Distance-to-Default in Banking: A Bridge Too Far?

September 1, 2006

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Format: Chicago

Amadou N Sy, and Jorge A Chan-Lau. Distance-to-Default in Banking: A Bridge Too Far?, (USA: International Monetary Fund, 2006) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

In contrast to corporate defaults, regulators typically take a number of statutory actions to avoid the large fiscal costs associated with bank defaults. The distance-to-default, a widely used market-based measure of corporate default risk, ignores such regulatory actions. To overcome this limitation, this paper introduces the concept of distance-to-capital that accounts for pre-default regulatory actions such as those in a prompt-corrective-actions framework. We show that both risk measures can be analyzed using the same theoretical framework but differ depending on the level of capital adequacy thresholds and asset volatility. We also use the framework to illustrate pre-default regulatory actions in Japan in 2001-03.

Subject: Asset valuation, Banking, Capital adequacy requirements, Deposit insurance, Post-clearance customs audit

Keywords: Bank, Bank regulator, Capital, Capital ratio, WP

Publication Details

Pages:

17
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2006/215
Stock No:

WPIEA2006215
ISBN:

9781451864755
ISSN:

1018-5941

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