Emerging Market Bank Ratings 1997: Rating good and bad banks

Suddenly, the world is awash with banks that most investors and counterparties have never heard of. Hailing from emerging markets, these banks could be tomorrow's global players or they could be future BCCIs. Evaluating them is a nightmare. Data quality is poor, accounting practices vary between countries and many new banks do not have international credit ratings. What can investors and potential counterparties do to avoid disaster?

The answer is the Euromoneyemerging market bank (Emba) rating, which is a key starting point for deeper analysis of emerging market banks. Using a specially devised mathematical formula, the rating gives a snapshot guide to good and bad banks. The result is a unique rating of more than 450 banks according to their creditworthiness. More than half these banks have no international ratings and the Euromoneysurvey is their first exposure in this area.

To help counterparties interpret the rating, banks are assigned a EuromoneyEmba rating class from triple alpha (*** - the highest, through ** and *), followed by middle-range betas (ßßß,ßß,ß) and lower-range gammas (***,** and *).

The results are fascinating, with a host of previously unrated banks that are little known internationally rising to the top of the top 50 overall and of the country lists. At the same time some well-known names whose loan portfolios and returns on assets are not everything they should be, sink to the bottom.

The formula used in the calculations was put together by Deutsche Morgan Grenfell in London using five financial ratios together with measures of local inflation, a bank's disclosure and its operating environment. The financial ratios are: net loans to total assets, non-performing loans to gross loans, return on average assets, overhead cost to net income, deposits to net loans. The first two were taken as measures of asset quality. Return on average assets was used as the profitability gauge. Cost/income provided a way of highlighting banks with high costs and deposits/loans as a measure of funding quality.

Inflation was factored in using the IMF'S 1996 consumer price index figures. A measure of disclosure was constructed on the basis of the number of financial ratios obtained out of a list of 12. The operating environment was allowed for by using Euromoney's country risk ratings. Although the survey aimed to ignore sovereign risk, an element of country risk was included to acccount for financial system strength, quality of regulation and the economic outlook in a bank's home country.

To calibrate the model, it was applied to 228 banks in 40 emerging markets, all of which had a Moody's bank financial strength rating and total assets in excess of $1 billion. Moody's financial strength ratings were chosen as they resemble what the Euromoneysurvey was trying to achieve. According to the agency, they "represent Moody's opinion of a bank's intrinsic safety and soundness and, as such, exclude certain external credit risks and credit support elements that are addressed by Moody's traditional debt and deposit ratings". In other words, they do not take account of whether the government or the bank's shareholders would intervene to save it or, conversely, the likelihood that a sovereign might prevent a bank meeting foreign currency obligations during a crisis. This is also the case with the Euromoneysurvey.

Using a multiple regression model, the formula was tested to discover how well it correlated with Moody's financial strength ratings, and to discover which variables had the most and least explanatory power. Other variables were inserted to see how they affected the outcome.

A number of variables were tried out that made sense from a financial analysis perspective but did not produce good statistical results. These included loan asset growth (adjusted for GDP growth), return on average equity, non-interest income to total income, profit before loan losses to average total assets, risk-weighted asset ratios (tier 1 and total capital ratio), equity to total assets, reliance on wholesale funding, domestic market share, and absolute size of equity. The "failure" of these ratios in the model does not mean they are insignificant on a stand-alone basis. It just means they are highly correlated with the main eight ratios and have no further impact.

After experiment and fine-tuning, the model gave a 63% correlation with Moody's financial strength ratings (see methodology). With the model performing well, it was applied to banks without Moody's financial strength ratings, allowing predictions of likely Moody's financial strength ratings. This is shown in the tables in the second column from the right. For further comparison other ratings are also given where available: Standard & Poor's long-term, Moody's long-term and IBCA individual. The Euromoneyrating is in the far-right column.

Finally the rankings were put before analysts to get their reactions. A list of banks faring very differently from analysts' expectations were reinvestigated to explain the differences. In most cases, they were due to old data or to declared data that was inaccurate and did not reflect the current situation. One flaw in the model was that if a bank was the only one in a country to declare non-performing loans, it could be penalized whereas its peers would receive the universe average. These problems were rectified either by finding more current data, by reworking the calculations to account for statistical anomalies, or, in a few cases, by removing banks from the list.

The final list shows clear winners and losers. The banks coming top are the private-sector firms that have established lucrative niches in fast-growing and liberalizing markets. Often new and relatively small, these are the banks serving the rising corporations in emerging countries. As these companies have exploited the opportunities around them, so their bankers have shared in their success.

In the private and retail sectors, these banks are the institutions most likely to count among their customers high-net-worth individuals and the new middle class. This clientele's loyalty has been gained by investing in technology and an efficient service.

The winning banks are unburdened by bad loans from past crises and the policy loans made by the state-owned banks. The survey does not look at management quality, but a pattern emerges among the best performers of an aggressive style in terms of expansion, alongside conservative provisioning. These banks are also ahead of the game in moving overseas and establishing a global presence.

The best banks are both commercial and investment banks. Investment banks do better in the survey than they would if rated by a conventional agency. Agencies mark down the fee and trading income vis-à-vis lending margins because of its volatile nature. Our survey makes no such distinction and is more in tune with the corporate trend away from bank loans towards capital markets.

Many of the best banks are run by new entrepreneurs who have spotted the changed demand in their countries' financial sectors, though some are older banks that have made successful transformations.

They make a stark contrast with the poor performers in the survey - the older, larger, state-owned banks. Weighed down with non-performing loans made for political reasons, these dinosaurs would be better regarded by a standard rating system because of their size and closeness to government. They are considered too big and too much part of the establishment to be allowed to fail. But judging them purely by financial ratios casts them in a harsher light and sends them tumbling down the lists. "They are plagued by non-performing loans, huge operating expenses, inefficient management and a lack of infrastructure while the foreign and private banks perform well on all the above counts," says one analyst.

One class of banks falling between these extremes is the big, solid commercial banks with strong franchises, wide deposit bases and capital strength. Some are private, some state-owned and others a mixture of the two, but in all cases they are mainstream institutions with a central role in the economy. Rating agencies give them high marks because again they are seen as too big to fail. The Euromoneysurvey gives no credence to size and franchise - factors that are a result of history more than present efforts - and instead judges all banks on the basis of their return on assets and the quality of those assets. Often these mainstream institutions do badly by these criteria. The Euromoneysurvey takes no account of capital strength because its use in the formula threw the results out of line.

This is probably because of the difficulty of comparing capital ratios. "Capital ratios are not directly comparable between emerging markets because of variations in the definition of equity, the effect of inflation and, above all, the impact of different valuation methods applied to some assets, which also often distorts profits," says DMG's head of European bank credit research, Simon Adamson.

While some bank analysts were taken aback by this omission, Tony Chan of Thomson BankWatch's Kuala Lumpur office points out that Finance One, which has run into trouble in the current Thai crisis, had a double-digit capital adequacy ratio. "Unlike developed markets with strict banking regulations, it would not be wise to place too much reliance on capital ratios in emerging markets," says Chan. "Due to lax requirements on non-performing loan (NPL) classification and provision for loan losses, a number of Thai financial institutions have stated capital ratios that are high in international comparisons."

Poor-quality information is the drawback of a number-crunching approach to credit scoring as taken in this survey. Lack of disclosure is partly offset by the disclosure measure penalizing banks that don't release standard information. But a worse problem is varying rules between countries on how accounts should be presented. In some countries, for example, a loan is classified as non-performing only when it has not been serviced for a year. This means problems in an individual bank or across a sector may not show up for some time.

"In a model such as this, where banks don't have conservative accounting practices or where financial disclosure is poor, banks tend to come out too highly, especially if operating conditions are worsening rapidly," says Adamson of DMG. This is currently the case in Thailand where the banks all receive ratings of either ßßß or ßß. Siam City Bank and Thai Military Bank, which come second and third in the Thailand list, are two banks that would be lower if the data were completely up to date and accurate.

Another health warning is the survey's concentration on one point in time. "The survey looks at only the snapshot picture of a financial institution," says Daniel Yoo, of Dongbang Peregrine Securities in Seoul. "In looking at the current status of a financial institution, the rating method seems extremely accurate. The model finds fundamentally sound companies with high profitability, productivity and sound asset quality.

"However, the model seems to have the following weaknesses: first, it cannot take account of market environment changes and how they will affect the companies in future; second, it does not look at riskiness of assets. This means banks of smaller asset size with high levels of risky assets might have strong returns in the short term, but things could change drastically."

Changing market and business patterns are areas where an analyst's market and institutional knowledge can never be substituted by a numbers game. Euromoneynever believed its credit scoring system would put analysts out of business. What it does provide is an unprejudiced look at emerging market banks, devoid of the disadvantages they suffer at the hands of the major rating agencies. A bank and its counterparties can get a good idea of how it would fare without assumptions on sovereign support and franchise.

The agencies themselves are responding to the situation by breaking sovereign ceilings in dollarized economies (in the case of Standard & Poor's) and by promoting financial strength and individual ratings (Moody's and IBCA). Banks and their regulators must push things forward from their side by harmonizing accounting practices and improving disclosure. Typically, these legal and accounting issues lag woefully behind economic developments such as the onset of global markets.

Taiwanese banks do extremely well in the Euromoney'semerging market bank (Emba) rating survey, Pakistani banks do badly. And some countries throw up interesting winners such as Banco Mercantil de Sao Paulo in Brazil and MashreqBank of the United Arab Emirates. These two banks are among five gaining a triple alpha (***) rating, the highest under the Euromoneyclassification system.

These individual results confirm the trend that smaller, private-sector banks perform best and larger, state-owned banks perform poorly. The number-one bank overall is Taiwan's Shanghai Commercial & Savings Bank (SCSB), which is a little different from its successful compatriots. SCSB is unusual in being an older Taiwanese bank whereas most of the island's dynamic banks are new. Unlike most older Taiwanese banks, SCSB is privately held. In a sense it has the best of both worlds - a loan and deposit base about twice the size of a typical new bank, giving it favourable funding costs, together with the cleaner loan portfolio and higher returns on assets associated with the start-ups.

"In 1996, SCSB had a return on assets of 2.34% far exceeding the average 0.59% of overall domestic banks in Taiwan. SCSB's outstanding return on assets is the key reason for its number one ranking in the survey," says Sherry Lin, an analyst with ING Barings in Taipei.

Lin ascribes Taiwanese banks' good performance as a whole to the strong regulation of the local banking system by the Central Bank of China, particularly the required reserve ratio on deposits - 8.4% of time deposits and 20% of demand deposits. These regulations help to manage loan growth and affect three variables used in the model - net loans to total assets, deposits to net loans and non-performing loans to gross loans. They assist the 37 Taiwanese banks in the survey to gain ratings between *** and * in all but three cases - Chinfon Commercial Bank, Baodao Commercial Bank and Overseas Chinese Bank - which gained ßßß status.

But the rigour of the Taiwanese financial system cannot be the only reason for the success of the territory's banks. A closer look at the successful Taiwanese banks shows some things in common. Many are new banks - Bank SinoPac which comes second overall, E Sun Bank which comes 28th, and highly rated Taishin International Bank, were all set up in 1992 following a change in local banking laws. They are privately owned - Taishin by a leading Taiwanese conglomerate, the Shinkong group; Bank SinoPac by a wide range of shareholders including companies controlled by Taiwan's ruling Kuomintang party; E Sun by a group of banking veterans.

They have high-quality assets with few non-performing loans. "SinoPac is known to the market as the bank with the best asset quality," says ING Barings' Lin. "Its non-performing loan (NPL) ratio has been kept below 1% whereas the average ratio for all 16 new banks in 1996 was 3.1%. The low NPL ratio is the result of the banks' aggressive approach in writing off doubtful accounts." E Sun and Taishin also have low NPLs of 1.75% and 2.21% respectively.

Other features of these top-performing Taiwanese banks are their high degree of automation, their success in carving out market niches and their high-quality management. Taishin is stong in credit cards and mortgages and is characterized by its aggressive style. E Sun is strong in the small and medium-sized business sector. The bank is noted for its quality of service and efficiency and has invested heavily in computer systems, giving it low overhead costs: salaries make up 7% of total revenues, well below the Taiwan banking average of 9%. SinoPac's management team is mostly ex-Citibank and its systems are based on those of the US giant. This has enabled it to grow rapidly without getting into trouble.

"Although as a new institution SinoPac has grown very rapidly, its asset quality appears to be very high," says a Capital Intelligence report released earlier this year. "Overall asset growth moderated to 39% in 1995, and for the first time the net loan portfolio expanded more slowly than the bank as a whole, increasing by 34.1% to form 72% of total assets at year-end." The bank aims to become a leading bank for Asia-Pacific and recently acquired the Far East National Bank in the US, making it the first of Taiwan's new banks to expand overseas.

Brazil's Banco Mercantil de Sao Paulo is generally regarded as a medium-ranking bank, but with assets of $5.3 billion it is only a fraction the size of the country's private-sector giants - Banco Bradesco, which is seven times bigger, Banco Itau nearly six times and Unibanco five times. Banco Mercantil was founded in 1938 and targets medium and large blue-chip corporates and high-net-worth individuals. The bank owns a brokerage, a leasing company, two insurance companies and an investment bank, Banco Finasa de Investimento, which has a number of foreign shareholders. Based in Sao Paulo and traded on the stock exchange, the bank is majority controlled by the Vidigal family which holds senior management positions and is noted for its prudent and conservative approach to banking.

"We regard it as one of Brazil's strongest banks," says John Works, a vice-president with JP Morgan Securities in New York.

Banco Mercantil is viewed as a safe haven during troubled periods in Brazil. An IBCA report says that "during 1995 the interbank markets remained turbulent as several banks experienced problems. Given its sound reputation [Banco Mercantil] benefited from this nervousness and its time deposits saw considerable growth". Despite its risk-averse strategy, the bank's returns are among the highest in Brazil, with a return on assets of 3.4% compared with Bradesco's 2.4%, Itau's 2.1% and Unibanco's 1.2%.

Banco Mercantil is a *** bank under Euromoney's credit scoring system but would do less well if graded by a major agency. This is because if the Brazilian banking system failed it would not be the first in line to be bailed out and possibly because the management is not so well versed in marketing rhetoric as some notable rivals. Making a glitzy presentation to a western agency is such an important part of the rating process that some banks hire advisers to tell them how best to do it.

Says the IBCA report: "Were [Banco Mercantil] to run into difficulties, support is likely to be provided by the authorities wishing to maintain confidence in Brazil's banking system. Although likely, such support cannot, however, be considered certain."

The analysts' favourite Brazilian bank is Itau which only does moderately well in the Euromoneysurvey - 18 in the Brazilian country list out of 52 banks. It just misses a single * rating. "Itau comes out rather poorly [in the survey]. It deserves to be number one or number two," says JP Morgan's Works. "One of the reasons is capital, which the Euromoneysurvey doesn't include. Itau's capital is superb relative to most other banks in the Brazilian system. Other reasons are qualitative - for example, how good is the management? Itau's is outstanding and most impressive. The bank has an aggressive strategy while still being conservative with its balance sheet. Its track record is good and it is very well diversified." JP Morgan Securities assigns Itau a domestic credit rating of A1 which along with Bradesco's is the highest in its entire Latin American coverage.

However, a look at the numbers explains the survey results. Capital is not counted and Itau is well capitalized with a 20.9% BIS ratio, but Banco Mercantil's is even better at 29.4% so this amendment would not change the banks' relative positions. More revealing is the figure for NPLs to gross loans which in Banco Itau's case is a high 4.7%, although it is well covered with reserves to past-due loans of 187%, using JP Morgan's figures. Equivalent figures for Bradesco are 2.8% and 162% and for Unibanco 1.8% and 331%. Banco Mercantil's NPL figure is also high at 4.2% with 73% coverage.

In fact, the NPL figure used in the Euromoneysurvey, which was taken from IBCA's BankScope, is considerably lower and may not reflect a deterioration in asset quality that could put Banco Mercantil further down in a subsequent survey. But there is no denying that Itau's own NPL figure is rather high and Mercantil's return on assets is superb. On the basis of the statistics Mercantil deserves its top position.

The idea that government-linked banks are better bets in a crisis and deserve higher ratings is challenged by MashreqBank of the United Arab Emirates (UAE). As the only wholly private bank in the UAE, MashreqBank tends to be marked down by the agencies in favour of mainstream institutions, such as National Bank of Abu Dhabi and National Bank of Dubai. In the Euromoneysurvey the positions are reversed, with MashreqBank coming highest of eight banks in the UAE, National Bank of Abu Dhabi coming fifth and National Bank of Dubai last.

The reality is that MashreqBank was the only bank to survive the mid-1980s recession in the UAE without government help. It stayed liquid throughout the 1990/91 Gulf crisis when money was withdrawn from the regional banking system. Throughout the bank's 30-year history, it has never required external support. The bank is majority owned by the Al-Ghurair family, with family members occupying top management positions.

"As MashreqBank is the only private bank in the UAE, some agencies think it's at a disadvantage because of lack of government support," says Andrew Beikos, an analyst with Cyprus-based Capital Intelligence. "But this is the only bank in the UAE that didn't require external help when the whole sector was in crisis. There are many banks in the market which don't have such a good track record as MashreqBank but they rate higher because they are in government hands." In a June report, Capital Intelligence assigned MashreqBank a short-term A-1 rating and long-term A.

MashreqBank's characteristics are similar to those of other banks performing well in the Euromoneysurvey - it's more aggressive in risk-taking than its peers while maintaining the quality of the loan book; it is highly automated and innovative having introduced credit cards and the electronic funds point-of-sale system to the UAE; it has an expansive strategy with a network of overseas offices. According to a Capital Intelligence report, the bank plans to diversify into investment banking with the setting up of an official stock exchange in the UAE. MashreqBank's return on assets is 2.4% compared with 1.2% for National Bank of Abu Dhabi and 1.6% for National Bank of Dubai.

But in common with most other banks in the UAE, MashreqBank falls short on financial disclosure and does not provide NPL figures. Capital Intelligence reports that "at least 70% of classified assets pertain to the pre-1985 era when recessionary conditions forced many companies out of business. These loans are almost fully provided and recoveries are being actively pursued." The agency goes on to say the annual provision charge of 1.94% of net loans is "considered fairly high by UAE standards, but essentially reflects a higher appetite for risk-taking than government-owned banks. The bank states that its provisioning policies are conservative and are aimed at building a comfortable cushion to withstand any future adversities."

Other banks performing well in the survey include Al-Rajhi Banking & Investment Corporation which comes number one in Saudi Arabia. Al-Rajhi has the advantage of being the only Islamic bank in Saudi Arabia, which is about the strongest niche a bank could have. On this basis Al-Rajhi amasses most of the Islamic deposits in Saudi Arabia, giving it low-cost funding which it channels into productive assets.

Then there is Crédit du Maroc which comes top in Morocco. Crédit du Maroc might get marked down by a rating agency because a major shareholder is France's troubled Crédit Lyonnais, which may not support the bank in a crisis. Yet analysts describe Crédit du Maroc as "a good, solid, little bank with a clean portfolio, well provided against". It is independently managed. In the Euromoneysurvey, having either strong or weak parents does not affect the result and so Crédit du Maroc is not constrained by its French connections.

Investment banks are also at an advantage in the survey because a standard rating approach would be to mark them down for earnings volatility. Bahrain's Investcorp Bank is an example of an investment bank that did well in the survey, coming third among Bahraini banks. One analyst describes it "as the best investment bank in the world".

The banks performing worst of all are state-owned banks and recently privatized banks still carrying the baggage of state ownership in the form of non-performing assets. These have not yet reaped the rewards of their new-found freedom. Pakistani banks provide the clearest illustration of this trend.

Five large banks dominate Pakistani banking, capturing a 72% share of total deposits, with foreign and new private banks catching up but still a long way behind, even though their greater efficiency has attracted many customers away from the monoliths. Of the five giants, three are state-owned - National Bank of Pakistan (NBP), Habib Bank and United Bank - and two were privatized in the 1990s - Muslim Commercial Bank and Allied Bank of Pakistan (ABP).

All do badly in the survey, coming in the bottom 30 of the full overall list (which is not included in the following tables) with Habib third from last and United at the very bottom. (Separating these two laggards is Brazil's Banerj, the state bank of Rio de Janeiro, which was bought by Itau in June and so should be on the road to improvement.)

The reasons for the malaise among Pakistan's big banks are not hard to find. Says Abbas Anjarwala, an analyst with brokerage Jahangir Siddiqui in Karachi: "The five large commercial banks, with some exceptions in the case of Muslim Commercial Bank, are plagued by non-performing loans, huge operating expenses, inefficient management and lack of infrastructure while the foreign and new private commercial banks have performed well on all of the above counts."

Although rating agencies may give credit for state ownership, bank customers frequently do not. "The general public's confidence in the larger banks has deteriorated considerably, despite implicit government guarantee, as the precarious condition of the larger banks has been highly publicized in the press," says Anjarwala.

Attempts to privatize United Bank have so far ended in failure. Saudi Basharahill Group bid for 25% in February 1996 but the government cancelled the sale. Meanwhile, the bank stumbles on, losing a 5% share of total deposits over a four-year period to 1996 and seeing its return on assets fall from a meagre 0.16% to a worse minus 1.25%. The Euromoneysurvey, using 1995 figures in the case of United Bank, caught the bank at minus 0.58% and so fails to reflect its full plight.

The condition of Pakistan's banking sector is extreme even by the standards of the worst emerging markets. Commercial banks there are not required to release figures for NPLs or provisions so analysts can only guess as to their true state.

"We believe that the precarious asset quality of these banks is largely attributable to politically motivated loans to favoured groups having no intention to pay back the granted loans whatsoever," says Anjarwala. Jahangir Siddiqui estimates that the NPLs of the big five banks reached Rs123 billion ($3.1 billion) at the end of 1996, which is 22.5% of advances.

As for capital adequacy, in a departure from global standards Pakistani banks calculate it through the liability side (capital-to-deposit ratio) which clouds the picture. Despite this it is clear that Pakistani banks are undercapitalized, with capital-to-deposit ratios for the big five falling from 3.8% to 2.5% between 1992 and 1996 while the 1996 figure for foreign banks stood at 9.3% and for new private banks 13%.

The Euromoneycredit rating survey is a snapshot of a bank's condition. It does not take account of rapidly changing market and business patterns. In South Korea, where the financial crisis is worsening daily, there are examples of banks whose fortunes may turn out differently from the survey's conclusions. (It is worth noting, though, that Korea First Bank, which is already in difficulties, comes bottom of the country list.)

Daniel Yoo, of Dongbang Peregrine Securities in Seoul pinpoints Asian Banking Corporation, the number-one Korean bank in the survey and third placed overall with a *** rating, as a bank whose fortunes may not be as rosy as they first seem. He cites Housing & Commercial Bank as a bank that could fare better than most of its peers in the current climate. In the survey Housing & Commercial Bank's predicted Moody's financial strength rating is three notches lower than its real rating - an unusually high variation (see methodology).

Asian Banking Corporation is a typical survey winner - a niche player focusing on short-term financing, leasing and offshore lending and investment. A well-managed and flexible bank, it has reaped high returns and experienced low levels of non-performing assets.

But, says Yoo, the future seems gloomy. "The leasing business is expected to decline sharply as corporates plan to reduce capital expenditure due to the economic downturn. Dependency on leasing for funding is in any case declining and margins will be squeezed," he says. "Short-term financing will disappear as Korea becomes a more liberalized market. Offshore investment could be extremely risky as the value of East Asian assets drops sharply."

By contrast Housing & Commercial Bank is a typical poor performer in the survey. The bank is state-owned with low return on assets, high costs and poor productivity. However, it is about to be privatized and should improve its performance. The bank's loan book is 80% mortgages and, since the Korean financial crisis has not yet resulted in falling values in the retail property sector and there is considerable demand, Housing & Commercial could be one of the few banks to survive the malaise relatively free from bad debts.

Methodology

The Euromoneyformula for calculating its emerging market bank (Emba) credit rating uses eight variables. These are: net loans to total assets, non-performing loans to gross loans, return on average assets, overhead costs to net income, deposits to net loans, inflation, disclosure and operating environment. The data for these financial ratios was taken from BankScope, a product of the rating agency IBCA. Our thanks to IBCA for letting us use the data. The data was a mixture of 1995 and 1996 figures and a "1" in the left-hand column of the country tables (second from left in the top 50) shows that 1996 data was used. The financial and rating information used was the latest available on July 28 1997.

The model was tested for its correlation with Moody's financial strength ratings on a sample of 224 banks from 40 emerging markets, all of which had a Moody's bank financial strength rating and total assets in excess of $1 billion. By using a multiple regression model, it was possible to test the formula to discover how well it correlated with Moody's financial strength ratings, to find which variables had the most and the least explanatory power and to insert other variables to see how this affected the outcome (see main story). It was discovered that return on average assets and country risk had the most explanatory power of all the variables.

The raw values of the different explanatory variables were replaced by their decile rankings in the total group of banks to give consistent numerical scores. These were compared with Moody's financial strength ratings by turning the ratings into figures using the following scale: A = 1, B+ = 2, B = 3, C+ = 4, C = 5, D+ = 6, D = 7, E+ = 8 and E = 9. The model gave a 63% correlation with Moody's financial strength ratings. In only two cases in the original sample was the variation between the model's results and Moody's ratings as high as three notches, eg, D to C+ or C to E+. In 26 cases the variation was two notches and for the remaining 196 the variation was either one notch or the result was the same. The model was then applied to a broader sample of banks, many without Moody's financial strength ratings. The results were ordered numerically and then converted into a Euromoneyrating using the Greek letters alpha, beta, gamma. Banks with scores in the range 4.500 to 4.699 (a low score denotes a high predicted rating) were ***, followed by ** for the next 0.200, and so on using *, ßßß, ßß, ß, ***, **, *.

Banks from countries that do not have data on inflation or political risk were eliminated as were banks where too few ratios are available, for example in Russia. If only some ratios are unavailable for a particular bank, that bank is assigned the average decile value for the entire universe for those ratios.

The original list of 642 banks was pared back by taking out branches and most wholly owned subsidiaries of foreign banks, but leaving in banks with foreign shareholders where it was considered that the bank was essentially a domestic institution. With the recent wave of Latin American acquisitions in mind, it was decided to leave in banks that, arguably, remain domestic institutions for the time being even though they are 100% foreign owned, such as Argentina's Banco Roberts and Brazil's Bamerindus, both 100% owned by HSBC.

Even with the surprisingly good results, the model should be used with caution* and can never be more than a first step in a fundamental credit analysis. Further company-specific analysis, also including more subjective factors, should definitely be taken into account. However, the model is useful in giving a first impression of the global relative financial strength of a bank based on important financial variables. The model was devised by Deutsche Morgan Grenfell's credit research department in London.

* Euromoney's Emba ratings are statements of opinions not statements of fact and the company does not have any liability for any loss or damage arising from actions or decisions taken using the information.

Click on the following links for the top-rated banks by country:

Letters A-C 

Letters C-I 

Letters I-L 

Letters M-P 

Letters R-V