3 Defining, Measuring, and Predicting Soundness

Matthew Saal, Carl-Johan Lindgren, and G. Garcia
Published Date:
September 1996
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Bank soundness is a concept commonly used to denote, for example, an ability to withstand adverse events. Nevertheless, its usage is typically imprecise and gives rise to questions regarding its definition, measurement, and prediction.

Defining a Sound Banking System

A sound banking system may be defined as one in which most banks (those accounting for most of the system’s assets and liabilities) are solvent and are likely to remain so. Solvency is reflected in the positive net worth of a bank, as measured by the difference between the assets and liabilities (excluding capital and reserves) in its balance sheet. In other words, the distance between soundness and insolvency can be gauged in terms of capitalization, since net worth is equivalent to capital plus reserves. The likelihood of remaining solvent will depend, inter alia, on banks’ being profitable, well managed, and sufficiently well capitalized to withstand adverse events. In a dynamic and competitive market economy, efficiency and profitability are linked, and their interaction will indicate the prospects for future solvency. Inefficient banks will make losses and eventually will become insolvent and illiquid.6 Undercapitalized banks, that is, those with low net worth, will be fragile in the sense of being more prone to collapse when faced with a destabilizing shock, such as a major policy change, a sharp asset price adjustment, financial sector liberalization, or a natural disaster.

It is difficult to precisely classify a banking system as “sound” or “unsound,” because there is no benchmark measure of systemic insolvency that determines when a banking system is unsound or when a crisis will occur. Banking systems may exhibit different degrees of vulnerability over time. They may be functioning poorly, or may be working relatively well now but exhibit signs (e.g., low earnings or capitalization) of probable future problems or potential crises. Nonetheless, having no precise classification does not detract from the usefulness of the concept of soundness, proxied by solvency, any more than the difficulty of precisely defining concepts like a realistic exchange rate or a sustainable balance of payments has barred the application of those useful notions.

Measuring Unsoundness

Accepting the usefulness of a definition is one thing; practical application from a macroeconomic policy perspective is another. Using current solvency as a proxy for the soundness of a banking system abstracts from important measurement and projection issues.

While solvency is straightforward to define, it is difficult to measure. Bank loans, which represent the bulk of bank assets in most countries, are extremely difficult to value; that is one reason why even in countries with well-developed capital markets bank loans are not readily traded or securitized.7 From an economic standpoint, insolvency results when the present value of the expected stream of future net cash flows becomes negative and exceeds capital. Obviously, a high reported level of nonperforming loans would indicate fragility. However, there is always an element of judgment in projecting and valuing uncertain future receipts. In addition, owners and managers of unsound banks have incentives to accrue unearned income and show loans as performing in order not to lose their bank. Thus, balance sheet figures on asset value and on nonperforming loans may not represent a bank’s actual circumstances. Assessing insolvency is further complicated by off-balance-sheet items and problems of consolidating the balance sheets of bank subsidiaries and other related financial units.

These weaknesses in information explain why banking problems emerge with little apparent warning even in the most advanced countries. Even the combined resources of external auditors, credit rating agencies, stock market analysts, and supervisors may not spot banking problems in time.

To the extent that it can be measured, solvency can be aggregated across banks; clearly a banking system in which a large portion of banks are insolvent at current valuation would be unsound. Aggregation across banks, however, may mask problems. For example, a key payments center bank whose net worth is slightly negative might have more significant systemic implications than a savings bank with a highly negative net worth.

Predicting Unsoundness

Apart from the difficulties in measuring current solvency is the additional complexity that the concept of a sound banking system should encompass its dynamic development and its susceptibility to shocks. Solvency is essentially a static concept: it characterizes a bank (or a banking system) at a point in time. A forward-looking measure of banking system health should capture the determinants of bank insolvency, which include poor asset quality and earnings, as well as less quantifiable factors such as management weaknesses, failures of internal and external control, and the potential impact of exogenous events. Thus, if a significant portion of bank profits derives from speculative activities, or if bank governance structures are such that they facilitate high-risk transactions, such as related-party lending, the probability of future insolvency will be higher.

Predicting Unsoundness at Individual Banks

Supervisors in some countries have constructed sets of indicators to provide an early warning that a particular bank is likely to experience difficulties. These indicators consist principally of bank-specific information provided by the reports banks make to the supervisory authority (“call reports”). Early warning indicators are usually used to determine where scarce supervisory resources would best be deployed in on-site examination.

Bank-reported data are often used in conjunction with complementary statistics from other sources and qualitative indicators, many of which are based on supervisory inspections. To the extent that bank data are inaccurate, the quality of such indicators and models is impaired. Even in such circumstances, though, the data may contain significant information: for example, an increase in loans past due provides a warning, even if such loans are systematically underestimated. Thus, specific indicators and trends derived from bank statistics, along with complementary data and judgment, can help to predict bank unsoundness.

Where data are available, some supervisors have constructed more complex econometric models to identify where severe problems are likely to develop. These empirical models identify factors that raise or reduce the probability of bank insolvency in any period. The characteristics of an individual bank can then be fed into the estimated equation to gauge the bank’s soundness. The relevant characteristics are mostly bank specific, but may also incorporate sectoral information (such as the concentration of the local banking market) and macroeconomic information (such as the regional unemployment rate). Supervisors then use the results of these models to identify banks that warrant greater supervisory attention, for example, in the form of more frequent on-site inspections.

There has been considerable published academic work in this area as well.8 Again, models try to predict whether a particular bank is likely to experience difficulties, often defined as insolvency. Published work has focused on the additional question of predicting failure, which is distinct from insolvency. Insolvency is determined by events in the banking market; a bank either is insolvent or is not. Failure in most cases hinges upon a supervisory decision, which may or may not be taken, and may be taken before or after insolvency. Failure usually depends on the same variables that determine insolvency, but as a regulatory decision, failure is subject to misincentives, forbearance, and political interference. Thus, the likelihood of insolvency and the timing of failure may hinge on different factors.

Insolvency should be the dependent variable in empirical exercises, but because banks are difficult to value, market value insolvency may not be observed or measured except after failure. Nevertheless, since regulators and other analysts all define an unsound bank in a similar fashion (focusing principally on insolvency), comparable sets of variables are used in most approaches. One key difference is that models used by regulators have access to a bank’s prior supervisory ratings. For example, the U.S. Federal Reserve’s Financial Institutions Monitoring System (FIMS) uses prior composite supervisory ratings as one of the predictors of future ratings and risk of failure.9 Such information is not normally available to outside investigators. While they do have access to some of the data underlying supervisory ratings, such as capital and earnings data, they would not normally have access to information on management and asset quality derived from on-site examinations. Research by supervisors has shown that using data from on-site inspections and from reports submitted by banks results in more accurate forecasts than relying on either alone; FIMS provides one example. In practice, however, supervisors tend to watch a larger number of variables than those identified by researchers.10 Despite the difficulties, models using publicly available data have been successfully formulated and applied.

Research has generally concluded that a small number of variables can accurately identify at an early stage those individual banks that will ultimately become insolvent (while avoiding incorrectly flagging banks that will survive). A summary of some of the variables used is provided in Table 1, along with the expected direction of the effect of each variable on the probability of insolvency.

Table 1.Early Warning Indicators of the Probability of Bank Insolvency
Variables1Expected Effect2Federal Reserve FIMS3Bank Balance Sheet Models4Asset-Pricing ModelsMacro Studies
Capital adequacy×
Loan-loss reserves/assets×
Bank size (ability to raise capital)×
Asset quality
Loans past due 30-89 days/assets+×
Loans past due 90 plus days/assets+×
Nonaccrual loans/assets+×
Foreclosed real estate/assets+×
Safe investment securities/assets×
Rate of asset growth+×××
Sectoral loans/assets (various sectors)+/−×
Examiners’ on-site rating of management×
Previous overall on-site rating×
Corporate structure+/−×
Expenses/total revenue+×
Net income/assets×
Loan revenue/total revenue+/−×
Revenue from secure assets/total revenue×
Change in interest and tee income/assets×
Change in interest expenses/assets+×
Large certificates of deposit/assets+×
Liquid assets/total assets×
Interest-sensitive funds/total funds+×
Market structure
Local banking market concentration+/−×
State of the economy
Deposit growth rate+/−×
Price of oil+/−××
Corporate default risk+××
Current account imbalance+×
Market interest rates/bond yields+/−××
Equity prices/yields+/−××
Terms of trade×
Real GDP×
International capital flows+/−×
Exchange rate changes+×
Government deficit, banking sector claims on government+×
Policy shocks+×

Similar variables have been grouped together; for example, for capital adequacy, studies use various versions of capital/assets. These are not shown separately.

This column indicates the direction of effect that an increase in each explanatory valuable is expected to have on the probability of bank insolvency. Thus, for example, a better on-site rating of management would be expected to correlate with a lower probability of insolvency. The direction of effect of some individual variables will depend also on other factors; these variables are idicated as +/−.

Financial Institutions Monitoring System. See Cole, Cornyn, and Gurther (1995).

As surveyed in Demirguc-Kunt (1989).

Similar variables have been grouped together; for example, for capital adequacy, studies use various versions of capital/assets. These are not shown separately.

This column indicates the direction of effect that an increase in each explanatory valuable is expected to have on the probability of bank insolvency. Thus, for example, a better on-site rating of management would be expected to correlate with a lower probability of insolvency. The direction of effect of some individual variables will depend also on other factors; these variables are idicated as +/−.

Financial Institutions Monitoring System. See Cole, Cornyn, and Gurther (1995).

As surveyed in Demirguc-Kunt (1989).

These variables include traditional measures of capital adequacy, asset quality, management, earnings, and liquidity. The impact of macroeconomic conditions on banks is captured in some of the variables used. Recognizing that a bank will not remain well capitalized unless it operates efficiently, some models also include measures of operating efficiency. Assessing efficiency through financial performance indicators, such as earnings relative to assets or relative to employees, requires some control for market structure; a monopolist may be inefficient but still show high earnings. Thus some studies have included market structure variables as well.

Most of the anticipated effects are straightforward, but some are complex. In general, supervisors should be concerned about banks with unusually high or low financial ratios. For example, a high capital-to-asset ratio, which will cause a low rate of return on equity (ROE), may lead to hostile takeover activity that can have positive or negative implications for bank soundness, while a low capital ratio implies a high probability of failure. A low loan-to-asset ratio implies that banks are not carrying out their intermediation role and may be involved in other, possibly speculative, activities, whereas a high ratio indicates high exposure to credit risk.

Much of the published work in this area has focused on the United States, whose large banking sector, extensive recent experience with bank failures, and well-developed statistical reporting systems have provided abundant data. Translating this work to other banking environments will require further research. Since the basic financial operations of banking are the same across countries, the sets of relevant variables would be expected to be similar. It must be recognized, however, that in many countries individual bank data do not exist, or are inaccurate and outdated, presenting such a large errors-in-variables problem as to call into question the validity of any empirical estimates of the probability of insolvency for those economies.

A different approach to gauging insolvency has recently been adopted by a number of researchers. If financial markets can assess a bank’s value, and the market price for equity reflects it, then an asset pricing model can be used to infer the risk of insolvency that the market has assigned to each bank. The capital asset pricing model was applied by Hall and Miles (1990) to assess bankruptcy risk for several U.K. banks and for a set of U.S. banks, including a subset that subsequently did fail. Clare (1995) used an arbitrage pricing model based principally on macroeconomic variables to estimate the probabilities of failure among individual U.K. merchant banks. Fischer and Gueyie (1995) applied an option pricing model to estimate the implied variance of bank assets in a number of countries that had liberalized their financial systems. The asset pricing approach has the advantages of using data that are publicly available, principally market prices for bank securities, and of incorporating the information inherent in financial market prices (see Table 1). However, to the extent that financial markets are less than fully informed and efficient, the inferences drawn from these models may be insufficient as an early warning of bank unsoundness (for a critical view, see Simons and Cross (1991)).

Predicting Systemic Unsoundness

Relatively little empirical work has been done on predicting systemic unsoundness. In part this is because supervisors use a bottom-up approach; they are concerned initially with individual banks, and the system is then viewed as the sum of all banks. Most early warning models focus on predicting problems at individual banks and require access to bank-specific data. There is potential, however, to measure or project systemic banking problems from aggregate economic data as well. Three possible approaches to predicting systemic unsoundness are summarized here, followed by a brief review of some recent literature.

Bottom-Up Approach

A bottom-up approach to systemic soundness estimates the probability of insolvency developing for each individual bank in the economy, based, for example, on a balance sheet model. These data then provide the basis for constructing a distribution of bank assets by probability of insolvency. A concern for systemic stability would be warranted when the probability of insolvency becomes significant for a large proportion of the country’s banking assets, or when that probability increases substantially in any period of time. The critical range is a matter of judgment and will depend in part on the risk-aversion of the supervisor or policymaker undertaking the evaluation.

While a full distribution provides a more complete picture, a single measure of the condition of the banking system might be constructed as an asset-weighted probability of insolvency based on the probability of insolvency for each bank. The sum of asset-weighted probabilities will range between zero (when all banking assets are housed in banks with no probability of insolvency) and 100 (when all the nation’s banking assets are in banks with a probability of insolvency equal to 1).

The principal drawback to applying this methodology is that sufficient bank-specific data to estimate the underlying model are not readily available for most countries. A secondary drawback is that it does not systematically take into account the different functions that banks may play in a market, and the degree of interaction between banks. Banks with certain functions, such as key payments centers, may be more important to the functioning of the system than simple asset weighting shows. The degree of interaction between banks, for example, interbank market exposure or overlapping exposure to certain sectors, will determine the extent of potential domino or contagion effects.

Aggregative Approach

Given the difficulty in obtaining bank-by-bank data, it might be useful to estimate the probability of systemic insolvency using aggregate banking sector data, which are often published by central banks or other official statistical sources. The approach here would be to apply a model based on single bank characteristics similar to those summarized in Table 1 to a synthetic aggregate bank. In this case, the model would have to be developed using cross-sectional data from countries with similar financial systems, since time-series data for a single country might not provide sufficient instances of systemic insolvency to establish the necessary econometric relationships. The model could then be applied to the aggregate bank data to determine the probability of systemic insolvency for that system.

One significant drawback to this approach is that aggregation may hide problems. For example, while the capital-to-asset ratio is used as an indicator of individual bank condition, it is not possible to adequately assess the strength of the banking sector as a whole by looking at an average, even an asset-weighted average of the capital-to-asset ratio. Two banking systems each with ten equally sized banks might have an average capital-to-asset ratio of zero percent. In one system, each bank could have zero capital and so offer the public no sound banking options. The other might consist of half the banks with capital ratios of 10 percent and the other half with minus 10 percent. This system offers sound options to the public. Thus a distribution of bank assets by capital ratio is needed to assess the vulnerability of the banking system to systemic crisis. When a significant proportion of banking assets is held by undercapitalized or insolvent banks, the banking system would be considered unsound. An aggregate measure, however, would not always provide this information.

Another drawback would be the difficulty in estimating the model from cross-country data. First, as noted, defining systemic insolvency presents a number of challenges, although one might alternatively focus on predicting the extent of likely undercapitalization. Second, legal, regulatory, financial infrastructure, political and even cultural factors come into play in determining the degree to which a bank may be subject to losses, runs, and failure. Direct comparability across countries will be difficult to establish, but analysis using countries with similar economic structures or at similar stages of development might yield worthwhile insights.

Macroeconomic Approach

Banks are derivative institutions in that their health reflects the health of their customers, which in turn reflects the health of the economy as a whole. Instead of looking at bank balance sheet data for internal sources of unsoundness, it should be possible to establish systematic relationships between economywide variables and an indicator of bank soundness, such as capitalization. A number of macroeconomic variables would be expected to affect the banking system or reflect its condition. Indeed, some of the models summarized in the first columns of Table 1 employ macroeconomic variables to predict problems at specific banks. One would expect these same variables to be significant for the soundness of the system as a whole.

Broadly speaking, these macroeconomic factors can be grouped as indicators of macroeconomic conditions and indicators of financial fragility. The former group would include GDP and sectoral growth rates, indices of industrial activity, and indicators of macroeconomic balance, such as capital account, current account, and fiscal balances. For example, if an economy or certain important sectors are in a prolonged recession, there is cause for concern about the soundness of the banking system; indicators of macroeconomic conditions would be relevant in these cases.

Indicators of financial fragility would include data on money and credit, interest rates, asset price indices, consumer credit, corporate indebtedness, and bankruptcy rates. For example, excessive credit growth relative to GDP and rapid rises in asset prices have been associated with a weakening of the quality of bank portfolios and an increase in risk exposure. Indicators of systemic distress would include frequent requests by banks for liquidity support and a tiered interbank market. Qualitative variables reflecting the political situation, legal and financial infrastructure, and regulatory environment might also be useful barometers in that the resilience of banking systems will depend to a significant degree on the framework in which they operate, as discussed in Part III.

Data availability for most of these variables should be high. Some researchers have looked at the history of banking crises in a particular country over time; an example is Gorton (1988), who studied the national banking era in the United States (1865-1914), during which there were numerous panics. Under current institutional structures in most countries, estimation of an insolvency probability model at the systemic level would again require cross-country data. Such an approach might provide a means of estimating the impact of particular events, such as a fall in asset prices, on the banking system as a whole. Where bank-specific data are available, macroeconomic factors could be applied to individual banks to derive their sensitivities to particular factors. Even where bank-specific data are not available, some insight into the sensitivity of the banking system as a whole to these factors could be derived from aggregate data, as described (and subject to the caveats noted) above.

Recent Literature

Recent literature has begun to look systematically at banking crises across countries with a view to better understanding the contributing factors. The methodology applied has been a case study approach: examples of countries that have experienced crises are selected, and common macroeconomic trends surrounding the crises are analyzed. The papers in Sundararajan and Baliño (1991) and the studies of Baer and Klingebiel (1995), Caprio and Klingebiel (1996), and Garcia (1994 and 1995) identify a number of the macroeconomic and financial fragility variables listed above as contributors to banking sector crises. The analysis of these studies is largely retrospective, focusing on explanation rather than prediction.

A few recent works have taken a more forward-looking view. Mishkin (1994) attempts to outline signals that a financial crisis is in prospect.

These include declines in stock prices, increases in interest rates and corporate indebtedness, and unanticipated declines in inflation. Hausmann and Gavin (1995) note that loan delinquencies are lagging indicators, and focus instead on macroeconomic shocks to asset quality and bank funding, and the role of credit booms in fostering financial fragility. Kaminsky and Reinhart (1996) focus on the links between balance of payments and banking crises and conclude that financial liberalization helps to predict banking crises across a range of countries, although this may be due to selection bias. As precursors, they identify recessionary conditions, declining economic activity, export sector weakening, sinking asset prices, rapid credit expansion, reversals of capital inflows, increases in the money multiplier, and high real interest rates. Fischer and Gueyie (1995) use a combination of bank balance sheet, macroeconomic, and policy variables to explain changes in bankruptcy probability (as gauged by an option pricing model).

Some of the variables that have been characterized by these studies as contributing to the emergence of a crisis are listed in Table 1. The studies are largely qualitative; no formal model to predict the onset of a crisis or the emergence of an unsound system has been estimated. An appropriate set of early warning signals will vary across countries, depending on the quality and availability of banking and macroeconomic data, and the specific institutional setting. However, as guides to policy these studies are important contributions. The logic underlying the importance of the identified macroeconomic factors is explored further in the next chapters.

Survey of Banking Problems Worldwide

A review of the experiences since 1980 of the 181 current Fund member countries reveals that 133 have experienced significant banking sector problems at some stage during the past fifteen years.11 This figure represents 73.5 percent of Fund member countries. A summary of the review is presented in Table 2. Two general classes are identified: “crisis” (41 instances in 36 countries) and “significant” problems (108 instances). There is some degree of judgment in these classifications, but in general, following Sundararajan and Balino (1991), we refer to cases where there were runs or other substantial portfolio shifts, collapses of financial firms, or massive government intervention, as crises. Extensive unsoundness short of a crisis is termed significant.

Table 2.Survey of Banking Problems: 1980-Spring 19961
CountryType of ProblemMeasure of Extent

SignificantThirty-one percent of “new” (post-July 1992 cleanup) loans are nonperforming; some banks are facing liquidity problems owing to a logjam of interbank liabilities.

SignificantFifty percent of loans were nonperforming and were taken over by the treasury; operations covered all the 5 commercial banks, and were followed by ongoing structural reforms.

SignificantThe two-tier banking system (established in 1991) is still not consolidated; 2 commercial banks (state-owned) are experiencing solvency problems.

CrisisNine percent of loans were nonperforming in 1980 and 30% in 1985; 168 institutions were closed.
(1989–90)CrisisNonperforming assets constituted 27% of the aggregate portfolio and 37% of the portfolios of state-owned banks. Failed banks held 40% of financial system assets.
(January to September 1995)CrisisThrough September 1995, 45 of 205 institutions were closed or merged.

SignificantThe central bank has closed half of the active banks since August 1994, but the nonperforming asset problem of the large banks remains to be tackled. The Savings Bank has negligible capital.

SignificantNonperforming loans rose to 6% of total assets in 1991-92. State-owned banks, especially in Victoria and South Australia, had to be rescued at a cost to the state governments of 1.9% of GDP. A large building society failed.

SignificantOne large state-owned bank is facing a serious liquidity problem; new management has been appointed; 12 private banks have been closed owing to noncompliance with regulations; 3 large state-owned banks will be insolvent if loan losses are written off.
BahrainThe system withstood deposit withdrawals from the offshore center during the Persian Gulf war.

SignificantIn 1987, 20% of the loans of 4 major banks, whose assets accounted for 70% of all lending, were nonperforming.

SignificantMany banks are undercapitalized; forced mergers have burdened some banks with poor loan portfolios; the regulatory environment is uncertain.

CrisisAll three commercial banks collapsed; 78% of loans were nonperforming at the end of 1988.

(Early 1990s–present)
SignificantNonperforming loans amount to approximately 7% of total loans.

SignificantNonperforming loans reached 30% of banking assets.
(1994–present)SignificantTwo banks with 11% of assets were closed in November 1994. Four of 15 domestic banks, with 30% of assets, were undercapitalized and had liquidity problems and high levels of nonperforming loans in 1995.

SignificantThere has been no major bank closure. Loans made in the late 1980s and early 1990s are in default owing to the breakup of the former Yugoslavia and the war; this also translates into unrepayable commercial bank debt to international lenders.

SignificantOne problem bank was merged in 1994, a small bank was liquidated in 1995, and the state-owned National Development Bank was recapitalized at a cost of 0.6% of GDP.

SignificantTwenty-nine banks, holding 15.4% of total deposits, were subjected to official intervention, placed under special administration, or received assistance to merge.
Brunei Darussalam

SignificantSeveral financial firms failed in the mid-1980s. The second largest bank failed in 1986. In 1991, 9% of loans were past due; the level of such loans has subsequently declined.

CrisisAbout 75% of nongovernment loans were nonperforming in 1995, leaving many banks insolvent. Runs on banks have been reflected in pressure on reserve money and a queue of unsettled interbank payments.
Burkina Faso

SignificantThirty-four percent of loans were nonperforming.

SignificantTwenty-five percent of loans were nonperforming in 1995; one bank was liquidated.

SignificantCommercial banks have rapidly expanded in the past two years. A number of banks do not meet prudential regulations. As supervisory capacity is rudimentary, there is no current information on the quality of the banks’ portfolios.

CrisisIn 1989, 60-70% of loans were nonperforming.
(1995–present)CrisisAbout 30% of loans were nonperforming in 1996.

SignificantFifteen members of the Canadian Deposit Insurance Corporation, including 2 banks, failed.
Cape Verde

SignificantIn September 1993, the central bank was separated from the principal commercial bank. An estimated 30% of loans of the commercial bank were nonperforming at the end of 1995. This is in addition to nonperforming loans of public enterprises amounting to about 7% of GDP that remained with the central bank and were transferred to the government in September 1994.
Central African Republic

CrisisFour banks were liquidated.
(1995–present)SignificantForty percent of loans are nonperforming; one state-owned bank is being taken over by a private group.

CrisisFull banking operations were resumed after the 1979 civil war, with a moratorium on some loans and deposits.
(1992)SignificantThirty-five percent of loans to the private sector were nonperforming. The central bank consolidated those loans held by the 3 main commercial banks.

CrisisThe authorities intervened in 4 banks and 4 nonbank financial institutions (with 33% of outstanding loans) in 1981; 9 other banks and 2 more nonbanks (with 45% of outstanding loans) were subject to intervention in 1982–83, and many others were assisted. At the end of 1983, 19% of loans were nonperforming.

SignificantProblems have been recognized, but their size is very unclear; official estimates suggest that between 10% and 20% of bank loans could be nonperforming.

SignificantThe authorities intervened in 6 major banks and 8 finance companies. 15% of loans were nonperforming in 1984–85 (5.5% in 1980, 6.6% in 1988). Some insolvent banks were nationalized in 1985-86.

Republic of(1994–present)
CrisisSeventy-five percent of loans to the private sector are nonperforming; 2 state-owned banks are being liquidated and 2 other state-owned banks are being privatized.
Costa Rica

SignificantOne large state-owned commercial bank was closed in December 1994. The ratio of overdue loans (net of provisions) to net worth in state commercial banks exceeded 100% in June 1995.
Côte d’ lvoire

SignificantFive specialized financial institutions and one commercial bank were restructured. Nonperforming loans reached 12% of bank credit.

SignificantBanks accounting for 47% of bank credit have been found to be unsound and have been, or are scheduled to be, taken over by the Bank Rehabilitation Agency during 1996.
Czech Republic

SignificantIn 1994-95, 38% of loans were nonperforming. Several banks have been closed since 1993.

SignificantCumulative loan losses over the period 1990-92 were 9% of loans; 40 of the 60 problem banks were merged.

SignificantTwo of 6 commercial banks ceased operations in 1991 and 1992; their bankruptcy is being finalized. Another bank experienced difficulties.
Dominican Republic

SignificantMore than 5% of the total loans of the financial system are estimated to be nonperforming. In the past three years, 3 small banks have been liquidated. In April 1996, the Monetary Board intervened in the third largest bank, which represents 7% of the assets of the banking system.

SignificantHigh levels of nonperforming loans; the authorities intervened in several smaller financial institutions in late 1995 to early 1996 and in the fifth largest commercial bank in March 1996.

SignificantFour main public sector banks were given capital assistance.
El Salvador

SignificantNine state-owned commercial banks (later privatized between 1991 and 1993) had 37% of loans nonperforming in 1989.
Equatorial Guinea

CrisisTwo of the country’s largest banks were liquidated.
(1995)SignificantThe principal bank’s main shareholder has been placed in liquidation.

SignificantState-owned banks were undercapitalized, but information on the quality of bank portfolios is scarce.

CrisisInsolvent banks held 41% of banking system assets. The licenses of 5 banks have been revoked, 2 major banks were merged and nationalized, and 2 large banks were merged and converted to a loan-recovery agency.

SignificantA government-owned bank was restructured, and its nonperforming loans were taken over by the government.

SignificantTen percent of the loans are nonperforming. The problems are concentrated in one large bank that has 30% nonperforming loans.

CrisisNonperforming loans and credit losses reached 13% of total exposure at their peak in 1992; there was a liquidity crisis in September 1991.

SignificantNonperforming loans were 8.9% of total loans in 1994. Fifteen percent ($27 billion) of Credit Lyonnais’ loans were nonperforming, and some other banks have posted large losses.

SignificantNine percent of loans are nonperforming; one bank was temporarily closed in 1995.

SignificantTen percent of bank credit was nonperforming in 1992. A government bank was restructured and privatized in 1992.

SignificantAbout a third of banks’ outstanding loans are nonperforming; most large banks would be insolvent if adequate provisions were made for all nonperforming assets.

SignificantThere were major problems at state-owned banks in East Germany following unification. The costs were handled by an extrabudgetary fund.

SignificantForty percent of bank credit to nongovernment borrowers was nonperforming in 1989; one bank was closed and two were merged.

SignificantThere were localized problems that required significant injections of public funds into specialized lending institutions.
GuatemalaTwo small state-owned banks had high nonperforming assets; these banks discontinued operations in the early 1990s.

CrisisThe state-owned banking system collapsed; 80% of loans were nonperforming.

SignificantAfter transition to a system in which the central bank and private commercial banks operate separately, sizable nonperforming loans (equivalent to 3.5% of GDP) were assumed by the treasury in early 1996.
(1988–present)SignificantIn August 1995, 26% of loans were nonperforming.

SignificantOne public bank was liquidated and merged with another public bank, holding more than one third of financial sector deposits. The surviving bank is to be restructured because of high levels of nonperforming loans. In 1993-94, US$28 million (approximately 7% of GDP) in nonperforming loans were written off.

SignificantThe political situation in 1994 resulted in a disruption of normal banking and a run on banks.

SignificantEight banks, accounting for 25% of financial system assets, became insolvent. At the end of 1993, 23% of total loans were problematic.

SignificantOne of three state-owned banks became insolvent and was eventually privatized in a merger with 3 private banks.
(1993)SignificantThe government was forced to inject capital into one of the largest state-owned commercial banks after it had suffered serious loan losses.

SignificantThe nonperforming domestic assets of the 27 public sector banks were estimated at 19.5% of total loans and advances of these banks as of the end of March 1995. At that time, 15 banks did not meet Basle capital adequacy standards.

SignificantNonperforming loans, which were concentrated in state-owned banks, were over 25% of total lending in 1993 but declined to 12% in September 1995. A large private bank was closed in 1992.

SignificantOne of the four clearing banks wrote off one fourth of its capital when its insurance subsidiary sustained losses and was placed under administration.

SignificantThe government nationalized major banks accounting for 90% of the market; there had been an undercapitalization problem exacerbated by a crisis in the stock market.

SignificantProblems were concentrated in the south, affecting particular institutions. Systemwide, nonperforming loans were 10% of total in 1995. During 1990-94, 58 banks (accounting for 11% of total lending) were in difficulties and were merged with other institutions, and 3 of the 10 largest banks received significant injections of public funds; 10 banks were undercapitalized in 1994.

SignificantA merchant banking group was closed in December 1994; a medium-sized bank was supported in 1995.

SignificantIn early 1996, the Ministry of Finance estimated problem loans at around 8% of GDP.

CrisisThe third largest bank collapsed in August 1989; six other financial institutions encountered difficulties. The central bank provided overdrafts equivalent to 10% of GDP to meet a run on deposits and allow banks to settle foreign obligations.

SignificantForty percent of assets are to be written off; 80% of banks would be insolvent if all loan losses were written off.

SignificantAbout 66% of loans of one third of the commercial banks were nonperforming. The local subsidiary of Meridien BIAO was closed in 1995 with little spillover.

SignificantNonperforming loans of deposit money banks rose significantly in the first half of the 1980s, exceeding 7% of total assets in 1986. The ratio of nonperforming loans to total assets declined subsequently to 0.9% in 1995.

CrisisThere was a banking collapse associated with problems in the informal stock market. An estimated 40% of loans were nonperforming in 1986.
(1990–91)SignificantA large part of the private sector’s loan portfolio became nonperforming due to the loss of property and collateral.
Kyrgyz Republic

SignificantEighty to ninety percent of all loans are doubtful; 4 small commercial banks were closed in the past year and 2 large state banks are facing problems.
Lao People’s Democratic Republic

(Early 1990s)
SignificantNonperforming loans dominated the portfolios of the state-owned commercial banks. In 1994, these banks were recapitalized with an injection of cash and bonds equivalent to 1.5% of GDP.

CrisisTwo thirds of audited banks recorded losses in 1994. Eight bank licenses were revoked in 1994 and 15 more were revoked during the first seven months of 1995. The subsequent closure of the largest bank (with 30% of deposits) and two other major banks triggered a banking crisis in the spring of 1995.

CrisisFour banks became insolvent; 11 banks had to resort to central bank lending.

SignificantOf 4 commercial banks, 1 that serves mostly the agricultural sector and has only a small share of bank assets has had a large portfolio of nonperforming loans. Banking services were disrupted for two months in 1991 owing to a strike.

CrisisSeven out of 11 banks are not operational; their assets were equivalent to 60% of total bank assets at mid-1995.

CrisisOf 25 banks, 12 small ones are being liquidated and 4 larger ones do not meet the capital adequacy requirements. The fourth largest bank was closed. The operations of 2 banks, which accounted for 1 5% of deposits, were supported in 1995.
Macedonia, former Yugoslav Republic of

CrisisSeventy percent of loans were nonperforming. The government took responsibility for banks’ foreign debts and closed the second largest bank.

SignificantFive major banks had nonperforming loans ranging from 45% to 75% of their portfolios.
(1991–95)SignificantThere were severe management problems in the 2 remaining state-owned banks. Loan losses resulted in reserve deficiencies and the need for substantial provisions in 1994.

CrisisThe largest domestic bank wrote off nonperforming loans equivalent to approximately 1.4% of GDP in 1983. Nonperforming loans were estimated at 32% of total loans in 1988.

SignificantThe largest bank was nearly illiquid, with 75% of its loans nonperforming; it was restructured in 1989 with equity injection and government loan guarantees.
(1995)SignificantThe government made an “equity” loan to strengthen the capital of one bank following the collapse of Meridien Bank.

SignificantThe Development Bank ceased operations and was liquidated in 1994; 3 of the 4 commercial banks required substantial recapitalization.
MauritiusThe central bank closed 2 of 12 commercial banks for fraud and other irregularities in 1996.

CrisisThe government took over the troubled banking system.
(1994–present)CrisisThe ratio of nonperforming to total loans rose from 9% at the end of 1994 to 12% in December 1995. The authorities intervened in 2 banks in September 1994 and 4 of the remaining 35 banks (holding 17.5% of total end-1994 assets) in 1995. An additional 2 were taken under the administration of FOBAPROA (the deposit insurance agency). The overall cost of the several programs to support the banking system is estimated (in present value) at 6.5% of GDP.

SignificantA significant stock of nonperforming assets has built up in most banks, largely resulting from earlier directed credits. Audits of the 4 largest banks will help quantify the extent of the problem.

SignificantTwenty-five percent of loans were nonperforming in 1995.

SignificantMost of the loans outstanding at the end of 1988 were written off with central bank assistance.
(1994–95)SignificantThe 2 dominant state-owned banks became increasingly dependent on central bank support, pending privatization.

SignificantThe banking system is dominated by 4 state-owned commercial banks, the largest of which is experiencing heavy losses and has a large portfolio of nonperforming loans. The other state-owned banks are widely recognized to be undercapitalized, but information on the quality of these banks’ portfolios is scarce.

(Late 1980s–present)
SignificantOfficial estimates indicate that nonperforming loans amount to between 10% and 15% of total loans in the two large public banks, which account for nearly 70% of total bank deposits.
NetherlandsBanks overcame problems with mortgage loans in the late 1970s.
New Zealand

SignificantOf 4 large banks, 1 that was state-owned and accounted for one fourth of banking assets required a capital injection of almost 1% of GDP because of bad loan problems.

(Late 1980s–present)
SignificantTwo large state-owned banks have had longstanding financial problems. About 50% of loans are nonperforming.

CrisisIn the mid-1980s, 50% of loans were nonperforming. Four banks were liquidated and 3 restructured in the late 1980s. Reform was initiated in 1987-90, and the restructuring process is still under way.

SignificantIn 1991, 77% of loans were nonperforming. Of 115 banks, 34, accounting for 10% of deposits, were technically insolvent at the end of 1994.

CrisisSix percent of commercial bank loans were nonperforming. Heavy losses and insolvencies led to a crisis at the end of 1991. The government became the principal owner of the three largest banks, whose share of total commercial bank assets was approximately 85%.

SignificantNonperforming loans are estimated to be 10% of bank assets.

CrisisA bank holiday that lasted for nine weeks was declared in March 1988. As a result of uncertainty and loss of confidence caused by a political crisis, the public banks were particularly affected by a loss of deposits and a rapid deterioration in their loan portfolios that stemmed from poor lending decisions and the sharp contraction of the economy. The financial position of most commercial banks also weakened, and 15 banks ceased operations.
Papua New Guinea

SignificantA severe economic downturn in 1989 led sharp increases in loan losses at commercial banks. Eighty-five percent of the savings and loan associations ceased operations as a result of the economic problems, mismanagement, or fraud. The public lost confidence in the banking system and withdrew deposits in 1994.

SignificantThe authorities invervened in institutions accounting for some 10% of financial system deposits during the summer of 1995. There have been interventions in 6 other financial institutions
since then. Depositor restitution and operations to facilitate borrowing by distressed institutions cost an estimated 4% of GDP by the end of 1995.

SignificantTwo large banks failed. There were high levels of nonperforming loans and financial disintermediation following nationalization of the banking system in 1987.

CrisisBanks accounting for 1.6% of banking system assets failed in 1981. Through the mid-1980s, a number of institutions failed or were taken over by government financial institutions. Nonperforming assets of two state-owned institutions were transferred to a government agency. These assets accounted for nearly 30% of total banking assets. In 1986, 19% of loans were nonperforming.

SignificantSixteen percent loans were classified as losses, 22% as doubtful, and 24% as substandard in 1991.

SignificantFive major state-owned commercial banks had 35% of their accrued interest receivables overdue as of June 30, 1994.

SignificantOfficial estimates of loan arrears were 40% of total credit to the private sector at the end of 1995.

SignificantThere is a substantial amount of nonperforming loans. One bank, with a well-established network, has been closed.
Sao Tome and Principe

CrisisOver 90% of loans of the monobank were nonperforming in 1992. In 1993, a new central bank began operations. The commercial and development departments of the former monobank were liquidated, as was the only other financial institution. At the same time, 2 new banks were licensed and took over many of the assets of their predecessors. The credit operations of one newly created bank have been suspended since the end of 1994.

CrisisIn 1988, 50% of loans were nonperforming. Reform was implemented in 1988-91; 8 banks were liquidated and the remaining 8 were restructured.
Sierra Leone

SignificantIn 1995, 40-50% of loans were nonperforming. Recapitalization and restructuring is ongoing. The license of one bank was suspended in 1994.
SingaporeNonperforming loans at domestic commercial banks reached 0.6% of GDP in 1982.
Slovak Republic

SignificantLoans classified as nonstandard were high at the end of August 1995. There were no runs or major bank closures, but all 5 major banks required government-sponsored restructuring operations.

SignificantThree banks, with two thirds of banking system assets, were restructured during this period. The percentage of bad loans is not known. Bank rehabilitation was completed in 1995.

CrisisThere were nonperforming claims on both private and public sector borrowers during the civil unrest.
South Africa

CrisisBanks built up large short-term foreign liabilities owing to high domestic interest rates. When foreign banks began to reduce their exposure, in part owing to political factors, the exchange depreciation and liquidity squeeze on banks resulted in an official moratorium on external capital repayments.
(1989-present)In 1989-90, one major bank, which held about 15% of banking assets, was recapitalized and reorganized after suffering loan losses and management problems. Since 1991, several small banks have been liquidated or put into curatorship, with no systemic repercussions.

CrisisFrom 1978 through 1982, 110 banks, accounting for 20% of deposits, were rescued. In addition, in 1983 one group that controlled 100 enterprises and 20 banks was nationalized.
Sri Lanka

(Early 1990s)
SignificantThirty-five percent of the portfolios of the two state-owned commercial banks, which accounted for over 60% of banking system assets, were nonperforming. In March 1993, bonds equivalent to 4.8% of GDP were issued to recapitalize these banks.
St. Vincent and the Grenadines

SignificantThe only domestic bank is a state-owned commercial bank, which accounts for 30% of deposits. About 10% of its assets are nonperforming.
SudanSmaller banks are being encouraged to merge with larger banks to ensure compliance with the Basle capital standards before June 1997.

SignificantMeridien BIAO Swaziland was taken over by the central bank. The central bank also took over the
Swaziland Development and Savings Bank (SDSB), which faced severe portfolio problems; the government is now expected to sign an agreement that will allow a foreign bank to take over the management of the SDSB.

CrisisEighteen percent of total unconsolidated bank loans were reported lost and the two main banks were assisted.

SignificantOne of the largest banks is insolvent; 1 small bank has been closed and another (out of 17) is in the process of liquidation.

CrisisState-owned commercial banks, accounting for over 95% of the system, were insolvent. At the end of 1994, 60% to 80% of all loans were nonperforming and the losses of the largest bank were equivalent to 70% of deposits.

CrisisFifteen percent of bank assets were nonperforming. There were runs during the crisis of 1983-85 and 15 finance companies failed. More than 25% of the financial system’s assets were affected.

SignificantOne of 10 commercial banks with 7% of bank credit was insolvent and liquidated and its credits were taken over by the government.
Trinidad and Tobago

(Early 1982–93)
SignificantThe banking sector expanded rapidly in the mid-1970s in a time of lax supervisory and prudential controls. With the onset of the general downturn in the economy in the early 1980s, some financial institutions experienced solvency problems, resulting in the merging of three government-owned banks in 1993 as an intermediate stage to the planned privatization of the merged bank.

SignificantIntroduction of new loan classification and provisioning standards and capital adequacy requirements in 1991, coupled with extensive portfolio audits in 1992, made clear that most commercial banks were undercapitalized. (State-owned banks accounted for over 65% of total lending.) From 1991 to 1994, the banking system raised equity equivalent to 1.5% of GDP and made provisions equivalent to another 1.5%. Thus recapitalization through 1994 required at least 3% of GDP, and some banks remained undercapitalized; recapitalization continued through 1996.

CrisisSeveral small banks and most brokerage houses collapsed.
(1991)CrisisThe start of the Persian Gulf war led to bank runs.
(1994)SignificantDepositor runs in the spring of 1994 resulted in the closure of 3 medium-sized banks. To stem further runs, the government introduced full deposit insurance in May 1994.

SignificantA small bank failed in early 1993. Several other banks are in difficulty or insolvent, including state-owned banks accounting for more than 40% of banking system assets.

SignificantIn 1994, many banks did not meet capital and other prudential requirements. Audits indicated that one of the five largest banks was insolvent. Approximately 30% of loans outstanding were in arrears. The authorities intervened at 20 small to medium-sized banks in 1995.
United Kingdom3No systemic problems, but several notable bank failures, including Johnson Matthey (1984), Bank of Credit and Commerce International (1991), and Barings (1995), have occurred.
United States

SignificantDuring the period, 1,142 savings and loan (S&L) associations and 1,395 banks were closed; 4.1% of commercial bank loans were nonperforming in 1987.

CrisisEleven percent of loans were nonperforming in 1982, 59% in 1986.

SignificantAlmost 10% of loans were reported to be overdue in October 1995.

CrisisIn 1993, before the crisis started, 8.5% of loans were reported as nonperforming. The authorities intervened in 13 of 47 banks, which held 50% of deposits, in 1994, and 5 additional banks in 1995. Support by the government and the central bank to the banking system amounted to almost 17% of GDP in 1994–95.

SignificantState-owned banks are widely recognized to be undercapitalized, but information on the quality of their portfolios remains scarce.
Yemen Arab Republic

SignificantBanks have extensive nonperforming loans and heavy foreign currency exposure.

SignificantFour state-owned banks are insolvent; a fifth bank is to be recapitalized with private participation.

SignificantOne of the largest commercial banks, the local Meridien BIAO subsidiary, failed in early 1995 and received official support equivalent to approximately 1.5% of GDP. Two small banks failed in late 1995, and several others are fragile.

SignificantTwo of the 5 commercial banks are unable to meet their statutory reserve requirements owing to a high percentage of nonperforming loans.

Under “Problems,” a blank space indicates that there was a problem but that it was neither “significant” nor a “crisis.” Years in parentheses denote the period of banking problems.

In 1995, fraud resulted in major losses and depositor runs at two institutions in Taiwan Province of China; one was taken over by a state-owned bank and the other supported by the central bank and a state-owned bank. The large state-owned banks are reported to have an overhang of bad loans to real estate projects.

From 1982-86, 16 Hong Kong banks and other deposit-taking institutions failed, were liquidated, or were taken over. The closure of the BCCI subsidiary in Hong Kong in 1991 led to minor runs on several local banks.

Under “Problems,” a blank space indicates that there was a problem but that it was neither “significant” nor a “crisis.” Years in parentheses denote the period of banking problems.

In 1995, fraud resulted in major losses and depositor runs at two institutions in Taiwan Province of China; one was taken over by a state-owned bank and the other supported by the central bank and a state-owned bank. The large state-owned banks are reported to have an overhang of bad loans to real estate projects.

From 1982-86, 16 Hong Kong banks and other deposit-taking institutions failed, were liquidated, or were taken over. The closure of the BCCI subsidiary in Hong Kong in 1991 led to minor runs on several local banks.

As is evident from the table, several countries experienced repeated problems. In others there were problems in some banks that did not have a significant impact on either the functioning of the banking sector as a whole or the macroeconomy; information on 7 such cases was available and is recorded as well but not categorized as crisis or significant.

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