The use of accounting and stock market data to predict bank rating changes :

the case of South East Asia Isabelle DISTINGUIN

Jocelyn TRINIDAD

Amine TARAZI

Issue and objective:

• Emphasis on market forces in Basel II and indirect market discipline ? Can stock prices be useful for bank supervisors?

• How do accounting and market early indicators perform to predict rating changes ? Is there a specific contribution of market indicators compared to standard financial ratios?

Sample:

64 banks from 8 countries of South East Asia

Period : 1999-2004

Hong Kong, Korea, Singapore, Taiwan, Malaysia, Indonesia, Thailand, PhilippinesIndicators: - annual changes in accounting ratios grouped into four categories (capital, asset quality, earnings and liquidity)

- market indicators derived from weekly stock pricesMethod:

• Multinomial logit model employed to estimate the probability of a rating change (prediction horizon of 1 year)

• Downgrades and Upgrades from 3 major rating agencies• Stepwise to select the optimal set of indicators•Test for possible influence of size and/or balance sheet structure of banks on the effectiveness of early indicators

Results

1. Both accounting and market indicators perform better to predict Upgrades than Downgrades

2. For Large banks both types of indicators are significant in predicting Upgrades but not Downgrades (too-big-to-fail)

For Small banks only market indicators can be useful in the early detection of Downgrades and Upgrades are not

predictable

3. Early indicators are mainly significant to predict rating changes for banks heavily involved in traditional intermediation activities (deposits and loans)