A factor-analytic approach to bank condition

This paper explores a new approach to early warning systems for commercial banks. Factor analysis and logit estimation are used to measure the condition of individual institutions and to assign each of them a probability of being a problem bank. The model employs widely used financial ratios and information taken from bank examinations. The factors produced by the model for use in the logit estimation are very similar to the CAMEL rating system used by bank examiners. Empirical results show that the combination of factor analysis and logit estimation is a promising method of evaluating bank condition.