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Are Basel III requirements up to the task? Evidence from bankruptcy prediction models

Author

Listed:
  • Pierre Durand

    (Université Paris Est Créteil, ERUDITE, 94010 Créteil Cedex, France)

  • Gaëtan Le Quang

    (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France)

  • Arnold Vialfont

    (Université Paris Est Créteil, ERUDITE, 94010 Créteil Cedex, France)

Abstract
Using a database comprising US bank balance sheet variables covering the 2000-2018 period and the list of failed banks as provided by the FDIC, we run various models to exhibit the main determinants of bank default. Among these models, Logistic Regression, Random Forest, Histogram-based Gradient Boosting Classification and Gradient Boosting Classification perform the best. Relying on various machine learning interpretation tools, we manage to provide evidence that 1) capital is a stronger predictor of default than liquidity, 2) Basel III capital requirements are set at a too low level. More precisely, having a look at the impact of the interaction between capital ratios (the risk-weighted ratio and the simple leverage ratio) and the liquidity ratio (liquid assets over total assets) on the probability of default, we show that the influence of capital on this latter completely outweighs that of liquidity, which is in fact very limited. From a prudential perspective, this questions the recent stress put on liquidity regulation. Concerning capital requirements, we provide evidence that setting the risk-weighted ratio at 15% and the simple leverage ratio at 10% would significantly decrease the probability of default without hampering banks'activities. Overall, these results therefore call for strengthening capital requirements while at the same time releasing the regulatory pressure put on liquidity.

Suggested Citation

  • Pierre Durand & Gaëtan Le Quang & Arnold Vialfont, 2023. "Are Basel III requirements up to the task? Evidence from bankruptcy prediction models," Working Papers 2308, Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon.
    • Handle: RePEc:gat:wpaper:2308
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Basel III; capital requirements ; liquidity regulation ; bankruptcy prediction models ; statistical learning ; classification;
    All these keywords.

    JEL classification:

    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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