An Early Warning System for Bankruptcy Prediction: lessons from the Venezuelan Bank Crisis

TL;DR

This paper develops an early warning system using financial and macroeconomic data to predict bank bankruptcies, successfully identifying crisis signals months in advance during Venezuela's 1993-94 banking crisis.

Contribution

It introduces a discriminant analysis model based on pre-crisis data for early detection of bank failures, demonstrating high accuracy and robustness.

Findings

Model accurately predicted Banco Capital's crisis months before intervention.

Discriminant functions showed high precision in error estimation.

Early warning signals were detected well before actual bank interventions.

Abstract

During 1993-94 Venezuela experienced a severe banking crisis which ended up with 18 commercial banks intervened by the government. Here we develop an early warning system for detecting credit related bankruptcy through discriminant functions developed on financial and macroeconomic data predating the crisis. A robustness test performed on these functions shows high precision in error estimation. The model calibrated on pre-crisis data could detect abnormal financial tension in the late Banco Capital many months before it was intervened and liquidated.