While I was doing an applied study related to the study of risks in banks and when collecting the data necessary to apply a regression, one of the independent variables caught my eye, which is the ( Z-Score - Nonmanufacturers ), where almost all banks share that they have a low ( Z-Score - Nonmanufacturers ) that ranges approximately within a range of 1 over the years ... I searched for the reason for this and I did not find anyone to explain this thing... But I expect this is the result of the nature of the working mechanism of banks, which requires entering at a higher level of risk than other sectors ..... But I want to make sure of this information ... as This will mean that the results of Z-Score for banks must be interpreted in a different way, not at the general levels of measurement, which are:
- 0–1.8: indicates the company will declare bankruptcy in the future.
- 1.8–3: indicates the company is likely to declare bankruptcy.
- 3: indicates the company will not declare bankruptcy.
Banks usually cannot be compared with the same variables that we use for the service sector. The core reason is that Banks are in the business of lending and deposits are their liabilities and loans are their assets. Hence, it might be inappropriate to use "essential checks" that we use in stock market analysis on banks - such as Altman Z-Score, Pitrosky F-Score and Modified C-Score
Vijaya Kittu Manda
Thank you for taking the time to answer the question...
Allow me to clarify that I did not use the normal Z-Score model for the manufacturer companies, but rather I used the modified Z-Score model for the non-manufacturer companies .
in which the model variables are :
X1 = (current assets − current liabilities) / total assets
X2 = retained earnings / total assets
X3 = earnings before interest and taxes / total assets
X4 = book value of equity / total liabilities
Does that make a difference to your answer in which you talk about the impossibility of applying a Z-Score model to banks?
The Altman Z score is an inappropriate model to evaluate banks or similar financial institutions. By their very nature they are highly geared and have low scores on the three variables simply because their liabilities and assets are always very high in relation to their earnings. The relationship between current assets and current liabilities are inevitably abnormal because one of their basic functions is the transformation of the maturities of financial assets. Depositors invest short term and borrowers borrow long term. Altman did not develop his model for use in the financial sector and it is unreasonable to expect it to have any predictive power. In many types of financial research, firms in the financial sector are excluded from test samples because they do not behave in the same way as other firms because of the nature of their operations and balance sheets.
please, share with us their leverage ratios. Highly leveraged banks which is the norm of banks leads to the results you obtained.
Altman Z-score model is not appropriate model for assessing the financial health of financial institutions because of the following reasons:
1. They are regulated institutions
2. The regulated requires a certain percentage of funds to be kept at the central bank.
3. Off-balance sheet transactions which are common with banks.
4. Deposit taking resulting in high liabilities for the banks
I agree with both Profs. Maccarthy and Pinford. Regulation because of their importance in the economic and financial space but adequate capital/risk capital to support business decisions rightly call for more capital. Despite the "locked-up funds" with the Central Banks, banks being what they are will rather use other peoples money to generate additional profits for their shareholders (high leverage). Low ROAs and extremely high ROEs.
If Altman is in appropriate, Sir can you please suggest some other measure to evaluate banks? Looking forward for your reply.@John
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