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ABSTRACT
KURT, Asım. “Early Warning System for Banking Sector using Pattern Recognition
Technique: The Turkish Case (1997-2001)”, Master‟s Thesis, Ankara, 2011.
One of the most important requirements of confidence and stability in financial markets is
foreseeing possible financial distress in banking sector and getting necessary actions timely. The
aim of this study is to develop an early warning system for predicting financial failure in banks
and to analyze the reasons of financial failure. An early warning system, which makes reliable
predictions, will provide good information to various decision makers including regulation and
supervision agencies, bank holders, investors and auditors in order to assess and manage the
risks of financial failure. For this purpose, a sample of 40 privately-owned commercial banks
balance sheets is used. The time span of the data set covered 1997-2001 where 19 banks failed.
As a methodology for prediction decision tree is preferred since it produces easily
understandable „if-then‟ rules for financial failures.
A set of financial ratios were created and Classification and regression tree (CART), a popular
decision tree technique, was applied to obtain failure classifications of banks 1 year before
failure happens. The reasons for the bank failures were analyzed by means of extracted rules
from the tree.
As a result, the setup model correctly predicted %73-78 of failed banks 1 year before failure,
varying ratios with different sampling methods. In the study, it is observed that CART is
superior to statistical methods in predicting financial failure. Furthermore, rules extracted from
model, showed that banks were sensitive to rising interest rates during 1997-2001 and banks
with weak capital structure were not able to survive with high interest rates in that period.
Key Words
Financial Failure, Bank, Decision Trees, CART, Kolmogorov-Smirnov Test