Measuring bank risk: forward-looking z-score

Hafeez, Bilal ORCID: https://orcid.org/0000-0003-3628-0860, Li, Xiping, Kabir, M. Humayun and Tripe, David 2022. Measuring bank risk: forward-looking z-score. International Review of Financial Analysis 80 , 102039. 10.1016/j.irfa.2022.102039

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Abstract

While the z-score has been widely used to evaluate bank risk, it is criticized as a backward-looking measure. We propose a forward-looking method to construct the z-score by incorporating analyst forecasts. Empirical results show that the forward-looking z-score can predict the movement of the standard z-score one quarter ahead of time, and its predictive ability on banks' downward risk is better than the standard z-score. Moreover, we find that the predictive ability of the forward-looking z-score improves after the Dodd-Frank Act of 2010, especially for large banks, showing the consequences of strengthened regulation and transparency. The forward-looking z-score is also significantly associated with the probability of default and market-based risk measures and can provide predictive signals for banks' future profitability. Overall, our findings suggest that the forward-looking z-score mitigates the shortcomings of the standard z-score and provides a reliable early warning signal for banks' future risk and performance.

Item Type:	Article
Date Type:	Publication
Status:	Published
Schools:	Business (Including Economics)
Publisher:	Elsevier
ISSN:	1057-5219
Date of First Compliant Deposit:	27 September 2023
Date of Acceptance:	12 January 2022
Last Modified:	01 Nov 2023 15:00
URI:	https://orca.cardiff.ac.uk/id/eprint/162802

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