By Austen Saunders and Matthew Willison
Banks come in different shapes and sizes. Do prudential regulations that work well for big banks work as well for small ones? To help us find out, we measure the effectiveness of some key regulatory ratios as predictors of bank failure. We do so using ‘receiver operating characteristic’ – or ‘ROC’ – analysis of simple threshold rules. When we do this, we find that we can use the ratios we test to make better predictions for large banks than for small ones. This provides evidence that an efficient set of regulations for large banks might not be as efficient for small ones.