Some Measures of Financial Fragility in the Chilean Banking System: An Early Warning Indicators Application

Abstract

There is an ample literature whose main subject is to build models able to anticipate or provide some early warning signals of problematic financial institutions. This article overview these literature in an attempt to detect latent fragility in the Chilean financial system. Most applications in this area estimate some probability model with discrete dependent variables that separate, ex-post, failed or bailed-out institutions from the healthy ones, an exercise that during the nineties is not feasible in the Chilean case. We adopt a simpler approach by estimating a linear reduced form model of determination of past due loans and inter-bank spread as measures of financial fragility, which can be interpreted as probability indicators of credit and liquidity risk. Bank financial ratios and macro variables form our set of explanatory variables. The models estimated in this article intend to capture financial fragility in the context of non-crisis environment, which characterizes the Chilean financial system during the present decade. Although some institutions had left the market, failure or insolvency was not the main cause.