Identification of Indicators’ Applicability to Settle Borrowers’ Probability of Default

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Abstract

Borrowers default risk is one of the most relevant types of risk in commercial banking and its assessment is important to secure business profitability and avoid huge losses during economic turbulences. This leads to necessity to investigate topics related to assessment of borrowers’ default probability and applicability of factors, which would enable to capture the newest trends of borrowers’ markets. Leading economic indicators (in addition to financial and other economic indicators) are often suggested as forward-looking in scientific literature. However, there is still a discussion going on applicability of financial ratios and economic indicators. As the problem is relevant in theoretical view as well as for practitioners, this article aims to identify applicability of leading economic indicators for the estimation of default probability. Further, the qualitative criteria for factor selection were identified and used when using detailing, grouping and SWOT analysis methods. Based on current scientific literature analysis, this paper concludes that although leading economic indicators are able to capture forward-looking signals, they should be used with careful analysis of its drawbacks and in combination with financial factors in order to avoid overshooting effects. The limitation of the article is the analysis of factors based on rather theoretical analysis than estimation of quantitative criteria. This suggests that every time using leading economic indicators requires using empirical study of particular indicators’ set.

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