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Predicting bank failure: An improvement by implementing machine learning approach on classical financial ratios

Author

Listed:
  • Hong Hanh Le

    (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR - Université de Rennes - CNRS - Centre National de la Recherche Scientifique)

  • Jean-Laurent Viviani

    (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR - Université de Rennes - CNRS - Centre National de la Recherche Scientifique)

Abstract

This research compares the accuracy of two approaches: traditional statistical techniques and machine learning techniques, which attempt to predict the failure of banks. A sample of 3000 US banks (1438 failures and 1562 active banks) is investigated by two traditional statistical approaches (Discriminant analysis and Logistic regression) and three machine learning approaches (Artificial neural network, Support Vector Machines and k-nearest neighbors). For each bank, data were collected for a 5-year period before they become inactive. 31 financial ratios extracted from bank financial reports covered 5 main aspects: Loan quality, Capital quality, Operations efficiency, Profitability and Liquidity. The empirical result reveals that the artificial neural network and k-nearest neighbor methods are the most accurate.

Suggested Citation

  • Hong Hanh Le & Jean-Laurent Viviani, 2018. "Predicting bank failure: An improvement by implementing machine learning approach on classical financial ratios," Post-Print halshs-01615106, HAL.
    • Handle: RePEc:hal:journl:halshs-01615106
    DOI: 10.1016/j.ribaf.2017.07.104
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    Cited by:

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    2. Citterio, Alberto & King, Timothy, 2023. "The role of Environmental, Social, and Governance (ESG) in predicting bank financial distress," Finance Research Letters, Elsevier, vol. 51(C).
    3. Buckmann, Marcus & Gallego Marquez, Paula & Gimpelewicz, Mariana & Kapadia, Sujit & Rismanchi, Katie, 2023. "The more the merrier? Evidence on the value of multiple requirements in bank regulation," Journal of Banking & Finance, Elsevier, vol. 149(C).
    4. Sarbjit Singh Oberoi & Sayan Banerjee, 2023. "Bankruptcy Prediction of Indian Banks Using Advanced Analytics," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 4, pages 22-41.
    5. Anggraeni, Anggraeni & Mongid, Abdul & Suhartono,, 2020. "Prediction Models for Bank Failure: ASEAN Countries," Jurnal Ekonomi Malaysia, Faculty of Economics and Business, Universiti Kebangsaan Malaysia, vol. 54(2), pages 41-51.
    6. Carmona, Pedro & Dwekat, Aladdin & Mardawi, Zeena, 2022. "No more black boxes! Explaining the predictions of a machine learning XGBoost classifier algorithm in business failure," Research in International Business and Finance, Elsevier, vol. 61(C).
    7. Li Xian Liu & Shuangzhe Liu & Milind Sathye, 2021. "Predicting Bank Failures: A Synthesis of Literature and Directions for Future Research," JRFM, MDPI, vol. 14(10), pages 1-24, October.
    8. Pedro Guerra & Mauro Castelli, 2021. "Machine Learning Applied to Banking Supervision a Literature Review," Risks, MDPI, vol. 9(7), pages 1-24, July.
    9. Kim, Jong-Min & Kim, Dong H. & Jung, Hojin, 2021. "Applications of machine learning for corporate bond yield spread forecasting," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).
    10. Manthoulis, Georgios & Doumpos, Michalis & Zopounidis, Constantin & Galariotis, Emilios, 2020. "An ordinal classification framework for bank failure prediction: Methodology and empirical evidence for US banks," European Journal of Operational Research, Elsevier, vol. 282(2), pages 786-801.
    11. José Alejandro Fernández Fernández & Virginia Bejarano Vázquez & Juan Antonio Vicente Virseda, 2019. "Evaluación de riesgos con Data Mining: el sistema financiero español," Remef - Revista Mexicana de Economía y Finanzas Nueva Época REMEF (The Mexican Journal of Economics and Finance), Instituto Mexicano de Ejecutivos de Finanzas, IMEF, vol. 14(3), pages 309-328, Julio - S.
    12. Kristóf, Tamás & Virág, Miklós, 2022. "EU-27 bank failure prediction with C5.0 decision trees and deep learning neural networks," Research in International Business and Finance, Elsevier, vol. 61(C).
    13. Yuan, Kunpeng & Chi, Guotai & Zhou, Ying & Yin, Hailei, 2022. "A novel two-stage hybrid default prediction model with k-means clustering and support vector domain description," Research in International Business and Finance, Elsevier, vol. 59(C).
    14. Bou-Hamad, Imad & Jamali, Ibrahim, 2020. "Forecasting financial time-series using data mining models: A simulation study," Research in International Business and Finance, Elsevier, vol. 51(C).
    15. Pham, Xuan T.T. & Ho, Tin H., 2021. "Using boosting algorithms to predict bank failure: An untold story," International Review of Economics & Finance, Elsevier, vol. 76(C), pages 40-54.
    16. Aslam, Faheem & Hunjra, Ahmed Imran & Ftiti, Zied & Louhichi, Wael & Shams, Tahira, 2022. "Insurance fraud detection: Evidence from artificial intelligence and machine learning," Research in International Business and Finance, Elsevier, vol. 62(C).
    17. Bolívar, Fernando & Duran, Miguel A. & Lozano-Vivas, Ana, 2023. "Business model contributions to bank profit performance: A machine learning approach," Research in International Business and Finance, Elsevier, vol. 64(C).
    18. Wang, Dan & Chen, Zhi & Florescu, Ionuţ & Wen, Bingyang, 2023. "A sparsity algorithm for finding optimal counterfactual explanations: Application to corporate credit rating," Research in International Business and Finance, Elsevier, vol. 64(C).
    19. Suss, Joel & Treitel, Henry, 2019. "Predicting bank distress in the UK with machine learning," Bank of England working papers 831, Bank of England.
    20. Buckmann, Marcus & Gallego Marquez, Paula & Gimpelewicz, Mariana & Kapadia, Sujit & Rismanchi, Katie, 2021. "The more the merrier? Evidence from the global financial crisis on the value of multiple requirements in bank regulation," Bank of England working papers 905, Bank of England.
    21. Cullen F. Goenner, 2020. "Uncertain times and early predictions of bank failure," The Financial Review, Eastern Finance Association, vol. 55(4), pages 583-601, November.

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    More about this item

    Keywords

    Failure prediction Intelligent techniques Artificial neural network Support vector machines K-nearest neighbors US banks;

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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