because there is no open-market operation in UAE.

MENA: Is the greatest Middle East

Thank YouQ & A