Credit-risk evaluation of a

Tunisian commercial bank

Logistic regression vs. neural network modelling
Group 4
Rahul Gaikwad (4022/20)
Sahil Mehta (4043/20)
Shaurya Varma (4046/20)
Source: Credit-risk Evaluation Of A Tunisian Commercial Bank:
Logistic Regression vs Neural Network Modelling, Hamadi Matoussi,
University of Manouba, Tunisia (2010); IIMC library portal (Hyperlink)
The Case
Short term loans to Tunisian companies
Database of 1434 files of credits in 2003, 2004, 2005, and 2006
Results
Best prediction model is the multi-layered NN model
Classification rate: 97% (training) and 89.8% (validation)
Bank could have reduced the percentage of loss from 18.7% to 12% in 2007


Introduction
Basel Committee on Banking Supervision (June 2004)
Banking institutions allowed to use their own internal measures for key
drivers of credit risk as primary inputs to their minimum regulatory capital
requirement
Choice of two broad methodologies
External mapping
Internal rating
Traditional statistical methods (eg. Logistic regression)
Non-parametric statistical methods (k-nearest neighbour, classification trees)
Neural networks

Neural Networks
Structural vs. Empirical modelling
Structural: Default is endogenous, and related to the capital structure. Default occurs when
the asset value of the firm falls below a critical level.
Empirical: Instead of modelling the relationship of default with the characteristics of the firm,
this relationship is learned from the data.
Linear (Z-Score, O-Score)
Non-linear (Neural networks)
Advantages
Ability to model complex relationships
Benchmarking alternatives
Speeding up the decision
Architecture: Multilayer Feed-forward NN
Dataset: Financial and non-financial data (financial ratios, firm size, industry)


Sample and Data (1/3)
Training Data
Consists of a number of cases
containing a range of input
and output data
Variables :
Indicators of
Default Risk

Subject :
Borrowers
Statistical Methods
Artificial Neural Network
based methods in our
case
Default Risk
Levels
In the case, we would use data collected from a large
private commercial bank (BIAT) based in Tunisia
The data wasnt taken from a public sector bank to avoid
potential inefficiencies of a public bank
Although the data has been classified by BIAT into five
risk classes, we will divide the final output into two
classes only healthy and risky
Sample and Data (2/3)
Dependent Variable Composition
Sample and Data (3/3)
Independent Variable Composition
We have considered 24 indicators in all 22 financial indicators and 2 non-
financial indicators
Financial ratios analysis groups the ratios into different categories, such as
liquidity, operational, leverage and profitability, that tell us about different facets
of a companys finance and operations
Besides the commonly used financial ratios, two non-financial indicators, namely
collateral and firm size, have also been considered as independent variables
Empirical Model
In order to test the prediction capacity of model we split our sample
of the bank credit files into two sub samples.
The first sub-sample is composed of 924 files of short term loan
granted to 231 industrial Tunisian companies in 2003 and 2004,2005
and 2006.
The data of this sub-sample are used as a training set (the insample
set) to construct the prediction models.
The second one is composed of 510 files and is used for validation
(the out-of sample set).
Out of Sample Validation
Out-of-sample validation will be done on the second subsample,
which contains data on 510 files of short term loan granted to
Tunisian companies in 2003, 2004, 2005 and 2006.
Out of sample validation provides a way to assess the practical
applicability of the model.
The NN model was performing better than statistical regression
models.
Appendix Independent Variable Set
Appendix Independent Variable Set
Thank You