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where x x
1
; x
2
; . . . ; x
n
is the vector of decision
attributes (nancial ratios), w
1
; w
2
; . . . ; w
n
are
attributes weights dened such that w
i
50 and
P
i
w
i
1, and v
1
; v
2
; . . . ; v
n
are the attributes
marginal value functions normalized in [0, 1].
Each marginal value function, v
i
, is used to assess
the partial performance of each bank in attribute
x
i
in an increasing 01 scale.
Given the global values of the banks as dened
by the estimated additive value function, their
classication into q groups C
1
; C
2
; . . . ; C
q
can be
performed in a straightforward way through the
introduction of q1 value cut-o points
t
1
; t
2
; . . . ; t
q1
, such that
Vx
i
5t
1
, bank i belongs to group C
1
t
2
4Vx
i
5t
1
, bank i belongs to group C
2
.
.
.
.
.
.
Vx
i
5t
q1
,bank i belongs to group C
q
The estimation of the additive value function
and the cut-o thresholds is performed through
linear programming techniques. The objective of
the method is to develop the additive value model
so that the above classication rules can reproduce
the predetermined grouping of the banks as
accurately as possible. Therefore, a linear pro-
gramming formulation is employed to minimize
Table III. List of criteria (variables)
Financial
CAP Equity/total assets
PROVIS Loan loss provisions/net interest revenue
ROAA Return on average assets
EXPENSES Cost-to-income ratio
LIQ Liquid assets/customer and short-term funding
SIZE Logarithm of total assets
Non-nancial
SUBS The number of subsidiaries
OWNERS The number of institutional shareholders
LIST Dummy variable indicating whether the bank
is listed (LIST 1) in a stock exchange or not
(LIST 0)
MARKET Dummy variable indicating whether the bank
is operating in a developed (MARKET 1) or
developing (MARKET 0) market
5
Probably, the employment of a risk-weighted ratio
such as the Tier 1 ratio would be more appropriate.
However, due to too many missing values for Tier 1, we
rely on EQAS that is considered one of the basic ratios
whose use dates back to the 1900s, and is still being used
in many recent studies in banking.
6
Cost refers to overheads that are the expenses for
running business, such as sta salaries and benets, rent
expenses, equipment expenses and other administrative
expenses.
7
These are generally short-term assets that can be easily
converted into cash, such as cash itself, deposits with the
central bank, treasury bills, other government securities
and interbank deposits among others.
A MULTICRITERIA DECISION FRAMEWORK 107
Copyright # 2007 John Wiley & Sons, Ltd. J. Multi-Crit. Decis. Anal. 14: 103111 (2006)
DOI: 10.1002/mcda
the sum of all violations of the above classication
rules for all the banks in the training sample.
Detailed description of the mathematical program-
ming formulation can be found in the works of
Zopounidis and Doumpos (1999) and Doumpos
and Zopounidis (2002).
4. EMPIRICAL RESULTS
Table IV shows descriptive statistics while distin-
guishing between the three groups of banks, as
well as between developed and developing mar-
kets. We also present the results of a Kruskal
Table IV. Descriptive statistics and KruskalWallis test (total sample): (A) Continuous variables and (B)
Categorical variables (no.)
1 2 3
Mean Std. Deviation Mean Std. Deviation Mean Std. Deviation KruskalWallis
chi-square
(A)
SIZE
Total 4.388 0.669 3.843 0.689 3.535 0.865 188.992
***
Developed 4.398 0.678 4.010 0.764 4.462 0.885 26.279
***
Developing 4.221 0.506 3.650 0.529 3.328 0.713 50.538
***
PROVIS
Total 13.664 15.556 23.103 21.500 32.198 39.085 85.516
***
Developed 13.568 15.889 25.612 22.730 52.776 55.357 61.67
***
Developing 15.172 8.877 20.190 19.691 27.612 32.936 7.58
**
CAP
Total 8.159 3.690 9.297 4.874 9.443 6.099 6.51
**
Developed 8.019 3.654 7.970 4.612 5.543 3.962 27.919
***
Developing 10.353 3.615 10.838 4.735 10.312 6.159 4.127
ROAA
Total 1.189 0.740 1.124 1.043 1.231 1.609 3.652
Developed 1.152 0.715 0.589 0.669 0.061 0.772 121.639
***
Developing 1.763 0.899 1.746 1.056 1.492 1.632 11.268
***
EXPENSES
Total 57.054 13.241 57.105 15.577 57.891 18.599 0.551
Developed 57.625 12.921 62.432 14.597 57.708 17.537 11.503
***
Developing 48.131 15.148 50.918 14.406 57.932 18.876 12.365
***
LIQ
Total 19.588 19.473 28.024 21.329 30.632 19.763 82.258
***
Developed 18.666 19.198 25.675 23.702 15.611 17.039 11.591
***
Developing 34.014 18.322 30.752 17.923 33.979 18.785 3.098
OWNERS
Total 5.711 7.255 5.171 6.074 5.537 5.690 9.226
**
Developed 5.768 7.368 5.736 7.230 5.205 6.127 2.742
Developing 4.821 5.193 4.515 4.310 5.611 5.604 2.021
SUBS
Total 91.983 195.844 32.808 85.374 17.551 68.655 114.935
***
Developed 96.572 200.980 49.574 112.187 64.359 152.735 6.737
**
Developing 20.214 33.317 13.333 22.096 7.120 8.649 14.017
***
(B)
LIST 1 2 3
Total 466 214 214
Developed 438 115 39
Developing 28 99 175
Notes:
***
Signicant at the 1% level;
**
signicant at the 5% level;
*
signicant at the 10% level; variables are dened in Table III.
C. GAGANIS ET AL. 108
Copyright # 2007 John Wiley & Sons, Ltd. J. Multi-Crit. Decis. Anal. 14: 103111 (2006)
DOI: 10.1002/mcda
Wallis test to assess the means dierences across
the groups.
SIZE, PROVIS and SUBS are the only variables
that are statistically signicant in all cases.
However, while higher size results in higher
soundness in the cases of the total sample and
the developing markets sub-sample, the results are
mixed in the case of the developed markets sub-
sample, with an average SIZE equal to 4.398
(Group 1), 4.010 (Group 2) and 4.462 (Group 3).
Lower PROVIS results in higher soundness which
can be attributed to the perception that lower
provisions correspond to lower probability of
non-performing loans and higher asset quality.
As in the case of SIZE, the impact of SUBS on
soundness depends on the status of the market.
CAP and LIQ are signicant in the case of the
total sample and in developed countries, although
not in developing countries. ROAA and EX-
PENSES on the other hand are signicant in the
case of the two sub-samples, although not in
the case of the total sample. Higher ROAA results
in higher soundness, however, the results are
mixed with respect to EXPENSES. Finally, OWN-
ERS is signicant only in the case of the total
sample.
Table V presents the average weights of the
criteria over the 10 replications. The two most
important criteria are PROVIS and CAP, with
weights equal to 20 and 19.76%, respectively.
Hence, as in previous studies (Poon et al., 1999;
Poon and Firth, 2005; Pasiouras et al., 2006) and
consistent with the univariate results, lower asset
quality (in terms of loan portfolio) results in lower
soundness. As for CAP, our nding is consistent
with the view that capital is important for banks
for several reasons. For example, capital serves as
the last line of defence against the risk of banks
insolvency, as any losses a bank suers could be
potentially written o against capital. Even in the
case that insolvency becomes unavoidable, capital
protects to some degree depositors, creditors and
investors (Le Bras and Andrews, 2004). Further-
more, as mentioned by Theodore (1999) capital
allows the leveraging of a banks growth and
diversication, and a tight solvency position would
be an obstacle to do so.
The average weight of MARKET equals
15.66% showing that the country where the
banks operate has an important impact on their
classication. In other words, we nd that operat-
ing in a developed market results in higher
soundness. EXPENSES and ROAA also carry
an average weight above 10%, indicating that
higher eciency in expenses management and
higher protability result in higher bank sound-
ness. The least important variables are SIZE and
LIST. Especially, the latter carries an average
weight equal to 0%, indicating that it makes no
dierence whether the bank is listed in a stock
exchange or not.
Table VI presents the average classication
accuracies over the 10 replications. Panel A
corresponds to the training sample and Panel B
to the validation sample. For benchmarking
purposes, two additional models are developed
through DA and ordinary logistic regression
(OLR) using the same input variables and 10-fold
cross-validation process for estimating and testing
the models.
UTADIS obtains the highest overall classica-
tion accuracy in the training sample that equals
Table V. Weights of criteria (variables) in the UTADIS
model (averages of 10 replications)
Criteria (variables) Weights (%)
PROVIS 20.00
CAP 19.76
MARKET 15.66
EXPENSES 10.31
ROAA 10.21
LIQ 9.08
OWNERS 8.79
SUBS 4.58
SIZE 1.60
LIST 0.00
Note: Variables are dened in Table III.
Table VI. Classication results (averages over 10
replications): (A) Training and (B) Validation
Group
1 (%) 2 (%) 3 (%) Overall (%)
(A)
UTADIS 84.10 53.89 74.54 70.84
OLR 92.63 24.02 73.37 63.34
DA 90.17 27.1 79.78 65.68
(B)
UTADIS 83.47 50.49 72.75 68.91
OLR 92.63 23.33 72.68 62.88
DA 90.48 26.22 78.47 65.06
Notes: UTADIS, UTilite s Additives DIScriminantes; OLR,
ordinary logistic regression; DA, discriminant analysis.
A MULTICRITERIA DECISION FRAMEWORK 109
Copyright # 2007 John Wiley & Sons, Ltd. J. Multi-Crit. Decis. Anal. 14: 103111 (2006)
DOI: 10.1002/mcda
70.84%, while the corresponding gures for DA
and OLR are 65.58 and 63.34%, respectively. All
the three models classify correctly a high propor-
tion of banks from Group 1 that ranges between
84.19% (UTADIS) and 92.63% (OLR), followed
by banks in Group 3, but only a relatively smaller
proportion of banks in Group 2 that is between
24.02% (OLR) and 53.89% (UTADIS). The poor
performance in terms of classifying banks into
intermediate groups has been observed in past
studies as well (e.g. Pasiouras et al., 2007) and can
be attributed to the fact that banks falling in this
category might be closely related either to banks in
the lower band of Group 1 or the upper band of
Group 3, hence making their correct classication
a dicult task. The results of a t-test, used to
assess the dierences in the classication accura-
cies among the methods, indicate that the accura-
cies achieved by UTADIS are signicantly
dierent from the ones obtained by DA and
OLR at the 1% level.
Turning to the accuracies in the validation data
set, the highest overall accuracy (68.91%) is again
achieved by UTADIS, with group accuracies equal
to 83.47% (Group 1), 50.49% (Group 2) and
72.75% (Group 3). OLR and DA classify correct
62.88 and 65.06% of the banks in sample (i.e.
overall). As in the case of the training sample, all
three models classify correctly a higher proportion
of banks from Groups 1 and 3, and a relatively
lower proportion of banks from Group 2. The
dierence between UTADIS and DA is now
statistically signicant at the 5% level, whereas
the one between UTADIS and OLR remains
signicant at the 1% level.
5. CONCLUSIONS
In this paper, we developed a multicriteria model,
through UTADIS, to classify banks into three
groups on the basis of their soundness. The sample
consisted of 894 banks from 79 countries. The
model was developed through a 10-fold cross-
validation procedure using six nancial and four
non-nancial variables, while the ratings of Fitch
formed the basis for assessing the soundness of
banks.
The results indicate that asset quality (as
measured by loan loss provisions), capitalization
and the market where banks operate are the most
important criteria (in terms of weights) in classify-
ing the banks. Protability and eciency in
expenses management are also important attri-
butes, whereas size and listing in a stock exchange
are the least important ones.
UTADIS classied correctly 70.84 and 68.91%
of the banks in training and validation samples
accordingly, and was more ecient than models
developed through DA and OLR for benchmark-
ing purposes. Furthermore, the dierences in the
classication accuracies achieved by UTADIS and
the ones obtained by DA and OLS were statisti-
cally signicant in both the training and the
validation samples. Finally, all the techniques
experienced diculties in classifying banks in
intermediate situation.
The present study could be extended in various
ways, such as the classication of banks into more
groups, and the inclusion of additional bank-
specic variables into the model. It would also be
worthwhile to incorporate further country-specic
variables into the analysis, reecting the regulatory
and economic environment in the markets where
banks operate. Finally, one could benchmark the
developed model against the alternative classica-
tion techniques or develop integrated models.
ACKNOWLEDGEMENTS
We would like to thank two reviewers, and
participants at the 18th International Conference
on Multiple Criteria Decision Making (2006) for
helpful comments and suggestions that helped us
improve earlier versions of the paper circulated
under the title An assessment of banks credit-
worthiness: a multicriteria approach.
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A MULTICRITERIA DECISION FRAMEWORK 111
Copyright # 2007 John Wiley & Sons, Ltd. J. Multi-Crit. Decis. Anal. 14: 103111 (2006)
DOI: 10.1002/mcda