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Company-accounts-based Modelling of Business Failures
(96k)
(Issue 15, December 2003)

Default by companies on their debt poses a risk to financial stability. To monitor the threat it is important to identify the companies with significant amounts of debt that have the highest probabilities of failing and consequently defaulting. This article discusses a company-accounts-based approach to modelling corporate failure with the aim of highlighting such companies. It finds that information on profitability, interest cover, capital gearing, liquidity, company size, industry, whether a company is a subsidiary and overall economic conditions can all help to explain which companies fail. This paper also illustrates how firm-level probabilities of failure from the model can be used to construct aggregate measures of financial risk and to monitor the distribution underlying those aggregate estimates.

Predicting Default Among UK Companies: a Merton Approach
(105k)
(Issue 14, June 2003)

One of the key risks to financial stability is widespread default by UK companies. This article discusses an approach to quantifying the risk of default in individual companies using up-to-date market-based information. It finds that this Merton approach provides a reliable, ordinal, ranking of companies on the basis of their likelihood of going into liquidation. This is likely to prove to be a useful tool in regular surveillance.

Key Resources

Memorandum of Understanding between HM Treasury, the Bank of England and the Financial Services Authority Download PDF (50k)