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Liana Rahardja
FINANCIAL DISTRESS OF COMMERCIAL BANKS
USING ALTMAN Z-SCORES
Liana Rahardja
Universitas Multimedia Nusantara
liana@unimedia.ac.id
ABSTRACT
The general objective of this study was to determine the key variables influenced banks
bankruptcy in Indonesia by using Altman Z-Scores. Indonesia experienced financial crisis
started in July 1997 and deteriorated the real sector and later on injured the economic growth.
The prolong crisis has finally destroyed the banking sectors in Indonesia as indicated by
substantial increase on Non-Performing Loans (NPL) which was caused by the inability of
real sectors to comply with its obligations to banks when maturity.
A stratified random sampling technique was employed to select the samples. From 170
banks, which have survived, only 36 banks listed on IDX (Indonesian Stock Exchanges) from
1993-1999. A multivariate analysis, discriminate analysis was employed to determinate the
financial ratios which related to the banks bankruptcy.
The variables to be tested are: Loan to Deposit Ratio (LDR), Reserve Requirement (RR),
Return on Asset (ROA), Return on Equity (ROE), Productive Current Asset/Productive Total
Asset (PCA/PTA), Interest Revenue in Completion/Interest Income (IR/II), Net Interest
Margin (NIM), Operational Expense/Operational Revenue (OE/OR), Capital Adequacy Ratio
(CAR). The result shows that the key factors that influenced the bank bankruptcy are: Net
Interest Margin (NIM), Productive Current Asset/Productive Total Asset (PCA/PTA).
The result of this study is very useful in determining financial distress of the company,
identifying problems and taking corrective actions. Moreover, it is also useful to take a
preventive action, such as to give warning from bankruptcy.
Keywords: Bankruptcy, Financial Distress, Altman Z-Scores.
I. Introduction
East Asian countries have experienced financial crisis started in July 1997 and impacted on
its currencies. The crisis has deteriorated the real sector and later injured the economic
growth and even brought the East Asian economics toward negative growth. The prolong
crisis has finally destroyed the banking sectors in Indonesia as indicated by substantial
increase on Non-Performing Loans (NPL) which was caused by the inability of real sectors to
comply with its obligations to banks when maturity. On the other hand, banking sector
experienced negative spread as an impact of tight money policy conducted by the government
to drive up the currency appreciation.
Based on the reasons above, Indonesia government need to do the reorganization to
strengthen the banking sector. Since the crisis began, Indonesia had 237 commercial banks,
consisting of 7 state-owned banks, 160 private national banks, 27 regional government banks
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and 43 foreign joined banks. Then the government closed down 67 banks in March 1999,
leaving only 170 banks.
At the end of June 1997, Bank Indonesia estimated the bad loan 13,4% of the total loans from
the 7 state banks, but the ratio rose to 45% in February 1999. The NPL had risen from 10% in
1997 to 25% in March 1998 and reached 82,5% in May 1999. One important ratio to be
considered as healthy banks is CAR if the ratio is more than 4% and considered not healthy if
the ratio below 4%. Based on Bank Indonesia regulation, Pasal 1, Surat Edaran Bank
Indonesia No. 26/1/BPPP, 1993, bank has to maintain CAR 8% minimum. But since the new
regulation being announced as Surat Keputusan Direksi Bank Indonesia No.
31/146/KEP/DIR, 1998 (Appendix A), a bank has to have CAR 4% minimum, the regulation
changed due to the banking fall down.
This study aims to investigate the banking reforms that have already been done by the
Indonesian government which is expected to create a solid and competitive banking system in
the future. It could bring a positive signal to the banking stock prices. From the existing 170
banks, only 36 banks listed on IDX from 1993-1999, the lists are:
1. Bank Arya Panduarta
2. Bank Bahari
3. Bank Bali
4. Bank Bira
5. Bank Central Asia (BCA)
6. Bank CIC
7. Bank Dagang Negara Indonesia
8. Bank Danamon
9. Bank Danpac
10. Bank Duta
11. Bank Global International
12. Bank International Indonesia (BII)
13. Bank Mashill Utama
14. Bank Mayapada
15. Bank Mega
16. Bank Negara Indonesia 1946
17. Bank Niaga
18. Bank NISP
19. Bank Papan Sejahtera
20. Bank PDFCI
21. Bank Pikko
22. Bank Rama
23. Bank Surya
24. Bank Tiara Asia
25. Bank Umum Nasional
26. Bank Umum Servitia
27. Bank Universal
28. Bank Victoria Internasional
29. Ficorinvest Bank
30. Indovest Bank
31. Inter-Pacific Bank
32. Lippo Bank
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33. Modern Bank
34. Panin Bank
35. Tamara Bank
36. Unibank
Edwards I. Altman created multiple discriminate analysis, called Altman Z-Scores which
consists of financial ratios to predict corporate bankruptcy. It would give the information
about the bank's condition which is very useful for decision making. From 36 commercial
banks listed on IDX, the question to be answered is: Which variables among LDR, RR, ROA,
ROE, PCA/PTA, IR/II, NIM, OE/OR, CAR will influence the bankruptcy of 46 commercial
banks from 1993-1999?
The information would be useful for:
1. Internal users, such as: shareholders, bank managers in order to take a preventive action if
the bank condition is getting worse.
2. External users, such as: investors, public and also government as the regulator.
II. Theoritical Framework
Based on Undang-Undang No: 7, 1992, the definition of bank is: "Bank adalah badan usaha
yang menghimpun dana dari masyarakat dalam rangka untuk meningkatkan taraf hidup
rakyat banyak". The types of bank in Indonesia based on UU No: 7, 1992 are:
1. Commercial Banks
a. State Banks
Banks owned by the government, for example: BNI'46, BRI, BDN, now it's called
Bank mandiri.
b. Regional Government Banks
Banks which accept deposits and/or issuing marketable securities for long term, and
also giving long term loans to country's development, for example: Bank
Pembangunan Indonesia and Bank Pembangunan Daerah.
c. Private National Banks
Banks owned by private company and operates in national, for example: BII, Lippo
Bank and Bank Danamon.
d. Foreign Banks
Banks owned by foreign investors, for example: Citibank, Chase Manhattan Bank and
Standard Chartered Bank.
e. Joint Banks
Banks owned by private company in Indoensia and also foreign investors, for
example: Fuji International Bank (BII with Fuji Bank) and Tokai Lippo Bank (Lippo
Bank with Bangue National de Paris).
2. Rural Credit Banks
Banks which accept deposits, save deposits and/or forms that have the same meaning.
a. Before October 1988 Pact
The law based on staatblad, Peraturan Daerah, Keputusan Gubernur of each
province, for example: Badan Kredit Desa, Non Badan Kredit Desa, Lembaga Desa
and Kredit Pedesaan.
b. After October 1988 Pact
Banks established on October 1988 with minimum capital IDR 50 million.
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3. Syariah Banks
Banks activities based on Islamic rules and not permitted Riba nasi'ah, like the bank
interests for the borrowers.
The objective of bank based on UU No: 7, 1992 is: "Perbankan Indonesia bertujuan
menjunjung pelaksanaan pembangunan nasional dalam rangka meningkatkan pemerataan,
pertumbuhan ekonomi, dan stabilitas nasional ke arah peningkatan kesejahteraan rakyat
banyak". Moreover, the function of bank is: the trust function, the credit function, the
investment/planning function, the payment function, the thrift/saving function, the cash
management function, the investment banking/underwriting function, the brokerage function,
and the insurance function". The bank plays an important role in the economy as follows
(Rose 1999:7):
1. The intermediation role
Transforming saving received primarily from households into credit (loans) for business
firms and others in order to make investments in new buildings, equipments, and other
goods.
2. The payments role
Carry out payments for goods and services on behalf of their customers (such as by issuing
and clearing checks, wiring funds, providing a conduit for electronic payments, and
dispersing currency and coins.
3. The guarantor role
Standing behind the customers to pay off customer debts when those customers are unable
to pay (such as by issuing letters of credit).
4. The agency role
Acting on behalf of customers to manage and protect their property or issue and redeem
their securities (usually provided through the bank's trust department).
5. The policy role
Serving as a conduit for government policy in attempting to regulate the growth of the
economy and pursue social goals.
The definition of Bankruptcy by Epstein (1988) and White (1989:129-151) stated that when a
company could no longer pay its bills, it may file for bankruptcy. If it fails to do so, its unpaid
creditors may be able to force it into bankruptcy. Recent studies have identified a few factors
that influenced bankruptcy the most are: problems in their loan portfolio (NPL), economy
declines, leadership (mismanagement) and expense control problems.
Altman, who creates a discriminate function Z as a function of 5 financial ratios: net working
capital as a percentage of total assets, retained earnings as percentage of total assets, earnings
before interest and taxes as percentage of total assets, market value of equity as percentage of
book value of debt and sales as a percentage of total assets. He arrived at the following
discriminate function (Damodaran, 1996:44).
Z = .012x1 + .014X2 + .033X3 + .006X4 + .999X5
Where:
X1 = Net working capital/Total assets
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X2 = Retained earnings/Total assets
X3 = Earnings before interest and taxes/Total assets
X4 = Market value of equity/Book value of debt
X5 = Sales/Total assets
In applying this function, Altman found that Z-Scores less than 1.8 indicated a high
probability of bankruptcy, whereas Z-Scores higher than 3.00 indicated a low probability. ZScores between 1.81-2.99 were in a gray area.
Altman Z-Scores
Bankruptcy Possibility
> 1.80
Very high
1.81 - 2.99
Not clear
< 3.00
Very low
Those financial ratios normally used for companies, which are quite different from the
banking industry. Therefore, the financial ratios in valuing bank performance are as follows
(Infobank, July no. 251/2000) are:
1. Liquidity
- Loan to Deposit Ratio (LDR) = Loan / (Third parties funds + Equity)
- Reserve Requirement (RR) = Current Account in Bank Indonesia / Third parties funds
2. Rentability
- Return on Asset (ROA) = Net income / Total Assets
- Return on Equity (ROE) = Net income / Equity
3. Quality of Asset
- Productive Current Asset/Productive Total Asset (PCA/PTA)
- Interest Revenue in Completion/Interest Income (IR/II)
4. Efficiency
- Net Interest Margin (NIM) = Net interest income / Productive assets
- Operational Expense/Operational Revenue (OE/OR)
5. Capital
- Capital Adequacy Ratio (CAR) = Equity/Risk Adjusted Assets
The conceptual framework:
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Dependent Variables:
Code 0 = Bankrupt
Code 1 = Survive
Independent Variables:
- Loan to Deposit Ratio (LDR),
- Reserve Requirement (RR),
- Return on Asset (ROA),
- Return on Equity (ROE),
- Productive Current Asset/Productive Total Asset (PCA/PTA),
- Interest Revenue in Completion/Interest Income (IR/II),
- Net Interest Margin (NIM),
- Operational Expense/Operational Revenue (OE/OR),
- Capital Adequacy Ratio (CAR).
Hypotheses
Ha: variables LDR, RR, ROA, ROE, PCA/PTA, IR/II, NIM, OE/OR, CAR will differ with
bankruptcy variables.
III. Research Design
This research is a descriptive research and the goal is to identify the variables among LDR,
RR, ROA, ROE, PCA/PTA, IR/II, NIM, OE/OR, CAR which influenced bank bankruptcy of
36 commercial banks in Indonesia from 1993-1999.
In this research, the independent variables are: LDR, RR, ROA, ROE, PCA/PTA, IR/II, NIM,
OE/OR, CAR. On the other hand, the dependent variables are: code 0 = bankrupt, code 1 =
survive. Base on the fact that 13 banks out of 36 banks bankrupt. Stratified random sampling
method is used to determine the samples. Data gathered mostly from library and IDX. This
research use secondary data: annual reports, prospectuses, books, magazines, journals, and
internet. Discriminate analysis with stepwise method is used to test the alternative hypothesis
by using SPSS version 10.
IV. Results and Discussions
1. Stepwise Statistics
The bankruptcy or the survival of the bank is influenced by NIM and PCA/PTA as
indicated by higher exact F.
2. Summary of Canonical Discriminate Functions
- From the Eigenvalues table, the canonical correlation is 0.563 and if it is squared, it
will be 0.0312. It means that 31.2% variance from bankruptcy can be explained by the
discriminate model by only two dependent variables which are: NIM and PCA/PTA.
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-
From the Wilk’s Lambda table, the chi-square value is 12.555 and the sig. value is
0.002. it indicates that there is a significant difference within the two groups
(bankrupt and survive) in the model. Therefore, the bankruptcy variables significantly
differ with the survival variables.
-
From the Stucture Matrix table, variable NIM discriminates the most bank bankruptcy
or survival, and the second variable is PCA/PTA.
-
From the Discriminate Model Interpretation table, NIM and PCA/PTA have higher
value than others.
-
From the Classification table, in a cross validation table, the number of banks which
experienced bankrupt is 11 banks and survived 2 banks. In reality, the banks
experienced bankrupt are 13 banks. Therefore the prediction model accuracy is about
75%, means that the discriminate model above can be used in discriminate analysis
and also valid to use.
V. Conclusions
The conclusion of this thesis is as follows:
1. The bankruptcy variables significantly differ with the survival variables.
2. Variables NIM (Net Interest margin) and PCA/PTA (Productive Current
Asset/Productive) discriminates the most in the banks bankruptcy or survival.
3. Based on above, the 7 variables from 9 variables do not differ whether the banks bankrupt
or survive. The variables are: Loan to Deposit Ratio (LDR), Reserve Requirement (RR),
Return on Asset (ROA), Return on Equity (ROE), Interest Revenue in
Completion/Interest Income (IR/II), Operational Expense/Operational Revenue (OE/OR),
Capital Adequacy Ratio (CAR).
4. The discriminate model is valid because of high cross validation about 75%, therefore the
management could use the model to predict bankruptcy.
This study is expected to give a warning sign of bankruptcy in banking institutions,
identifying the problems and taking corrective action to prevent company from bankruptcy.
The limitations of this study is only in the banking institutions, therefore it is recommended
to do research in broaden scope with many financial ratios taken into accounts and also
longer timelines.
VI. References
Azahari, Azril. Bentuk dan Gaya Penulisan Karya Tulis Ilmiah. Jakarta: Penerbit Universitas
Trisakti, 1996.
Casserly, and Gibb. Banking Asia: The End of Entitlement. Singapore: John Wiley & Sons,
1999.
Damodaran, Aswath. Investment Valuation: Tools and Techniques for Determining the Value
of Any Assets. Canada: John Wiley & Sons, 1996.
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De Lucia, R. Damien, and Peters, J. Commercial Management: Functions and Objectives. 3rd
ed. New South Wales: Serendip Publications, 1993.
Emory, C. William., and Donald R. Cooper. Business Research Methods. 5th ed. Illinois:
Irwin, 1995.
Epstein, David G. Debtor-Creditor law in a Nutshell. 2nd ed. St. Paul: West, 1988.
Irmayanto, Juli., et.al. Bank dan Lembaga Keuangan Lainnya. Jakarta: Penerbit Universitas
Trisakti, 1999.
Kohn, Meir. Money, Banking and Financial Markets. 2nd ed. Fort Worth: the Dryden Press
and Harcourt Brace Jovanovich College Publishers, 1993.
Rose, Peter S. Commercial Bank Management. 4th ed. Singapore: Mc Graw-Hill, 1999.
Supriyanto, Eko B. “Efek Samping Kawin Paksa”. Infobank, vol. 12, no. 247, March 2000,
12-16.
White, Michelle J. “The Corporate Bankruptcy Decision”, Journal of Economic Perspectives
3 (2) 1989: 129-151.
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VII. Appendices
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