An econometric analysis of banking financial results in Ukraine

Journal of the Academy of Business and Economics, March, 2004 by Oleg Vasyurenko, Galyna Azarenkova, Nancy J. Scannell

ABSTRACT

This paper explores the building of an econometric model with a binomial dependent variable for analysis of banking activities financial results in Ukraine. Identified are salient factors that exert substantial impact on banking financial results in the country. Statistical data for the period 2000 to 2002 were employed in this study. The extracted factors are useful in explicating the division of Ukrainian banks into respective clusters based upon their financial characteristics. The bank clusters statistically derived by the present study might be considered functional peer-groupings by financial professionals, policy makers and regulators when conducting comparative analyses among banks in Ukraine.

1. INTRODUCTION

A study of factors which potentially impact the dynamics (including capital flows) and sustainable development of a banking system is integral given the decisive role that banks play in the virtually any economy. What can be learned from the incorporated analyses contributes to the germane literature in a timely fashion, given Ukraine's present status as a transitional economy--a nation punctuated by unpredictable economic events and pervasive governmental amendments to economic policies. Even in stable economies, banks may fall victim to unintended negative consequences owing to frequent systemic financial and credit irregularities: economic crises; bankruptcies; insolvencies; oscillations in the money and capital markets; and other manifestations of an unbalanced market economy.

This study prospectively bears further implications; specific testing outcomes may arguably be regarded as signals to an early detection of unreliable banks. In such cases, timely sanitation procedures could then be strategically exacted to remedy, for example, a bank's unpredictability--a common symptomatic precursor to bank liquidation. An undertaking of this sort is generally carried out by a country's national bank which is charged with the monitoring of development dynamics of individual banks as well as the banking system as a whole based upon a certain system of indices and regulations. The development of like banking control is in the offing in Ukraine.

Notwithstanding extant controls, this paper advocates for broader applications of various analytical model constructions and qualitative analyses of banking system parameters; the development of versatile econometric models and studies can contribute to more fairly-weighted decision-making in the banking sector, and, hence, to a potentially more stable and efficient banking system. Accordingly, this paper constructs a statistical model aimed to detect indices that may differentiate functional stability from functional instability within the Ukraine banking system.

2. BANK ASSESSMENT STUDIES

Bank condition diagnostics are widely employed by banking supervision authorities in developed countries under the name of Early Warning Systems (EWS). For a review of such systems see Sahawala and Berg (2000).

The most common international banking valuation technique, and one which is adhered to in the Ukrainian Banking system, is referred to as CAMEL, a banking mnemonic for the five principal areas of bank assessment: Capital, Assets, Management, Earnings and Liquidity. Though understood to be germane to banking, the CAMEL criteria have been applied in assessing even broader economic strata (Lavelle, 2004).

Three risks that have consistently produced financial distress in commercial banks are leverage risk, credit risk, and liquidity risk. Bank size and CAMELS-related variables capture the impact of other factors that may affect downgrade risk (Putnam, 1983; and Cole and Gunther, 1998). Leverage risk is the risk that losses will exceed capital, rendering a bank insolvent; Credit risk is the risk that borrowers will fail to make promised interest and principal payments; and liquidity risk is the risk that a bank will be unable to fund loan commitments or meet withdrawal demands at a reasonable cost (Gilbert, Meyer and Vaughan, 2002).

With respect to countries comprising the Former Soviet Union (FSU), some aspects of banking systems, including functional efficiency, reliability and development efficacy, are treated in works by, for instance, Matovnikov (2000), Garshin (2003), Vasyurenko and Azarenkova (2003), and Scannell, Safdari and Newton (2003). Additionally, a key aspect of banking activities analysis, bank stability, is studied in works by Garshin (2003), Kolary, Glennon, Shin and Caputo (2002), and Cole and Gunther (1998). These papers focus on factors that essentially contribute to bankruptcies.

3. DATA PECULIARITIES CHARACTERIZING UKRAINE'S BANKING ACTIVITIES

The matter of bankruptcy is a pertinent concern for a developing Ukrainian banking system. Figure 1 presents a chronology from 1992 to 2002 of Ukraine's registered (shaded) versus liquidated banks.

As is evident from Figure 1, and in concert with findings in a study by Stone and Rasp (1991), the data samples are not sufficiently large enough to warrant tests of significance. The small number of observations may lead to unsubstantiated statistical interpretation of econometric results. It is worth specifying that parallel works by Russian scholars are based on sample sizes upwards of 1000 registered banks and liquidated banks.