Prof. Ed Altman on Failure Prediction Models

The following is an excerpt from a Treasury and Risk article entitled, “Know Thy Banking Partners.”

Edward Altman, a finance professor at New York University’s Stern School of Business who devised a formula, the Z-score, for predicting corporate defaults, cautioned that coming up with a method for predicting which banks are going to run into problems has proven more difficult than building a model to identify which industrial companies are likely to default.

“It’s my experience that failure prediction models have done fairly poorly when it comes to financial institutions,” Altman said. “It always seem that the latest banking crisis is caused by something fairly unique to the current situation and not necessarily correlated with prior bank crises.”

In terms of frequency, a CEB survey last year of more than 60 finance executives found that the biggest group, 32%, said they monitor their banks “as needed.” Twenty-one percent said they monitor their banks weekly, 16% do so daily, another 16% monthly, and 10% quarterly. Just 6% of the executives said their company had no monitoring process.

CEB’s Gannon emphasized that treasuries’ efforts don’t stop at monitoring. “On top of that is a mitigation strategy,” he said. “In the last couple of years, treasury teams have gone to the next level—knowing what to do if somebody gets to level we’re uncomfortable with, what’s our actual exit strategy.

“It’s monitoring for the sake of looking for triggers and thresholds that would make you take action to shore up your exposure or mitigate risk in other ways,” Gannon added.

Read the entire article here.

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