Regulator Use of Market Data to Improve the Identification of Bank Financial Distress

This paper assesses the extent to which stock market information may help bank regulators identify bank financial distress. The research specifies a variety of stock return and other market-related variables that might contain elements of longer-term trends and be capable of anticipating changes in regulatory ratings of commercial banks and thrift institutions. Univariate tests confirm a remarkable tendency for market-related variables to decline, or otherwise move, far in advance of formal regulatory rating downgrades, a finding suggesting that these variables may have useful predictive content. Furthermore, multivariate tests support the notion that market-related variables add predictive value to the value contained in publicly available Call Report financial data. The evidence supports the use of market-related variables in off-site monitoring applications.

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