The Impact of Bank Stability Metrics on Distance-from-Default

Abstract The study aims to determine whether bank stability metrics can predict the default risk of listed banks in Bangladesh. To achieve this, a sample of 29 banks (7 Shariah-based banks and 22 conventional banks) from 2010 to 2023 is used. As a proxy for default risk, ROA based Altman’s Z score and Merton’s distance to default (DTD) were used. For bank stability ratios, Non-performing Loan to Equity (NPLE), Return on Equity (ROE), Liquidity Coverage Ratio (LCR), and Capital Adequacy Ratio (CRAR) were taken. Age, GDP growth, and a dummy for COVID were taken as control variables. Random effect model was tested to interpret the results across all models. The impact of stability metrics differs depending on the proxies taken in the study, as evidenced by the endogeneity and robustness test; however, it was found that capital adequacy, asset quality and profitability significantly impact bank’s default risk for all models, respectively. Additionally, shariah-based banks are more sensitive to asset quality and profitability, where changes in these factors have a heightened effect on default risk. Conventional banks tend to be more sensitive to capital adequacy suggesting that capital adequacy management is critical for these banks’ default risk. JEL Classification: C23, C36, G21, G32, G33, G41 Keywords: Z-score , Metron’s Distance to Default , Default Risk , Random Effect Model , Conventional Banks , Shariah-based Banks , Endogeneity Test