Global Finance Journal: Laura Chiaramonte, Ettore Croci, Federica Poli

Global Finance Journal 28 (2015) 111131
Contents lists available at ScienceDirect
Global Finance Journal

journal homepage: www.elsevier.com/locate/gfj
Should we trust the Z-score? Evidence from the

European Banking Industry
Laura Chiaramonte, Ettore Croci, Federica Poli
Department of Economics and Business Administration, Faculty of Economics, Universit Cattolica del Sacro Cuore, Largo Gemelli 1,
20123 Milan, Italy
a r t i c l e i n f o a b s t r a c t
Article history: We investigate the accuracy of the Z-score, a widely used proxy of bank
Received 8 October 2014 soundness, on a sample of European banks from 12 countries over the
Received in revised form 27 January 2015 period 20012011. Specically, we run a horse race analysis between
Accepted 5 February 2015
the Z-score and the CAMELS related covariates. Using probit and com-
Available online 18 April 2015
plementary loglog models, we nd that the Z-score's ability to identify
distress events, both in the whole period and during the crisis years
JEL classication:
(20082011), is at least as good as the CAMELS variables, but with the
G01
G21
advantage of being less data demanding. Finally, the Z-score proves to
be more effective when bank business models may be more sophisticat-
Keywords: ed as it is the case for large and commercial banks.
Bank distress 2015 Elsevier Inc. All rights reserved.
Z-score
CAMELS
Financial crisis
1. Introduction
Bank distress has been at the center of the political and economic debate during the recent nancial crises.
Both the credit crisis and the sovereign debt crisis have emphasized the need to properly assess the measures
of bank soundness. As a matter of fact, the existence of informational asymmetries and the limitations of bank
publicly disclosed information pose severe restrictions on the ability of external stakeholders (i.e., depositors,
borrowers, investors, nancial analysts, to name just a few) to identify in a timely way which banks are in
jeopardy of failing.
Unlike supervisors, who have often access to condential information on bank conditions, other external
parties must rely on regulated, disclosed information, such as nancial statements, which turn out to be the
main source of available data, especially for unlisted banks. Indeed, some of the most sophisticated
Corresponding author. Tel.: +39 02 72342942; fax: +39 02 72342670.

E-mail addresses: laura.chiaramonte@unicatt.it (L. Chiaramonte), ettore.croci@unicatt.it (E. Croci), federica.poli@unicatt.it (F. Poli)
http://dx.doi.org/10.1016/j.gfj.2015.02.002
1044-0283/ 2015 Elsevier Inc. All rights reserved.
112 L. Chiaramonte et al. / Global Finance Journal 28 (2015) 111131
approaches to quantify the risk of bank distress, like the Merton distance-to-default (DD), bond spreads and
credit default swaps (CDS), cannot be used to ascertain the nancial health of several banks, especially in
Europe where a large number of banking rms are not listed on Stock Exchanges and they have neither traded
bonds nor CDS quotes.1 When market-based measures of risk are not available or the quality of the market
data is poor, depositors, investors, analysts, and the public in general, have to rely on accounting data to de-
termine the likelihood of nancial distress.
In the empirical literature, there is a general agreement on the ability of accounting-based CAMELS vari-
ables (which stand for Capital, Asset quality, Management, Earnings, Liquidity and Sensitivity to market
risk) to capture banks' nancial vulnerability and to predict their distress (Poghosyan & ihk, 2011). Few re-
cent studies complement CAMELS indicators with the Z-score (Poghosyan & ihk, 2011; Vazquez & Federico,
2012), which is a widespread accounting measure of bank nancial soundness. The popularity of the Z-score
stems from its simplicity and the fact that it can be readily calculated using few accounting data. In this paper,
we examine whether the Z-score is a valuable tool to predict distress relative to the CAMELS-related
covariates, and if its ability of signaling differs through time, bank size, business model (shareholders vs.
stakeholders oriented banks), and geographic area.
Using probit and survival analysis models on a European sample banks from 12 countries over the period
20012011, we nd that the Z-score is overall a valuable and parsimonious measure to predict bank distress.
Indeed, the ability of the Z-score to predict distress, both over the whole period (20012011) and in the crisis
years (20082011), is at least as good as more data demanding models, like the one that employs CAMELS
variables. We also observe similar results when we compare the Z-score to its components: return on assets
(ROA); volatility of returns; and equity over total assets. When we add the Z-score to the CAMELS variables,
the model ability to predict bank distress slightly improves, but only in the whole period. During the nancial
and economic slowdown, as bank performances weaken the predictive accuracy of both the Z-score and the
set of CAMELS variables increases. Again, both models achieve substantially similar results. Finally, we show
that our results on the predictive ability of the Z-score are robust to changes in the computation of the Z-score.
We also nd that the Z-score is a more effective predictor for large banks and for commercial banks. This
suggests that the Z-score is a superior measure when bank business models are more complex of the nancial
institutions increases and their accounting practices are more scrutinized. Finally, the Z-score has relatively
more success in predicting distress and non-distress events in those European countries less affected by the
nancial crises. This latter result is consistent with the view that when a systematic crisis hits, rm-level
variables lose some of their ability to predict distress.
This study offers several contributions to the literature. Our horse race analysis between the sole Z-score
and CAMELS variables provides evidence that the former is a reliable leading indicator of bank distress. This
nding could be relevant to external bank stakeholders (for example, investors, borrowers, depositors,
suppliers) as well as, even if to a lesser extent, to supervisors when market-based measures of distress are
not available. Second, we improve the limited and controversial empirical literature that complements
CAMELS explanatory variables with the Z-score in order to predict bank distress. Finally, we compare a pooled
probit model and a survival model, specically a complementary loglog model (cloglog), and nd that the
results are remarkably similar.
We organize the remainder of this article as follows: in Section 2, we present a brief review of the litera-
ture. Section 3 describes the sample and how we identify distress events. Section 4 discusses the methodology
as well as the variables used in our paper and their descriptive statistics. Sections 5 and 6 present empirical
results and robustness tests. Section 7 concludes and offers some policy implications.
2. Literature review
The early detection of bank distress enables supervisory authorities to undertake prompt corrective ac-
tions designed to minimize the negative externalities and bailout's costs due to bank distress. To this aim,
bank supervisors of developed countries have developed their own early warning statistical models for the
last two decades, which are based on diversely heavy sets of economic and nancial variables. In the empirical
literature, the prediction of bank distress has been primarily focused on the identication of leading indicators
1
In our sample, only 160 banks out of 3125 are publicly listed on a stock exchange.
L. Chiaramonte et al. / Global Finance Journal 28 (2015) 111131 113
that contribute to generate reliable early-warning systems. Such signals may be grouped into two broad cat-
egories: market-based measures and accounting-based measures. The rst group of indicators relies mostly
on market prices of bank equity, to estimate bank's distance to default (Hagendorff & Kato, 2010;
Hagendorff & Vallascas, 2011; Vassalou & Xing, 2004); bond spreads (Bharath & Shumway, 2008; Flannery,
1998, 2000; Flannery & Sorescu, 1996; Jagtiani & Lemieux, 2001; Morgan & Stiroh, 2001; Sironi, 2000); and
more recently CDS spreads (Chiaramonte & Casu, 2013; Constantinos, 2010; Flannery, 2010; Norden &
Weber, 2010; Volz & Wedow, 2011). The adoption of market-based indicators is generally motivated by
their forward-looking nature, which should lead to a superior ability to anticipate a material weakening in
banks' nancial conditions as also conrmed by evidence for the US and Europe (Gropp, Vesala, & Vulpes,
2002).
Market-based indicators of bank distress have several advantages: rstly, they are generally available at
high frequency, providing more observations and shorter lags than nancial statements data. Secondly,
they are forward-looking since they incorporate market participants' expectations. Finally, they are not sub-
ject to condentiality biases as may be the case for some accounting data, i.e., those reported solely to super-
visory authorities (ihk, 2007).2 Nevertheless, the quality of market prices is conditional to the degree of
liquidity and transparency of nancial markets where bank stocks, debentures and CDS are traded. As a matter
of fact, the usefulness of market-based indicators is severely affected in case of illiquid and opaque markets.
Moreover since market-based indicators are usually available only for large and listed banks, they can be
used just for a relatively small fraction of banks, especially in Europe.
The second group of indicators of bank distress probability is dependent on nancial and accounting
values. In this approach, accounting data are proxies for fundamental bank attributes aimed to measure bank's
nancial vulnerability (Sinkey, 1979). The so-called CAMELS methodology is a well-known tool for superviso-
ry risk assessment.3 In the empirical literature, there is a general agreement on the ability of CAMELS variables
to assess banks in terms of their nancial vulnerability and to predict bank distress (Poghosyan & ihk,
2011). Low capital and risky assets are major causes of banks distress (Oshinsky & Olin, 2006). Larger capital
cushions allow banks to write-off bad loans in the future (Berger, Herring, & Szeg, 1995; Estrella, Park, &
Peristiani, 2000; Kick & Koetter, 2007) and make them less prone to distress during the global nancial crisis
(Beltratti & Stulz, 2012; Berger & Bouwman, 2013; Demirg-Kunt & Huizinga, 2010). Vazquez and Federico
(2012) analyze the evolution of bank funding structures in the run up to the global nancial crisis and show
that banks with weaker structural liquidity, higher leverage, and risk-taking in the pre-crisis period were
more likely to fail afterward.
The signicant episodes of systemic banking crises experienced by many emerging countries over the past
two decades stimulated several studies that use bank-level data focusing on a particular country or region or
at cross-country level (Arena, 2008; Bongini, Claessens, & Ferri, 2001; Gonzalez-Hermosillo, 1999). According
to Arena (2008), bank-level fundamentals, proxied by CAMELS related variables, explain why banks are likely
to fail in East Asia and Latin America.
Among the recent studies, mostly focused on the prediction of failures of commercial banks in the US, tra-
ditional CAMELS indicators are found to be successful in anticipating distress phenomena. However, the ex-
planatory power of the models increases with the addition of information on the banks' internal controls
on risk taking (Jin, Kanagaretnam, Lobo, & Mathieu, 2013), audit quality (Jin, Kanagaretnam, & Lobo, 2011),
income from non-traditional banking activities (De Young & Torna, 2013), market and macroeconomic data
(Cole & Wu, 2009), and commercial real-estate investments (Cole & White, 2012).
In recent studies, some efforts have been devoted to complement the CAMELS variables with book-based
indicators, such as a proxy of bank's distance-to-default, like the Z-score (Rojas-Suarez, 2001). The empirical
attractiveness of Z-score banks on the fact that it does not require strong assumptions about the distribution of
returns on assets (Boyd & Graham, 1986; Roy, 1952; Strobel, 2011). The latter represents an interesting ad-
vantage of Z-score, especially from the practitioners' point of view (Ivii, Kunovac, & Ljubaj, 2008). Contrary
to market-based risk measures, which are quantiable only for listed nancial institutions, the Z-score can be
computed for an extensive number of unlisted as well as listed banks. Despite its advantages, the Z-score is not
2
Indeed, if some relevant information is not publicly disclosed since it is collected and held by supervisors, prudential data can be su-
perior to market-based indicators in measuring banks' nancial soundness.
3
For example, the Federal Deposit Insurance Corporation (FDIC) in the US uses a composite CAMELS rating to determine whether a
bank must be included in its Problem list.
immune from some caveats. Firstly, as for the other accounting-based measures, its reliability depends on the
quality of underlying accounting and auditing framework, which is a serious concern in less-developed coun-
tries. Additionally, as banks may smooth accounting data over time, the Z-score may offer an excessively pos-
itive assessment of the risk of bank distress (Leaven & Majnoni, 2003). Secondly, as pointed out by ihk
(2007), the Z-score, as well as other market-based measures like the distance-to-default look at each bank
separately, potentially overlooking the risk that a distress in one nancial institution may cause loss to
other nancial institutions in the system. The few available results on the predictive power of Z-score are
mixed. Poghosyan and ihk (2011) nd that when the Z-score is added to the baseline predicting model,
the coefcient in front of the Z-score variable is insignicant, suggesting that the Z-score scarcely contributes
to predict bank distress. On the contrary, Vazquez and Federico (2012) nd that bank risk proles play a sig-
nicant role. Finally, Lepetit and Strobel (2013) compare different existing approaches to the construction of
Z-score measures, using a panel of banks for the G20 group of countries covering the period 19922009. Their
results are supportive of a time-varying Z-score measure which uses mean and standard deviation estimates
of the return on assets calculated over full samples combined with current values of the capitalasset ratio.
3. Sample selection and identifying distressed banks
3.1. Sample description
The study focuses on active and non-active banks operating in two main business models: commercial
banks (shareholders oriented banks), and cooperative, savings and real estate and mortgage banks (stake-
holders oriented bank), belonging to the following 12 European countries: Austria, Belgium, Denmark,
France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, Spain, and the United Kingdom. The sample
period covers the years from 2001 to 2011, which also allows us to investigate the predictive power of the Z-
score over the crisis years (20082011).4 We obtain accounting data from the Bureau Van Dijk's BankScope
database. We carry out our analysis using data from annual consolidated nancial statements and, when
not available, unconsolidated statements.5 Overall 4298 banks survive the screens described above. Unfortu-
nately, data necessary to compute our target variable (the natural logarithm of Z-score) are not available for
all banks. We remove banks for which we are not able to compute the Z-score from the sample. The nal
sample consists of 3242 banks, with 23,312 bank-year observations in total.
3.2. Identifying distressed banks
Our identication process starts from Bureau Van Dijk's BankScope database. BankScope assigns a status to
a bank that can take the following forms: active; under receivership; bankruptcy; dissolved; dissolved by
merger; in liquidation.6
We classify distressed banks as those banks that satisfy at least one of the following three conditions dur-
ing our sample period (20012011). The rst condition is that a formerly active bank changes its status to
under receivership,7 bankruptcy, dissolved, or in liquidation. The second condition regards banks that change
4
Considering our European sample banks, we identify the onset of the nancial crisis in 2008 rather than in 2007. Our results are re-
markably similar if we set the beginning of the nancial crisis in 2007.
5
We also attempted to run the analysis using quarterly data. Unfortunately, we are unable to perform the analysis due to the limited
availability of quarterly data for the majority of banks in our sample.
6
BankScope database denes: under receivership those banks that remain active, though they are in administration or receivership;
bankruptcy those banks that no longer exist because they have ceased their activities since they are in the process of bankruptcy; dis-
solved those banks that no longer exist as a legal entity; dissolved by merger those banks that no longer exist as a legal entity because
they have been included in a merger; in liquidation those banks that no longer exist because they have ceased their activities, since they
are in the process of liquidation. In BankScope database there are also the three following type of bank status: active, no longer with ac-
counts on BankScope that are banks still active, though their accounts are no longer updated on BankScope following an acquisition by
another bank with accounts on BankScope integrating the accounts of its subsidiary in its consolidated accounts; dissolved by demerger,
that are banks no longer exist as a legal entity. The reason for this is a demerger, the bank has been split; and inactive, that are banks no
longer active and the precise reason for inactivity is unknown. In our analysis we don't consider them given that they show no information
for our sample banks.
7
In light of the numerous data missing in BankScope database on banks under receivership, this kind of bank distress event is thus not
included in our analysis.
their status to dissolved by merger in BankScope. Unlike the majority of related studies (Poghosyan & ihk,
2011; Vazquez & Federico, 2012), we do not include banks dissolved by merger in the distressed banks' deni-
tion. Merger and acquisitions (M&As) might have been carried out for strategic reasons rather than for rescu-
ing troubled banks (Arena, 2008). For this reason, following Betz, Peltonen, and Sarlin (2014), banks with
status dissolved by merger are classied as distressed banks only if they have a negative coverage ratio (dened
as the ratio of total equity and loan loss reserve minus non-performing loans all divided to total assets, CR)
during the twelve months prior to the M&A. Finally, a bank is distressed when it receives state aids during
the period considered. State aids can take different forms such as: nationalization, recapitalization, guarantee
lines, loans, etc. Data on government bail-outs are collected from the database provided by Mediobanca
(2012).8
Panel A of Table 1 presents the sample distribution by bank status (healthy banks versus distressed banks)
for each of the 12 European countries during the period 20012011. We identied 261 distress events for 214
banks,9 which are not distributed evenly across countries and years. In particular, Panel A of Table 1 shows
that highest number of cases of distress occurred in Greece, followed by Ireland, Denmark, Netherlands and
Portugal. This result is to some extent expected because Greece, Ireland and Portugal were the most vulner-
able European countries during the sovereign debt crisis. The Danish banking system was also severely affect-
ed by the crisis due to a strong presence of subsidiaries in Ireland (for example, Danske Bank10). Concerning
the Netherlands, two large banks like ABN AMRO and ING went bankrupt. Other countries that experienced a
relatively high number of distress events are France, Spain, United Kingdom and Belgium. The banking sys-
tems of Italy, Austria and Germany show the lowest ratio of troubled banks on total banks (see panel A of
Table 1). The low percentage of distressed banks in Germany is consistent with the evidence provided by
Dam and Kotter (2012).
Regarding the temporal distribution of distress events, Panel B of Table 1 displays that the majority of bank
distress events in Europe took place mainly during the nancial crises (73% of all cases of bank distress). This
pattern is analogous to what happened in the US, where more than 500 commercial banks under FDIC super-
vision went bankrupt between 2008 and 2013 compared to less than 50 between 2001 and 2007.11
4. Methodology, variables and descriptive statistics
4.1. Empirical methodology
Our analysis focuses on the near-term vulnerability of banks, and not on medium-to-long-term vulnerabil-
ities, which require the identication and evaluation of potential structural weaknesses that can affect incen-
tives to screen and monitor risks. We use two different econometric models to investigate the signaling
properties of the Z-score based indicator of bank fragility. The rst is a standard probit model:

Pr DBi;t 1 X i;t1 X i;t1 ; 1
where Pr is the probability; is the standard cumulative normal probability distribution; and parameter is
estimated by maximum likelihood. DBi,t is the binary variable that identies bank distress at time t.12 The
vector Xi,t 1 contains the independent variables (see paragraph 4.2 and Table A.1 in Appendix A) for bank
i at time t 1.
As a second model, we use a discrete time representation of a continuous time proportional hazards
model, the so-called complementary loglog model (cloglog) where, as for the probit model, the binary
8
Mediobanca is an Italian investment bank whose research department actively collects and publishes data on the banking industry.
For each European country considered, Mediobanca database includes all operations put in place to save the banks. Mediobanca database
is based only on ofcial sources: the budgets of individual institutions, the ofcial documents of the European Commission or the central
banks.
9
The number of banks is smaller than the number of distress events, since some banks experienced multiple distress events over time.
10
See for example, Sandstrom, G., Danske Bank Names New CEO, The Wall Street Journal, 19 December 2011.
11
See http://www.fdic.gov/bank/individual/failed/banklist.html.
12
In order to take into account the time varying nature of the bank status, we assigned to DB dummy variable the value of 0 in the years
before the distress and the value of 1 in the year of distress. In addition, distressed banks are eliminated from our dataset if the bank ceases
to operate.
Table 1
Database overview.
This table shows in Panel A the sample distribution by bank status (non-distressed banks versus distressed banks) and in Panel B the dis-
tressed banks distribution for each European country in each year. The numbers reported in the table refers only to those banks with data
available to compute our target variable (the natural logarithm of the Z-score). The sample period is from 2001 to 2011.
The non-distressed banks includes banks that satisfy one of these following two conditions during 20012011: (1) banks directly clas-
sied by BankScope database as active entities; (2) banks dened by BankScope database as dissolved by merge but with a coverage
ratio equals or higher than 0 within 12 months before the operation. Instead, the distressed banks includes banks that satisfy one of
these following three conditions during 20012011: (1) banks that, as dened by BankScope database, changed their status from active
to either: under receivership, bankruptcy, dissolved, or in liquidation; (2) banks dened by BankScope database dissolved by merger
but with a coverage ratio (CR) smaller than 0 within 12 months before the M&A; (3) banks that received state aids. Data on government
bail-outs are collected by Mediobanca (2012). The coverage ratio is dened as the ratio of total equity and loan loss reserve minus non-
performing loans all divided to total assets. In light of the numerous data missing in BankScope database on banks under receivership,
this kind of bank distress event is thus not included in our analysis. % is computed as the ratio of distressed banks on total banks.
Panel A: distressed banks by country
Country Bank-year observation Banks
Distressed Non-distressed Total Distressed Non-distressed Total %
Austria 8 1753 1761 7 210 217 3.22

Belgium 3 249 252 3 34 37 8.10
Denmark 35 574 609 34 85 119 28.57
France 37 1493 1530 35 216 251 13.94
Germany 37 14,253 14,290 23 1538 1561 1.47
Greece 16 68 84 9 16 25 36
Ireland 15 109 124 10 22 32 31.25
Italy 33 2595 2628 33 547 580 5.68
Netherlands 16 178 194 12 38 50 24
Portugal 7 96 103 7 27 34 20.58
Spain 26 590 616 19 129 148 12.83
United Kingdom 28 1093 1121 22 167 189 11.64
Total 261 23,051 23,312 214 3029 3243 6.59
Panel B: distressed banks by country and year (bank-year observation)
Distress by year
Country 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Austria 2 1 1 4
Belgium 2 1
Denmark 4 28 3
France 6 2 2 3 4 2 1 7 7 3
Germany 5 5 2 1 2 3 2 5 7 3 2
Greece 1 9 4 2
Ireland 2 4 3 4 2
Italy 3 6 2 1 4 17
Netherlands 1 1 7 5 2
Portugal 1 4 2
Spain 2 1 1 1 2 13 6
United Kingdom 1 1 1 1 1 4 8 7 3 1
Total 12 11 15 8 8 8 10 41 55 55 38
variable to identify bank distress is the dependent variable. Complementary loglog models are frequently
used when the probability of an event is very small or very large. In fact, cloglog belongs to the discrete
time functional specications applied when survival occurs in continuous time, but spell length is observed
only in interval as it is the case for bank distress recorded on annual basis in our sample.13 Guo (1993) ob-
serves that time-varying covariates offer an opportunity to examine the relation between the distress
13
Complementary loglog model specication for the hazard regression is also consistent with a continuous time model and interval
censored survival time data (Jenkins, 2005).
probability and the changing conditions under which the distress happens. Following Mnnasoo and Mayes
(2009), the cloglog hazard with time-varying covariates has the form:
h i

log log 1hj X j X 2
where X contains time-varying covariates and intercept. The hazard rate is derived from Eq. (2) as follows:
h i

pt 1 exp exp j X : 3
Prentice and Gloeckler (1978) show the equivalence among interval censored discrete-time model and
continuous time model with the proportional hazards assumption. As a consequence, it is possible to trans-
form the coefcients of this analysis into hazard ratios, which facilitate interpretations of the regression
results.14
Traditional probit and cloglog models assume duration independence, i.e., the probability of surviving or
failing at any point in time is always the same. In order to deal with time dependency problems arising
when using these models, we use robust standard errors clustered on the unit of analysis and include in the
vector X temporal dummy variables for each period or spell.
In addition, the cloglog model yields estimates of the impact of the indicators on the conditional probabil-
ity of distress, which means that we obtain distress probabilities, conditional on surviving to a certain point in
time.
In order to examine whether the models are able to correctly identify the banks in distress, we compute
two types of errors: Type 1 and Type 2. Type 1 error occurs when the model fails to identify distressed
banks (i.e., a missed distress). It is computed as the ratio of false negative (FN) events to the sum of false neg-
ative and true positive (TP) events. Type 2 error occurs when a healthy bank is falsely identied as distressed
(i.e., a false alarm). It is computed as the ratio of false positive (FP) events to the sum of false positive and true
negative (TN) events.
To assign a particular bank into one of the two categories (distressed versus healthy), we set up a cut-off
point in terms of the probability of bank distress. All banks above (below) that cut-off point are considered as
distressed (healthy) banks. A higher cut-off point results in a lower number of banks on the blacklist of dis-
tressed banks, which tends to increase the Type 1 errors. In our analysis we report the two types of errors
(Type 1 and Type 2) and their sum computed using two different cut-off points: 1 and 10%.15 However, as al-
ready mentioned, policy-makers are more concerned of missing bank distress than issuing false alarms, and
early-warning signals trigger an in-depth review of fundamentals, business model and peers of the bank pre-
dicted to be in distress (Betz et al., 2014).16 For these reasons, we primarily focus on the Type 1 error results
obtained using the cut-off point equal to 1%.
The analysis based on errors is based on the arbitrary decision of the cut-off point. To overcome this prob-
lem, we also assess the accuracy of distress forecasts using the empirical distribution of the predicted proba-
bilities of distress generated by probit and cloglog models. We assign each observation to a decile of this
empirical distribution, and we count how many distress events fall into each decile. The accuracy of the
model increases when a high fraction of distress events fall in the deciles associated to high predicted proba-
bilities of distress.
14
In a cloglog model, the regression coefcients can be interpreted as in a Cox proportional hazard rate model. Having the underlying
variables in percentage form means that the coefcient captures a proportional percentage change in the hazard given a one percentage
point change in the covariate (Mnnasoo & Mayes, 2009).
15
Setting a lower cut-off point can reduce the Type 1 errors, but at the expense of generating more Type 2 errors. The optimal cut-off
point depends on the relative weights that an analyst puts on Type 1 and Type 2 errors. Some of the available literature simply adds Type
1 and Type 2 errors; however, from a prudential perspective, there is a case for putting a larger weight on Type 1 errors (Persons, 1999),
because supervisors are primarily concerned about missing a distressed bank (Poghosyan & ihk, 2011). This implies a preference for
relatively low cut-off points, which limit the Type 1 errors at the expense of relatively long blacklists (and potentially more Type 2 errors).
16
Betz et al. (2014) also argue that if the analysis reveals that the signal is false, there is no loss of credibility on behalf of the policy
authority.
4.2. Variables and descriptive statistics
Our variable of interest is the Z-score (Beck, De Jonghe, & Schepens, 2011; Beck & Laeven, 2006; Boyd &
Graham, 1986; Boyd & Runkle, 1993; Garcia-Marco & Roblez-Fernandez, 2008; Hannan & Hanweck, 1988;
Hesse & Cihk, 2007; Laeven & Levine, 2006; Maechler, Srobona, & Worrell, 2005), which is calculated as:
ROAA ETA
Zscore : 4
ROAA
ROAA is the bank's return on average assets, ETA represents the equity to total assets ratio and ROAA is the
standard deviation of return on average assets. In order to capture the changing pattern of the bank's return
volatility, we use a three-year rolling time window to calculate ROAA.17
The Z-score reects the number of standard deviations by which returns would have to fall from the mean
in order to wipe out the bank equity. Higher values of Z-score are indicative of lower probability of insolvency
risk and greater bank stability. Hence, we expect a negative sign for the relation between Z-score and our de-
pendent variable, the probability of bank distress. Since the Z-score is highly skewed, we use the natural log-
arithm of the Z-score, which is normally distributed (Ivii et al., 2008; Laeven & Levine, 2009; Liu, Molyneux,
& Wilson, 2013). We label the natural logarithm of Z-score as ln_Z.
As alternative to the Z-score, we use the CAMELS variables, which are related to bank characteristics like Cap-
ital, Asset quality, Managerial skills, Earnings, Liquidity and Sensitivity to market risk. The rst CAMELS variable is
a proxy for the bank's capital, which is measured as the ratio of total equity to total assets (ETA). We expect a
negative sign for the relation between ETA and our dependent variable. A low ETA means high leverage,
which makes the bank less resilient to shocks, other thing being equal. Asset quality, is computed as the ratio
of impaired loans to gross loans (CRED). The higher the ratio, the lower the quality of the loan portfolio.
Hence, an increase in CRED should lead to an increase in probability of bank distress. The managerial quality
of the bank, the third covariate, is approximated by the cost to income ratio (CIR).18 Since low values of CIR in-
dicate better managerial quality, the relationship between CIR and probability of distress is expected to be pos-
itive. To measure bank earnings, the fourth covariate, we use the return on average assets (ROAA).19 We expect a
negative sign for the relation between ROAA and distress, since an increase in protability reduces the likelihood
of a distress event. Liquidity, the fth covariate, is measured by the ratio of net loans to deposits and short term
funding (LIQ). The relationship between LIQ and the probability of bank distress is expected to be positive: banks
that nance large portions of their loan portfolios with short term liabilities (i.e., they engage in maturity trans-
formation) are more exposed to renancing problems in adverse macroeconomic scenarios. In such circum-
stances, banks may nd difcult to raise wholesale short-term funds and customer deposits and eventually
incur into deposits drainages. An increase in LIQ should therefore correspond to a higher probability of bank dis-
tress. The last CAMELS variable is a proxy for the sensitivity to market risk, which is measured as the ratio of non-
interest income to net operating revenue, INC_OPREV (Stiroh, 2004). Due to data availability constraints, we use
such a proxy because the magnitude of non-interest income greatly reects bank participation to nancial mar-
kets such as securities trading, asset management services, to name a few. The expected sign is uncertain. On the
one hand, we expect a negative sign because diversication leads to risk reduction and therefore lower proba-
bility of insolvency risk and greater bank stability. On the other hand, the sign may be positive since a high de-
pendence from market related income may threaten banks stability in times of nancial market downturns. This
17
Z-score may be estimated both for cross-sectional and time-varying analyses. Additionally, a number of approaches have been devel-
oped for its construction. For instance, Boyd, De Nicol, and Jalal (2006) employ in a cross-sectional study three years mean capital-to-
asset ratio (CAR), current values of return on average assets (ROAA) and standard deviations of returns computed over the recent three
years. In the same work, they use for an international sample the Z-score calculated at each date as the sum of the current ROAA, the cur-
rent CAR and an instantaneous estimation of standard deviation of returns. Beck and Laeven (2006) calculated the Z-score as the sum of
current values of ROAA and CAR, divided by the standard deviation of ROAA over the full period of investigation. In longitudinal cross-
country studies, Maechler, Srobona, and DeLisle (2007) use a three year rolling Z-score which is computed by using the three-year moving
ROAA plus the three-year moving average of CAR over the three-year standard deviation of return on average assets. Hesse and Cihk
(2007) use for a cross-country, time series research current values of CAR, average return as a percentage of banks' assets and standard
deviations of ROAA computed over the period. Yeyati and Micco (2007) computed Z-scores for each bank and year, using the sample
mean and variance of ROAA over a three-year period and current values of CAR.
18
All values for the CIR variable are positive in our sample.
19
We also computed the Return on Average Equity (ROAE) rather than ROAA and we obtained very similar results in the regressions.
Table 2
Summary statistics of Z-score and CAMELS variables by bank status.
This table reports summary statistics on our target variable, the natural logarithm of the Z-score (ln_Z), and on the CAMELS variables for
the full sample and for the distressed and non-distressed banks. Each descriptive statistic is tested on the whole period (20012011) and
on the crisis period (20082011). It also summarized their hypothesized relationships (irrespective of the time horizon) with the depen-
dent variable. The natural logarithm of the Z-score (ln_Z) is dened in Section 4. Equity to total assets (ETA), impaired loans to gross loans
(CRED), cost to income ratio (CIR), return on average assets (ROAA), net loans to deposits and short term funding (LIQ), and non-interest
income to net operating revenue (INC_OPREV) are the CAMELS variables. The numbers reported in the table refers only to those banks
with data available to compute our target variable. To mitigate the effect of outliers, we winsorize observations in the outside 1% of
each tail of each variable. The full sample includes the distressed and non-distressed banks. The non-distressed banks includes banks
that satisfy one of these following two conditions during 20012011: (1) banks directly classied by BankScope database as active en-
tities; (2) banks dened by BankScope database as dissolved by merge but with a coverage ratio equals or higher than 0 within
12 months before the operation. Instead, the distressed banks includes banks that satisfy one of these following three conditions during
20012011: (1) banks that, as dened by BankScope database, changed their status from active to either: under receivership, bankrupt-
cy, dissolved, or in liquidation; (2) banks dened by BankScope database dissolved by merger but with a coverage ratio (CR) smaller
than 0 within 12 months before the M&A; (3) banks that received state aids. Data on government bail-outs are collected by Mediobanca
(2012). The coverage ratio is dened as the ratio of total equity and loan loss reserve minus non-performing loans all divided to total as-
sets. In light of the numerous data missing in BankScope database on banks under receivership, this kind of bank distress event is thus not
included in our analysis. The values in the table are the averages. The medians are reported in parentheses. ***, **, and * denote statistical
signicance at 1%, 5%, and 10% levels, respectively.
Variables Non-distressed banks (1) Distressed banks (2) Difference (1)(2) Full sample Expected sign
Whole Crisis Whole Crisis Whole Crisis Whole Crisis

period period period period period period period period
ln_Z 4.551 4.461 3.030 2.987 1.521*** 1.474*** 4.533 4.436 NEGATIVE
(4.430) (4.292) (2.970) (2.922) (4.418) (4.272)
ETA 0.080 0.086 0.104 0.079 0.024*** 0.007* 0.080 0.086 NEGATIVE
(0.062) (0.070) (0.060) (0.053) (0.062) (0.070)
CRED 0.006 0.008 0.021 0.024 0.015*** 0.016*** 0.006 0.008 POSITIVE
(0) (0) (0.010) (0.018) (0) (0)
CIR 0.685 0.681 0.635 0.650 0.05* 0.031* 0.685 0.681 POSITIVE
(0.690) (0.685) (0.630) (0.621) (0.689) (0.684)
ROAA 0.003 0.003 0.001 0.0006 0.002*** 0.002*** 0.003 0.003 NEGATIVE
(0.002) (0.002) (0.002) (0.002) (0.002) (0.002)
LIQ 0.770 0.820 0.991 1.085 0.221*** 0.265*** 0.773 0.825 POSITIVE
(0.714) (0.725) (0.908) (0.981) (0.715) (0.728)
INC_OPREV 0.271 0.275 0.322 0.315 0.051** 0.04** 0.272 0.276 NEGATIVE/
(0.250) (0.260) (0.280) (0.280) (0.251) (0.260) POSITIVE
conjecture is supported by the US evidence provided by De Young and Torna (2013), who nd that the failure
probability increases with income from nontraditional banking activities.
Table 2 reports descriptive statistics relating to Z-score and the CAMELS variables for the full sample and
for the distressed and non-distressed banks. Each descriptive statistic is tested on the whole period (2001
2011) and on the crisis period (20082011).20
The average value of ln_Z is 4.553 in the whole period and 4.436 during the crisis years. As expected, non-
distressed banks show higher values for the average ln_Z than distressed banks both in the full period (4.551
vs. 3.030) and in the crisis period (4.461 vs. 2.987). This result can be largely explained both by a lower vol-
atility of returns (proxied by the standard deviation of ROAA)21 of non-distressed banks compared to distress-
ed banks and by higher average ROAA values (0.003 vs. 0.001 in the whole period and 0.003 vs. 0.0006 in the
crisis years). Not surprisingly, the average value of ROAA decreases during the crisis period only for the dis-
tressed banks. The reduction is due principally to the decline in operating prot. During the nancial crisis dis-
tressed banks show higher level of capitalization (ETA) compared to the non-distressed banks (0.079 vs.
0.086). In particular, ETA remains substantially unchanged for the non-distressed banks in the two time
periods considered (0.080 in the whole period and 0.086 in the crisis years), while show a strong decrease
for the distressed-banks (0.104 in the full period vs. 0.079 during the nancial crisis). The difference in
20
As a robustness check, we also dene the crisis period as the period from 2007 to 2011. Starting the crisis period from 2007 does not
produce any remarkable change in our ndings. Results are omitted for brevity and available from the authors.
21
Active banks show lower values for the average standard deviation of ROAA than distressed banks both in the full period (0.002 vs.
0.007) and in the crisis period (0.002 vs. 0.006).
Table 3
Correlations.
This table shows the correlation matrix for the variables used in the empirical analysis: the natural logarithm of the Z-score (ln_Z), our
target variable, and the CAMELS variables. Variables are dened in Section 4. Data in the table are referred to the whole period:
20012011.
ln_Z ETA CRED CIR ROAA LIQ INC_OPREV
ln_Z 1.0000
ETA 0.0904 1.0000
CRED 0.2610 0.1755 1.0000
CIR 0.0957 0.0265 0.0072 1.0000
ROAA 0.0432 0.2526 0.0275 0.4579 1.0000
LIQ 0.0918 0.1832 0.1791 0.1322 0.0694 1.0000
INC_OPREV 0.1496 0.2068 0.0678 0.1597 0.1549 0.1579 1.0000
terms of the mean test between active and distressed banks for the Z-score and its components is statistically
signicant at the 1% level during the whole period. This is true also for the crisis period, with the sole exception
of ETA that is statistically signicant at the 10% level.
Due to the deterioration of the credit quality in the last years, the average value of CRED grows for both
types of banks, but showing higher values for distressed banks (0.024 vs. 0.008 during the crisis period).
The average CIR values remains substantially unchanged between the whole period and the crisis period
for both the non-distressed banks and the distressed banks. The average value of LIQ shows a signicant
growth in the recent years for both distressed and non-distressed banks, mostly because of the drainage of
bank deposits and short term funding experienced by banks during the nancial turmoil than to the increase
in net loans. The average value of INC_OPREV remains stable across sub-periods in both groups, with distress-
ed banks showing a larger incidence of non-interest income. During the sample period, the test for difference
in means between active and distressed banks is statistically signicant at 1% level for LIQ and CRED; at 5%
level for INC_OPREV; and at 10% level for CIR. When we restrict the sample period to the crisis years, LIQ
and INC_OPREV are statistically signicant at 1 and 5%, respectively, while CRED and CIR are signicant at
10%. Finally, Table 3 presents the correlation matrix for the variables used in our estimations.22
5. Main results
We present the results of the regressions for bank distress in Table 4, which shows both the probit estima-
tions results and the hazard ratios of the complementary loglog models. All these regressions are carried out
on the full sample period (20012011). Following Mnnasoo and Mayes (2009), we assume that the fragility
of each bank is closely related to the overall propensity to banking crisis in which the bank-specic factors
play an important role in systemic stability.
We include in the vector Xi,t 1 year and country dummy variables in all regressions. Given that our sam-
ple includes banks from 12 different European countries, we include a country dummy to control for the dif-
ferent institutional and economic settings. To mitigate the effect of outliers data of each variable are
winsorized at the 1% percentile of the distribution. The rst three columns report a comparison between
our target variable, the natural logarithm of the Z-score (ln_Z),23 its components, and the CAMELS variables
as alternative to ln_Z variable, see regressions (I), (II), and (III), respectively. Finally, in regression (IV) we in-
clude both ln_Z and the CAMELS variables.
The log of the Z-score (ln_Z) is strongly signicant, showing the expected negative effect in both models
(see regression (I) of Table 4).24 The negative relation between the probability of bank distress and ln_Z
22
Table 3 shows that between Z-score and its components ETA and ROAA, used as CAMELS variables, there isn't any problem of
multicollinearity.
23
We obtain similar results if instead of a three-year rolling time window to calculate ROAA we use a ve-year rolling time window.
24
The Z-score's hazard ratio in column (I) means that banks with one unit higher of ln_Z have around 63% lower hazard rates or in other
words are less likely to fail. Generally speaking, the hazard ratios represent the complement to one of the probability of failure. For in-
stance, if the estimated hazard ratio for a bank characteristic j is 0.7, then the banks with that characteristic have a 30% lower probability
of exiting from the banking system than the referring group; instead, if the hazard ratio is 1.3 the banks have a 30% higher probability of
exiting from system.
Table 4
Predicting distress.
This table shows the probit estimations results and the hazard ratios of the complementary loglog model estimations obtained
regressing bank distress on: (I) our target variable, the natural logarithm of the Z-score (ln_Z); (II) the components of the Z-score: equity
to total assets (ETA), return on average assets (ROAA), and three-years standard deviation of ROAA (ROAA); (III) the CAMELS variables:
equity to total assets (ETA), impaired loans to gross loans (CRED), cost to income ratio (CIR), return on average assets (ROAA), net loans to
customer deposits and short term funding (LIQ), and non-interest income to net operating revenue (INC_OPREV); and (IV) the natural
logarithm of the Z-score plus the CAMELS variables. The sample period is 20012011. The dependent variable is the Distressed Bank
dummy variable (DBi,t) that takes the value of 1 if bank i becomes distressed (that is: under receivership, bankruptcy, dissolved, in liqui-
dation, dissolved by merger with a coverage ratio smaller than 0 within 12 months before the M&A, or government bail-out) at time t (the
year in progress) and 0 otherwise. The dependent variable and independent variables are dened in Section 4. All explanatory variables
are lagged by one year. All variables are winsorized at the 1% of each tail. Year and country dummy variables are also included in the
model. Robust standard errors are reported in parentheses. The superscripts ***, **, and * denote coefcients statistically different from
zero at the 1%, 5%, and 10% levels, respectively, in two-tailed tests.
This table also displays the relationship between model predictions and actual distress events on the full sample for the whole period
using a cut-off point equals to 0.01. TP stands for True Positive; FN stands for False Negative; FP stands for False Positive; TN stands
for True Negative. Type 1 error occurs when the model fails to identify the distressed bank. It is computed as: FN/(FN + TP). Type 2
error occurs when a healthy bank is falsely identied as distressed (i.e., a false alarm). It is computed as: FP/(FP + TN).
Variables Probit model Complementary loglog model
(I) (II) (III) (IV) (I) (II) (III) (IV)
ln_Z Components CAMELS ln_Z and ln_Z Components CAMELS ln_Z and
of ln_Z CAMELS of ln_Z CAMELS
ln_Z (1) 0.199*** 0.179*** 0.629*** 0.639***

(0.027) (0.031) (0.050) (0.061)
ROAA (1) 29.177*** 7.63em22***
(4.807) (7.40em23)
ETA (1) 0.363 0.321 0.494 0.347 0.908 1.935
(0.450) (0.378) (0.363) (0.348) (0.903) (1.703)
CRED (1) 2.986** 1.790 101.128 4.146
(1.354) (1.354) (290.925) (11.588)
CIR (1) 0.212 0.296 0.549 0.453
(0.217) (0.190) (0.280) (0.201)
ROAA (1) 7.283** 16.526*** 9.769** 7.04e-06 1.40e-15*** 1.71e-07**
(3.101) (4.387) (3.815) (0.000) (1.12e-14) (1.30e-06)
LIQ (1) 0.248*** 0.249*** 1.645*** 1.672***
(0.065) (0.060) (0.281) (0.270)
INC_OPREV (1) 0.570*** 0.335** 3.386*** 1.978*
(0.171) (0.161) (1.390) (0.728)
Year FE Yes Yes Yes Yes Yes Yes Yes Yes
Country FE Yes Yes Yes Yes Yes Yes Yes Yes
N. of obs. 20,122 20,122 20,122 20,122 20,122 20,122 20,122 20,122
Pseudo R2 0.2107 0.2075 0.2042 0.2257
Type errors:
TP 199 197 197 203 196 196 194 199
FN 41 43 43 37 44 44 46 41
FP 5296 5434 5123 5003 5117 5508 5159 4876
TN 14,586 14,448 14,759 14,879 14,765 14,374 14,723 15,006
Type 1 0.170 0.179 0.179 0.154 0.183 0.183 0.191 0.170
Type 2 0.266 0.273 0.257 0.251 0.257 0.277 0.259 0.245
means that high values of Z-score are associated with low probability of insolvency risk and greater bank
stability. This result is in line with Vazquez and Federico (2012), who nd that the probability of failure is
inuenced by the bank risk prole. We also regress the binary variable for bank distress on the three
components of the Z-score: ROA; volatility of returns, and the equity to total assets ratio. The results
are presented in regressions (II) of Table 4, which show that, regardless of the model used, the bank prob-
ability of distress is largely explained by the volatility of returns (proxied by the standard deviation of
ROAA, ROAA). As expected, higher values for the average ROAA imply an increase of the probability
Table 5
Distress forecasts.
This table reports the frequencies of distress events by deciles of the distribution of the predicted probabilities for the probit and the
complementary loglog models on the whole period (20012011) presented in Table 4. Decile 10 (1) is the decile with the highest
(lowest) predicted probabilities of distress events. Both probit the probit and the complementary loglog model include the following
regressors: (I) on our target variable, the natural logarithm of the Z-score (ln_Z); (II) on its components; (III) on the CAMELS variables
and (IV) on the natural logarithm of the Z-score plus the CAMELS variables.
Deciles Probit model Complementary loglog model
ln_Z Components of ln_Z CAMELS ln_Z and CAMELS ln_Z Components of ln_Z CAMELS ln_Z and CAMELS
10 0.629 0.625 0.604 0.620 0.612 0.612 0.591 0.612

9 0.108 0.104 0.129 0.166 0.116 0.108 0.120 0.158
8 0.120 0.133 0.137 0.083 0.129 0.137 0.133 0.087
7 0.045 0.058 0.033 0.058 0.054 0.062 0.054 0.058
6 0.025 0.016 0.016 0.004 0.016 0.012 0.012 0.025
15 0.070 0.062 0.079 0.066 0.062 0.066 0.087 0.058
of bank distress. The capitalization (proxied by the ratio of equity to total assets, ETA) is never signicant,
while the ROAA variable is signicant only in the probit model, but with a lower degree compared to
ROAA.
Concerning the CAMELS indicators, Table 4 shows that the asset quality measure (CRED), the earnings
variable (ROAA), the liquidity bank indicator (LIQ) and the sensitivity to market risk variable
(INC_OPREV) are signicant in the probit model. All these indicators show the expected sign. CRED is
positive, conrming that if the quality of the bank's loans decreases, the bank is more likely to fail. As ex-
pected, the positive relation between liquidity and the probability of bank distress seems to be related to
tough conditions in the interbank market and the loss of deposits (bank runs) experienced by several
banks during the crisis years. The result on ROAA is in line with those of Poghosyan and ihk (2011)
and Betz et al. (2014), who obtain a negative and signicant relationship between bank protability
and nancial distress. Consistent with De Young and Torna (2013), INC_OPREV has a positive coefcient.
The positive sign supports the view that a high dependence from market related income may increase a
bank's vulnerability in times of nancial crisis. Overall, we nd that, in the 20012011 period, character-
istics like poor quality loan portfolio, low protability, and diversication increase the likelihood that a
bank will face distress.
The CAMELS results of the complementary loglog model are qualitatively similar to those of the probit
regressions, with the surprising exception of ROAA that shows a hazard ratio larger than 1, which corresponds
to a positive coefcient rather than negative.
Finally, in columns IV and VIII, we include both the Z-score and the CAMELS variables in the model. Unlike
the Z-score, which always remains highly signicant, most of CAMELS indicators become less statistically sig-
nicant. This latter holds for both the probit and the complementary loglog specication.25 The pseudo R2
slightly improves considering together Z-score and CAMELS covariates.
Table 4 also displays the relationship between model predictions and actual distress events for both
models on the full sample for the whole period using a cut-off point equals to 1%.26 As already stated,
we mainly focus on the Type 1 error and we nd that in the two models considered the performance
using the ln_Z alone in the full period is similar to that of both its components and the CAMELS variables.
Specically, column (I) of Table 4 shows that during 20012011 the probit and the complementary logis-
tic models using only the ln_Z fail to correctly classify 41 distress events out of 199 and 44 distress events
out of 196, respectively. Thus, in the full period the probit model with only our target variable correctly
classies 199 out of 240 distress events (83%), while the cloglog model correctly classies 196 out of 240
distress events (82%).
25
To mitigate the concern that the number of distress events is extremely low compared to the total number of observations, we also
estimate a logistic regression in rare events data (King & Zeng, 2001) on the period from 2001 to 2011. The ndings of the logistic regres-
sion are remarkably similar to those in Table 4.
26
We obtain similar results if instead of 1% cut-of point we use 10% cut-off point.
The probit (complementary logistic) model using the components of the Z-score (see column II (VI) of
Table 4) fails to correctly classify 43 (44) distress events out of 197 (194). Hence, the probit (complemen-
tary logistic) model with the Z-score's components correctly classies 197 (196) out of 240 distress
events (82%). We obtain similar results using the CAMELS variables. Column (III) of Table 4 shows that
during the whole period the CAMELS variables fail to correctly classify 43 (46) distress events out of
197 (194) using the probit (cloglog) model. Consequently, probit model with only the CAMELS variables
correctly classies 197 out of 240 distress events (82%), while the cloglog model correctly classies 194
out of 240 distress events (81%).
Table 6
Predicting distress in the nancial crisis period.
This table shows the probit estimations results and the hazard ratios of the complementary loglog model estimations obtained
regressing bank distress on: (I) our target variable, the natural logarithm of the Z-score (ln_Z); (II) the components of the Z-score: equity
to total assets (ETA), return on average assets (ROAA), and three-years standard deviation of ROAA (ROAA); (III) the CAMELS variables:
equity to total assets (ETA), impaired loans to gross loans (CRED), cost to income ratio (CIR), return on average assets (ROAA), net loans to
customer deposits and short term funding (LIQ), and non-interest income to net operating revenue (INC_OPREV); and (IV) the natural
logarithm of the Z-score plus the CAMELS variables. The sample period is the crisis period 20082011. The dependent variable is the
Distressed Bank dummy variable (DBi,t) that takes the value of 1 if bank i becomes distressed (that is: under receivership, bankruptcy, dis-
solved, in liquidation, dissolved by merger with a coverage ratio smaller than 0 within 12 months before the M&A, or government bail-
out) at time t (the year in progress) and 0 otherwise. The dependent variable and independent variables are dened in Section 4. All ex-
planatory variables are lagged by one year. All variables are winsorized at the 1% of each tail. Year and country dummy variables are also
included in the model. Robust standard errors are reported in parentheses. The superscripts ***, **, and * denote coefcients statistically
different from zero at the 1%, 5%, and 10% levels, respectively, in two-tailed tests.
This table also displays the relationship between model predictions and actual distress events on the full sample for the whole period
using a cut-off point equals to 0.01. TP stands for True Positive; FN stands for False Negative; FP stands for False Positive; TN stands
for True Negative. Type 1 error occurs when the model fails to identify the distressed bank. It is computed as: FN/(FN + TP). Type 2
error occurs when a healthy bank is falsely identied as distressed (i.e., a false alarm). It is computed as: FP/(FP + TN).
ln_Z (1) 0.190*** 0.154** 0.651*** 0.676***

(0.037) (0.044) (0.060) (0.084)
ROAA (1) 27.473*** 3.16em23***
(8.090) (4.81em23)
ETA (1) 2.393 2.168** 1.815** 0.0004* 0.004 0.013
(1.319) (0.980) (0.922) (0.002) (0.012) (0.038)
CRED (1) 6.749*** 5.346*** 59,248.53*** 1616.063**
(1.882) (1.887) (21,994.2) (6075.855)
CIR (1) 0.097 0.187 0.833 0.617
(0.288) (0.258) (0.509) (0.360)
ROAA (1) 5.140 10.220 4.274 0.184 1.12e-08 0.393
(5.443) (6.651) (6.081) (2.271) (1.58e-07) (4.836)
LIQ (1) 0.523*** 0.524*** 2.397*** 2.448***
(0.077) (0.074) (0.435) (0.430)
INC_OPREV (1) 0.783*** 0.645*** 4.395*** 3.235***
(0.213) (0.205) (1.938) (1.319)
N. of obs. 10,849 10,849 10,849 10,849 10,849 10,849 10,849 10,849
Pseudo R2 0.2358 0.2329 0.2630 0.2757
Type errors:
TP 158 154 161 159 154 151 161 160
FN 25 29 22 24 29 32 22 23
FP 3275 3034 2820 2845 3182 3113 2997 2912
TN 7391 7632 7846 7821 7484 7553 7669 7754
Type 1 0.136 0.158 0.120 0.131 0.158 0.174 0.120 0.125
Type 2 0.306 0.284 0.264 0.266 0.298 0.291 0.280 0.273
Table 7
Distress forecasts in the nancial crisis period.
This table reports the frequencies of distress events by deciles of the distribution of the predicted probabilities for the probit and the com-
plementary loglog models on the crisis period (20082011) presented in Table 6. Decile 10 (1) is the decile with the highest (lowest)
predicted probabilities of distress events. Both probit the probit and the complementary loglog model include the following regressors:
(I) on our target variable, the natural logarithm of the Z-score (ln_Z); (II) on its components; (III) on the CAMELS variables and (IV) on the
natural logarithm of the Z-score plus the CAMELS variables.
Deciles Probit model Complementary loglog model
ln_Z Components of ln_Z CAMELS ln_Z and CAMELS ln_Z Components of ln_Z CAMELS ln_Z and CAMELS
10 0.672 0.677 0.710 0.721 0.666 0.661 0.688 0.699

9 0.109 0.120 0.142 0.136 0.120 0.114 0.147 0.147
8 0.109 0.114 0.092 0.076 0.098 0.114 0.098 0.065
7 0.038 0.043 0.016 0.027 0.043 0.071 0.016 0.049
6 0.016 0.016 0.000 0.005 0.021 0.016 0.010 0.005
15 0.054 0.027 0.038 0.032 0.049 0.021 0.038 0.032
Adding the Z-score to CAMELS variables improves the predictive power of both the models. In particular,
the probit model correctly classies 203 out of 240 distress events (84%), while the cloglog model correctly
classies 199 out of 240 distress events (83%).
The distress forecasts presented in Table 5 conrm the predictive accuracy of the Z-score alone
compared to both its components and the CAMELS variables. Following Bharath and Shumway
(2008), we assess the accuracy of our models by sorting banks in deciles based on the predicted
probabilities and calculating the percentage of defaults by decile of Z-score, its components, the
set of CAMELS variables, and the combination of the latter with the Z-score. Focusing on the probit
model, we observe that 63% of the bank distress events are in the top decile (i.e., banks with the
largest probability of distress) of the estimated probabilities when we consider the natural loga-
rithm of the Z-score alone. This percentage is about 62% for the Z-score's components, 60% for the
CAMELS variables, and 62% for the model with the Z-score plus CAMELS covariates. Results on dec-
iles for the cloglog model are qualitatively similar. Overall, we nd that the highest percentage of
distress is in the tenth decile, which conrms that Z-score and CAMELS are good predictor of
bank distress.
In light of the numerous distress events that characterized many European banks during the recent years,
we investigate the suitability of the Z-score as a measure of bank distress relative to both its components and
the CAMELS variables also on the only crisis period 20082011 (see Table 6). As in Table 4, we run the probit
and the complementary loglog model on the Z-score alone, its components, the CAMELS variables, and all the
covariates considered together. Our variable of interest, ln_Z, remains highly signicant with the correct sign
(negative) also during 20082011 in both models. As for the Z-score's components and the CAMELS variables,
results are remarkably similar to those of the whole period. Among the Z-score's components, the bank prob-
ability of distress is mostly explained by the volatility of returns. The ROAA variable is no longer signicant.
Moreover, with reference to the CAMELS variables, ETA becomes signicant with the hypothesized sign, but
only in the probit model (see column (III) of Table 6). The managerial quality variable (CIR), both in
Tables 4 and 6, is not signicant factor for determining bank vulnerability. This nding is in line with those
of Poghosyan and ihk (2011), who show that low costs do not indicate a better ability to prevent bank
distress.
In addition, we determine the relationship between model predictions and actual distress events during
the nancial turmoil using a cut-off point equals to 1%.27 Focusing on the type 1 error, Table 6 shows that
27
the predictive power of the Z-score, its components, the CAMELS variables improves compared to Table 4, al-
though the Z-score performs slightly worse than the CAMELS variables. The slightly improved predictive
power of the two models in the crisis period is also conrmed by the results of Table 7, which reports annual
distress forecast accuracy by deciles.
Finally, we evaluate the effectiveness of the Z-score as a bank distress predictor compared to the
CAMELS variables across bank size. Large banks may be deemed too-big-too-fail, and therefore they may
be prevented from entering nancial distress. For this reason, in Table 8 we run the probit and the comple-
mentary logistic models on the smallest banks (bottom quartile by total assets on the country's gross
Table 8
Predicting distress by bank size.
This table reports the probit estimations results and the hazard ratios of the complementary loglog model estimations for the
smallest banks (bottom quartile by total assets on the country's gross domestic product, TA_GDP) and for the biggest banks (top quar-
tile by TA_GDP) over the whole period, 20012011. Bank distress is: (I) the natural logarithm of the Z-score (ln_Z); and (II) the natural
logarithm of the Z-score plus the CAMELS variables. The dependent variable is the Distressed Bank dummy variable (DBi,t) that takes
the value of 1 if bank i becomes distressed (that is: under receivership, bankruptcy, dissolved, in liquidation, dissolved by merger with
a coverage ratio smaller than 0 within 12 months before the M&A, or government bail-out) at time t (the year in progress) and 0 oth-
erwise. The dependent variable and independent variables are dened in Section 4. All explanatory variables are lagged by one year.
All variables are winsorized at the 1% of each tail. Year and country dummy variables are also included in the model. Robust standard
errors are reported in parentheses. The superscripts ***, **, and * denote coefcients statistically different from zero at the 1%, 5%, and
10% levels, respectively, in two-tailed tests. This table also displays the relationship between model predictions and actual distress
events on the full sample for the whole period using a cut-off point equals to 0.01. TP stands for True Positive; FN stands for False
Negative; FP stands for False Positive; TN stands for True Negative. Type 1 error occurs when the model fails to identify the distress-
ed bank. It is computed as: FN/(FN + TP). Type 2 error occurs when a healthy bank is falsely identied as distressed (i.e., a false
alarm). It is computed as: FP/(FP + TN).
Variables Small banks Large banks
Probit model Complementary Probit model Complementary

loglog model loglog model
(I) (II) (I) (II) (I) (II) (I) (II)
ln_Z CAMELS ln_Z CAMELS ln_Z CAMELS ln_Z CAMELS
ln_Z (1) 0.357*** 0.466*** 0.203*** 0.676***

(0.104) (0.119) (0.033) (0.052)
ETA (1) 1.027 8.688 0.672 0.047
(0.7709) (20.273) (0.830) (0.109)
CRED (1) 7.685** 8.27em07*** 0.966 3.936
(3.644) (5.67em08) (1.751) (14.752)
CIR (1) 0.704 0.239 0.091 0.842
(0.764) (0.459) (0.251) (0.452)
ROAA (1) 9.841 0.084 18.088*** 3.131***
(12.217) (2.690) (5.806) (3.721)
LIQ (1) 0.390 0.546 0.264*** 1.697***
(0.330) (0.513) (0.071) (0.294)
INC_OPREV (1) 0.739 3.888 0.480*** 2.527**
(0.482) (3.611) (0.184) (0.922)
N. of obs. 5139 5139 5139 5139 4860 4860 4860 4860
Pseudo R2 0.3927 0.3715 0.1871 0.1858
Type errors:
TP 15 14 15 14 164 164 165 163
FN 4 5 4 5 11 11 10 12
FP 287 186 232 155 2726 2733 2700 2669
TN 4833 4934 4888 4965 1959 1952 1985 2016
Type 1 0.210 0.263 0.210 0.263 0.062 0.062 0.057 0.068
Type 2 0.056 0.036 0.045 0.030 0.581 0.583 0.576 0.569
Table 9
Distress forecasts by bank size.
This table reports the frequencies of distress events by deciles of the distribution of the predicted probabilities for the probit and
the complementary loglog models on the whole period (20012011) presented in Table 8. Decile 10 (1) is the decile with the
highest (lowest) predicted probabilities of distress events. Both probit the probit and the complementary loglog model include
the following regressors (I) the natural logarithm of the Z-score (ln_Z), and (II) on the natural logarithm of the Z-score plus the
CAMELS variables.
Deciles Small banks Large banks
Probit model Complementary Probit model Complementary

loglog model loglog model
(I) (II) (I) (II) (I) (II) (I) (II)
ln_Z CAMELS ln_Z CAMELS ln_Z CAMELS ln_Z CAMELS
10 0.473 0.736 0.473 0.684 0.617 0.685 0.600 0.657

9 0.210 0.000 0.157 0.052 0.091 0.017 0.080 0.028
8 0.105 0.000 0.105 0 0.074 0.017 0.085 0.011
7 0.000 0.000 0.052 0 0.028 0.051 0.028 0.074
6 0.105 0.052 0.105 0 0.068 0.097 0.057 0.097
15 0.105 0.210 0.105 0.263 0.120 0.131 0.148 0.131
domestic product, TA_GDP28) and the biggest banks (top quartile by TA_GDP). In the table, we report the
results of the two regressions for the whole period on: (I) the natural logarithm of the Z-score; and (II) the
CAMELS variables.
Results for type 1 errors using the probit model show that the model including CAMEL variables does
not offer any advantage in terms of predictive power when we compare them to a simple model based on
ln_Z.29 Moreover, the predictive power of the natural logarithm of the Z-score is higher for banks having a
large size. These results indicate that the natural logarithm of the Z-score is more effective when the size
of the nancial institution increases. An explanation for these results is that smaller banks may result
more nancially opaque since less subject to accounting and reporting scrutiny than larger banks. Finally,
the predictive power of the Z-score for the largest banks is also conrmed by the distress forecasts of
Table 9.
6. Robustness tests
To assess whether the predictive ability of the Z-score shown in previous tables relies on the way it is
computed, we compute our target variable using an alternative measure. We follow Yeyati and Micco
(2007) and compute the Z-score using the sample mean and variance of ROAA over a three-year period
(A_ROAA) and current values of ETA. Table 10 shows the probit estimations results and the hazard ratios of
the complementary loglog models over the whole period (20012011). Comparing the results of Table 10
(see Panels A and B) with those of Tables 4 and 5, we nd that the ability of the alternative Z-score measure
to predict bank distress improves in both models,30 but the number of observations drastically decreases
(8711 vs. 20,122 of Table 4).
28
As measure of bank size we use the ratio of total assets to the country's GDP in order to take into account the importance of banks
compared to the size of the economy. We obtain very similar results using only total assets rather than TA_GDP.
29
We obtain similar results estimating the probit and the complementary loglog models on the Z-score's components.
30
Panel A of Table 10 shows that, during 20012011, the probit model on the alternative Z-score measure correctly classies 86 out of
100 distress events (86% vs. 82% of the Z-score of Table 4). This nding is also conrmed by the distress forecasts of Panel B (see Table 10).
Results for the cloglog model are qualitatively similar.
Finally, in Table 11 we perform further additional tests to assess the validity of our results in the following
subsamples: commercial bank versus cooperative, savings, and real estate and mortgage banks, (which we
call other banks); and banks from a PIIGS countries (Portugal, Ireland, Italy, Greece, Spain) versus non-
Table 10
Predictions and forecasts of bank distress using an alternative Z-score measure.
This table shows in Panel A the probit estimations results and the hazard ratios of the complementary loglog model estimations using an
alternative measure of our target variable, the Z-score (ln_Z). Following Yeyati and Micco (2007), we compute the Z-score using the
three-year moving return of average assets (A_ROAA) in the numerator. The other components of the Z-score are: equity to total assets
(ETA) and three-year moving return of average assets (A_ROAA). We regress the distress bank binary variable on: (I) the natural loga-
rithm of the Z-score (ln_Z); (II) the components of the Z-score (ETA, A_ROAA, and A_ROAA); (III) the CAMELS variables: equity to
total assets (ETA), impaired loans to gross loans (CRED), cost to income ratio (CIR), three-year moving return of average assets
(A_ROAA), net loans to customer deposits and short term funding (LIQ), and non-interest income to net operating revenue (INC_OPREV);
and (IV) the natural logarithm of the Z-score plus the CAMELS variables. The sample period is 20012011. The dependent variable is the
Distressed Bank dummy variable (DBi,t) that takes the value of 1 if bank i becomes distressed (that is: under receivership, bankruptcy, dis-
solved, in liquidation, dissolved by merger with a coverage ratio smaller than 0 within 12 months before the M&A, or government bail-
out) at time t (the year in progress) and 0 otherwise. The dependent variable and independent variables are dened in Section 4. All ex-
planatory variables are lagged by one year. All variables are winsorized at the 1% of each tail. Year and country dummy variables are also
included in the model. Robust standard errors are reported in parentheses. The superscripts ***, **, and * denote coefcients statistically
different from zero at the 1%, 5%, and 10% levels, respectively, in two-tailed tests. The table of Panel A also displays the relationship be-
tween model predictions and actual distress events on the full sample for the whole period using a cut-off point equals to 0.01. TP stands
for True Positive; FN stands for False Negative; FP stands for False Positive; TN stands for True Negative. Type 1 error occurs when the
model fails to identify the distressed bank. It is computed as: FN/(FN + TP). Type 2 error occurs when a healthy bank is falsely identied
as distressed (i.e., a false alarm). It is computed as: FP/(FP + TN). In addition, Panel B reports the frequencies of distress events by deciles
of the distribution of the predicted probabilities for the probit and the complementary loglog models in Panel A. Decile 10 (1) is the dec-
ile with the highest (lowest) predicted probabilities of distress events.
Panel A: estimations results and type errors (whole period)
ln_Z (1) 0.260*** 0.250*** 0.552*** 0.539***

(0.047) (0.051) (0.068) (0.086)
A_ROAA (1) 74.614*** 8.77em57***
(14.252) (2.28em59)
ETA (1) 0.614 0.111 0.402 0.230 0.616 2.210
(0.755) (80.625) (0.556) (0.258) (0.894) (2.578)
CRED (1) 3.964* 1.244 195.884 1.069
(2.133) (2.129) (794.636) (4.457)
CIR (1) 0.025 0.135 0.864 0.554
(0.332) (0.286) (0.629) (0.364)
A_ROAA (1) 8.674 20.049*** 10.889 0.0003 2.631* 7.860
(6.770) (9.629) (8.428) (0.004) (4.851) (0.00001)
LIQ (1) 0.415*** 0.388*** 1.858* 1.883**
(0.115) (0.103) (0.532) (0.497)
INC_OPREV (1) 0.456 0.095 2.690 1.158
(0.280) (0.265) (1.754) (0.658)
N. of obs. 8711 8711 8711 8711 8711 8711 8711 8711
Pseudo R2 0.2845 0.2804 0.2677 0.3044
Type errors:
TP 86 77 81 88 83 76 77 85
FN 14 23 19 12 17 24 23 15
FP 1458 1217 1237 1367 1351 1190 1189 1310
TN 7153 7394 7374 7244 7260 7421 7422 7301
Type 1 0.140 0.230 0.190 0.120 0.170 0.240 0.230 0.150
Type 2 0.169 0.141 0.143 0.158 0.156 0.138 0.138 0.152
(continued on next page)

Table 10 (continued)
Panel B: Forecasts
Probit model Complementary loglog model
10 0.680 0.730 0.380 0.780 0.670 0.690 0.420 0.720

9 0.200 0.120 0.360 0.110 0.210 0.130 0.290 0.160
8 0.020 0.040 0.130 0.020 0.020 0.030 0.160 0.030
7 0 0.010 0.030 0.010 0 0.060 0.010 0.010
6 0.030 0.030 0.030 0.020 0.020 0.010 0.040 0.010
15 0.070 0.070 0.070 0.060 0.080 0.080 0.080 0.070
PIIGS banks. In the table, we report the results of probit regressions on: (I) the natural logarithm of the
Z-score; and (II) the CAMELS variables.31
Focusing on the probit and the type 1 errors results obtained using a cut-off point equal to 1% (see
Panel A),32 we observe that the model based on CAMEL variables does not offer any advantage in terms of
predictive power when we compare it to a simple model based on ln_Z. Moreover, the predictive power of
the natural logarithm of the Z-score is higher for commercial banks. This result combined with those of
Table 8, which show a higher predictive power for the Z-score in banks having a large size, indicate that the
natural logarithm of the Z-score is more effective as bank business models may become more sophisticated.
An explanation for these results is that smaller banks may result more nancially opaque as less subject to
accounting and reporting scrutiny than larger and listed banks. Concerning PIIGS, the models tend to over-
identify events of distress because of the severity of the crises in these countries. In fact, while the type 1
error is low in the PIIGS sample, the type 2 error is extremely high.
Finally, the predictive power of the Z-score in each subsample considered during 20012011 is also
conrmed by the distress forecasts of Panel B, with the exception of PIIGS/no PIIGS countries. In fact, for
these two subsamples Panel B shows that the models perform better (i.e., more distress events in the top
deciles) for countries that were less affected by the nancial crises.
7. Conclusions
We examine whether the Z-score, a well-known accounting-based proxy for bank stability, is an accurate
tool to predict bank distress on a sample of banks from 12 European countries.
Estimating probit and complementary loglog models, we nd that specications that use the natural
logarithm of the Z-score show a good predictive power to identify banks in distress. In particular, the key re-
sults indicate that the Z-score performs as well as the CAMELS variables, but it has the advantage to be more
parsimonious than CAMELS models, because it demands less accounting and questionable data (i.e., the covar-
iates to be used in CAMELS related analyses). Such a result is extremely valuable for those stakeholders
(i.e., investors, depositors, nancial analysts, etc.) who rely solely on public available information and look
for simple and trustable measures of bank soundness. Finally, we nd that the predictive ability of the
Z-score holds even using a different computational approach which takes into account the average of returns
on assets over a three year period.
We also assess the predictive power of the Z-score according to different bank characteristics and
nd that the Z-score is slightly more effective when the organizational and productive complexity
of banks increase along with the public incentives to scrutinize bank riskiness, as it is the case for
large banks. Finally, we show that during the nancial crisis the accuracy of the Z-score (and also of the
31
Similar results were achieved carrying out the complementary loglog model.
32
Table 11
Predictions and forecasts of bank distress in different subsamples.
This table reports in Panel A the probit and the type errors results (see Panel A) for different subsamples: commercial bank versus other
banks (i.e.,: cooperative, savings and real estate and mortgage banks); and PIIGS banks versus banks non-PIIGS banks. The sample period
is 20012011. The dependent variable is the Distressed Bank dummy variable (DBi,t) that takes the value of 1 if bank i becomes distressed
(that is: under receivership, bankruptcy, dissolved, in liquidation, dissolved by merger with a coverage ratio smaller than 0 within
12 months before the M&A, or government bail-out) at time t (the year in progress) and 0 otherwise. The dependent variable and inde-
pendent variables are dened in Section 4. All explanatory variables are lagged by one year. All variables are winsorized at the 1% of each
tail. Year and country dummy variables are also included in the model. Robust standard errors are reported in parentheses. The super-
scripts ***, **, and * denote coefcients statistically different from zero at the 1%, 5%, and 10% levels, respectively, in two-tailed tests.
In addition, Panel B reports the frequencies of distress events by deciles of the distribution of the predicted probabilities for the probit
models in Panel A. Decile 10 (1) is the decile with the highest (lowest) predicted probabilities of distress events.
Panel A: probit estimations results and type errors (whole period)
Variables Commercial banks Other banks PIIGS Non-PIIGS
(I) (II) (I) (II) (I) (II) (I) (II)
ln_Z (1) 0.172*** 0.184*** 0.173*** 0.210***

(0.034) (0.048) (0.057) (0.032)
ETA (1) 0.498 1.251 3.343** 0.863**
(0.349) (1.208) (1.629) (0.373)
CRED (1) 0.693 8.719*** 7.297*** 1.768
(1.684) (2.571) (2.750) (81.654)
CIR (1) 0.006 0.351 0.667 0.107
(0.221) (0.367) (0.369) (247)
ROAA (1) 10.942** 28.104*** 17.956** 11.579***
(4.721) (7.745) (8.597) (5.256)
LIQ (1) 0.216*** 0.391*** 0.206 0.329***
(0.071) (0.103) (0.127) (0.074)
INC_OPREV (1) 0.094 0.763** 1.310*** 0.338*
(1.684) (0.343) (0.331) (0.199)
N. of obs. 3644 3644 16,478 16,478 2788 2788 17,313 17,313
Pseudo R2 0.1281 0.1209 0.2090 0.2436 0.1936 0.2460 0.2101 0.2007
Type errors:
TP 137 134 73 76 91 93 116 108
FN 5 8 25 22 4 2 29 37
FP 2797 2980 2429 2055 1784 1520 2971 2598
TN 705 522 13,951 14,325 909 1173 14,197 14,570
Type 1 0.035 0.056 0.255 0.224 0.042 0.021 0.200 0.255
Type 2 0.798 0.850 0.148 0.125 0.662 0.564 0.173 0.151
Panel B: forecasts
Commercial banks Other banks PIIGS No PIIGS
Deciles (I) (II) (I) (II) (I) (II) (I) (II)
10 0.690 0.605 0.530 0.612 0.526 0.578 0.634 0.627

9 0.091 0.105 0.204 0.193 0.221 0.221 0.179 0.186
8 0.049 0.028 0.102 0.051 0.052 0.115 0.034 0.034
7 0.035 0.063 0.030 0.020 0.073 0.021 0.048 0.027
6 0.042 0.070 0.020 0.000 0.042 0.031 0.013 0.041
15 0.091 0.126 0.112 0.122 0.084 0.031 0.075 0.082
CAMELS variables) marginally improves with respect to the whole period. The latter nding may result from
the mounting efforts of European supervisors and regulators to make bank balance sheet less opaque and sub-
ject to accounting manipulations (i.e., see the several changes in the EU regulations on IAS and IFRS occurred
in 2008 and 2009 aimed to strengthen transparency and minimize accounting discretion). Overall such evi-
dence calls for further analyses on the effects of earnings management and accounting rules on bank riskiness.
Appendix A
Table A.1
Variable denitions.
This table reports variable denitions. Data used to compute the variables are from BankScope.
Variable Denition
ln_Z Dened as the natural logarithm of the sum of ROAA and ETA all divided by ROAA (the standard deviation of return on
average assets computed using a three-year rolling time window).
ETA Computed as the ratio of equity (i.e., book value of common equity) to total assets.
CRED Dened as the ratio of impaired loans (obtained as the sum of impaired loans & advances to customers and impaired
loans and advances to banks) to gross loans (computed as net loans plus reserves for impaired loans).
CIR Computed as the ratio of the overheads (or costs of running the bank) to the sum of net interest income (dened as the
difference between gross interest & dividend income and total interest expense) and other operating income.
ROAA Dened as the ratio of net income to average total assets.
LIQ Computed as the ratio of net loans to customer deposits and short term funding.
INC_OPREV Dened as the ratio of non-interest income to net operating revenue. Non-interest income is equal to the sum of net
gains (losses) on trading and derivatives, net gains (losses) on other securities, net gains (losses) on assets at fair value
through income statement, net insurance income, net fee and commissions and other operating income. Net operating
revenue is equal to the sum of total non-interest income and net interest income.
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Global Finance Journal 28 (2015) 111131

Contents lists available at ScienceDirect

Global Finance Journal

Should we trust the Z-score? Evidence from the

Corresponding author. Tel.: +39 02 72342942; fax: +39 02 72342670.

3. Sample selection and identifying distressed banks

3.1. Sample description

3.2. Identifying distressed banks

4. Methodology, variables and descriptive statistics

4.1. Empirical methodology

Panel A: distressed banks by country

Country Bank-year observation Banks

Distressed Non-distressed Total Distressed Non-distressed Total %

Austria 8 1753 1761 7 210 217 3.22

Panel B: distressed banks by country and year (bank-year observation)

4.2. Variables and descriptive statistics

Whole Crisis Whole Crisis Whole Crisis Whole Crisis

ln_Z ETA CRED CIR ROAA LIQ INC_OPREV

Variables Probit model Complementary loglog model

(I) (II) (III) (IV) (I) (II) (III) (IV)

ln_Z (1) 0.199*** 0.179*** 0.629*** 0.639***

Deciles Probit model Complementary loglog model

(I) (II) (III) (IV) (I) (II) (III) (IV)

10 0.629 0.625 0.604 0.620 0.612 0.612 0.591 0.612

Variables Probit model Complementary loglog model

(I) (II) (III) (IV) (I) (II) (III) (IV)

ln_Z (1) 0.190*** 0.154** 0.651*** 0.676***

Deciles Probit model Complementary loglog model

(I) (II) (III) (IV) (I) (II) (III) (IV)

10 0.672 0.677 0.710 0.721 0.666 0.661 0.688 0.699

Variables Small banks Large banks

Probit model Complementary Probit model Complementary

(I) (II) (I) (II) (I) (II) (I) (II)

ln_Z CAMELS ln_Z CAMELS ln_Z CAMELS ln_Z CAMELS

ln_Z (1) 0.357*** 0.466*** 0.203*** 0.676***

Deciles Small banks Large banks

Probit model Complementary Probit model Complementary

(I) (II) (I) (II) (I) (II) (I) (II)

ln_Z CAMELS ln_Z CAMELS ln_Z CAMELS ln_Z CAMELS

10 0.473 0.736 0.473 0.684 0.617 0.685 0.600 0.657

Panel A: estimations results and type errors (whole period)

Variables Probit model Complementary loglog model

(I) (II) (III) (IV) (I) (II) (III) (IV)

ln_Z (1) 0.260*** 0.250*** 0.552*** 0.539***

(continued on next page)

Probit model Complementary loglog model

(I) (II) (III) (IV) (I) (II) (III) (IV)

10 0.680 0.730 0.380 0.780 0.670 0.690 0.420 0.720

Panel A: probit estimations results and type errors (whole period)

Variables Commercial banks Other banks PIIGS Non-PIIGS

(I) (II) (I) (II) (I) (II) (I) (II)

ln_Z (1) 0.172*** 0.184*** 0.173*** 0.210***

Commercial banks Other banks PIIGS No PIIGS

Deciles (I) (II) (I) (II) (I) (II) (I) (II)

10 0.690 0.605 0.530 0.612 0.526 0.578 0.634 0.627

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ln_Z (1) 0.199* 0.179* 0.629* 0.639*

ln_Z (1) 0.190* 0.154 0.651* 0.676*

ln_Z (1) 0.357* 0.466* 0.203* 0.676*

ln_Z (1) 0.260* 0.250* 0.552* 0.539*

ln_Z (1) 0.172* 0.184* 0.173* 0.210*