Probability of bank distress: Investigating a risk landscape of an emerging economy

The banking sector in Albania plays a significant role in maintaining financial stability. In the context of a changing global environment, banks can be impacted by various risks, including climate risk, geopolitical, technological, and cyber risks. By addressing these risks, banks in Albania can enhance their resilience. Based on the latest financial stability report of the Bank of Albania (2023b), the banking sector’s resilience to withstand risks is assessed as robust. The purpose of this research is to provide an understanding of the prevailing risk landscape and to measure the probability of default (PD) of banks in Albania based on various financial metrics. Logistic regression is used as the methodology for predicting the likelihood of distress. The findings reveal that capitalization, profitability, managerial quality, asset quality, and concentration are significant predictors of default, with asset and managerial quality having the largest impact on the odds of default. The study is relevant, as assessing the distress of banks and the likelihood of their default by establishing an early warning system and evaluating financial and operational metrics, alongside macroeconomic factors is crucial to take corrective actions before banks become critical to systemic risk and financial stability.