World Economics & Finance Bulletin (WEFB)

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PREDICTING THE FINANCIAL FAILURE OF COMMERCIAL BANKS

USING THE KIDA MODEL AND SHERROD MODEL.
(AN ANALYTICAL STUDY IN A NUMBER OF IRAQI COMMERCIAL (
)BANKS)
Lecturer. Dr. Wisam Sami Jabbar Zinal
Technical Institute of Hawija
Northern Technical University
[email protected]
Article history: Abstract:
Received: 26th January 2023 The research aims to shed light on the financial failure that
Accepted: 26th February 2023 commercial banks may experience at the end of their financial decline stages
Published: 30th March 2023 as a result of their exposure to various and sequential financial risks, starting
with the risk of liquidity and ending with the risk of bankruptcy and
liquidation. Among these models are the Kida model and the Sherrod model.
The research reached a set of conclusions, the most important of which is
that all commercial banks are in the research sample listed in the Iraq Stock
Exchange, according to the models (Kida) and (Sherrod), in the case of safety
from financial failure, except for the Bank of Baghdad, the United Bank for
Investment, and the Mansour Investment Bank, which are threatened with
financial failure.
Based on the conclusions, the researcher presented a set of
recommendations that are consistent with these conclusions, the most
important of which is the need to direct financial banks to use mathematical
models to predict financial failure as a tool for early warning about the state
of the research sample bank.
Keywords: Financial failure, (Kida) model, (Sherrod) model.

INTRODUCTION: information and data about the financial position of

The banking sector is essential for economic the bank and to predict the performance of the bank
growth. In addition to the interdependence and wide during a certain period in order to assist in the
overlap between the banking sector and other sectors financial planning process of the bank, to verify the
of the economy, it has become necessary to follow all extent of the bank’s success or failure in achieving the
the fluctuations and changes that occur in the banking goals, to obtain indicators indicating whether the
sector because any failure or decline in banks and bank’s policies are sound or need to be modified, and
their activities will affect the rest of the sectors then to help in the decision-making process within the
through the repercussions and results of these bank. One of the most important and common
changes. financial analysis tools are the financial ratios, which
In view of the potential damage that may be express the mathematical relationship between two
inflicted on all sectors and entities related to the values or two or more items in the financial
banking sector, including investors, official bodies, and statements and thus allow the situation to be
lenders, the process of predicting the financial failure assessed. The financial ratios of the bank and its
of banks listed in the stock market was a very performance during a specific period were compared
important issue. The main objective of the financial by making comparisons between the financial ratios of
analysis is to provide the concerned groups with a particular bank and the financial ratios of similar

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banks. Through analyzing the financial ratios of banks, the presence of mathematical models capable of
it was able to compare the performance of the bank predicting the financial position of banks helps to draw
and its financial position and determine its attention to the surrounding dangers before they
performance trends in successive periods of time. occur, and it will benefit all participants in the financial
Among the most prominent uses of financial ratio statements of companies, including investors in the
analysis is the evaluation of the financial performance financial assets of these banks or dealers in the stock
of banks. Despite this, the financial default in banks is market, which enhances confidence in them and the
one of the problems that many try to deal with consequent decisions serve the financial sector and
cautiously because of the danger it represents to the the national economy.
banks’ business. his obligations to creditors and the Research Objectives:
fulfillment of his debts. The research aims to reach:
1. Know the concept of financial failure.
RESEARCH METHODOLOGY 2. When do commercial banks reach the stage of
Search Problem: financial failure?
Most of the depositors and investors in the 3. Measuring the degree of financial failure in
stock markets suffer from several problems, most commercial banks within the research sample
notably the abundance of fear and anxiety from 4. The possibility of applying the Kida model in
investing in the banking sector because of the risk of commercial banks
default and the inability to pay its obligations towards 5. The possibility of applying the Sherrod model to
others. Because the frequent stumbling and failure of commercial banks
listed banks leads investors to refrain from entering Research Hypotheses:
the financial markets, and this in turn leads to For the purpose of answering the research
negative effects on the banking and financial sector on questions and reaching the research objectives, the
the one hand and on the national economy on the following research hypotheses were adopted:
other, as financial markets and banks are a major 1. All commercial banks reach financial failure in the
component of the economy. last stages of their lives.
Hence, the research problem can be 2. The commercial banks and the research sample
formulated with the following question: face financial failure.
Is there an ability to predict the financial failure of the 3. The Kida model cannot be used to measure the
banks listed in the financial market to reassure degree of financial failure in commercial banks.
depositors and investors? 4.The Sherrod model cannot be used to measure the
The Importance of Research: degree of financial failure in commercial banks.
The importance of the research boils down to Research Sample:
highlighting the dangers associated with the failure of A sample of eight commercial banks listed on
banks listed in the stock markets and their impact on the Iraq Stock Exchange was selected based on a
the financial positions of depositors and investors number of standards and indicators and their financial
dealing in those markets, which in turn affects the data published in the year 2020, as shown in Table
national economy as a whole. From this point of view, No. 1.
Table No. 1: The research sample banks
No. Name of the bank Bank code Establishment of the bank

1 Iraqi Commercial Bank BCOI February 11, 1992

2 Baghdad Bank BBOB February 18, 1992

3 Iraqi Investment Bank BIBI July 13, 1993

4 United Bank for Investment BUND August 20, 1994

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5 The National Bank of Iraq BNOI March 28, 1995

6 Sumer Commercial Bank BSUC May 26, 1999

7 Ashur International Bank BASH September 22, 2005

8 Mansour Investment Bank BMNS September 13, 2005

Source: (Iraq Stock Exchange, www.isx-iq.net)

LITERATURE REVIEW financial decisions, and this is also due to its inability
First: What is the prediction of financial failure? to adapt to the laws and decisions that regulate its
The word prediction in the language has been activity. financially if it has achieved losses for three
derived from the origin of the verb news, and it means consecutive years (Seddik,2017:4).
the news, so the news is the news, the predictor is the 2. Financial insolvency: it refers to the weakness of the
informer, and prediction means news of the unseen bank's financial suitability and the bank’s inability to
and knowledge of the future. And setting the pay its obligations (Abdul Rahman,2011:32). Financial
appropriate possibilities for those events, taking into hardship takes two forms:
account the internal and external effects of the ❖ Financial insolvency (technical): It is the first
institution (Akaer & Khashan,2019:116), financial manifestation of insolvency in which the bank is
failure is one of the serious matters that financial unable to meet its due obligations even though its
activities in institutions are exposed to, and the assets exceed its obligations. This concept is usually
reasons for its occurrence are many, including internal called a liquidity crisis, as the bank faces its inability to
and external factors, whose symptoms appear in the meet its immediate cash needs for a period of time
form of liquidity imbalance and weakness. Financial starting from one day. It may continue, and in this
structure and a decrease in profitability, all of which case, it is called "temporary financial default, and in
lead to bankruptcy and liquidation this case the bank can overcome the crisis without
(Mhmood,2021:181), and financial failure is also having to reach bankruptcy by selling its assets to
defined as the inability of pedestrian revenues to cover cover its due and urgent obligations (Juma &
all costs, including the cost of financing capital, which Abd,2016:24).
leads to legal liquidation when the value of book ❖ Real financial hardship Real insolvency is the
assets becomes less From the value of book second manifestation of financial failure in which
obligations so that the company reaches bankruptcy as financial stumbling is continuous, i.e., the bank is
a result of the establishment’s inability to pay its debts unable to meet its due obligations and the value of its
(Bulut,2018:177) or the bank’s inability to continue obligations exceeds the value of its assets; in some
providing its services to customers (Duc, cases, the bank may not succeed in obtaining the
at.el.,2019:1), how much financial failure is defined as financing necessary for treatment as another solution
the inability of the bank’s revenues to cover all costs, (Juma & Abd,2016:25).
including the cost of capital, and the inability of Second: Financial Failure Stages:
management to achieve a return on invested capital The Financial Failure Process Goes Through the
commensurate with those investments Following Stages:
(Qader,2020:368)? 1. Emergence stage: There is no doubt that the
It can be clarified about the terms (financial default, company does not suddenly begin to deteriorate.
financial hardship) in financial and accounting thought Rather, there are a set of indicators that can be
as follows: addressed by the management, such as the change in
1. Financial Distress: It is represented in the situation demand for products, the continuous rise in indirect
in which the bank is exposed to a state of lack of costs, the obsolescence of production methods, the
liquidity and the accumulation of losses for a number increase in competition, the decrease in credit
of years as a result of wrong administrative and facilities, the increase in burdens, and the weakness of

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capital. Working money at this stage, the return on • Low control over working capital
assets is less than the moderate percentage of the • The continuous increase in the volume of debt
company, and it is preferable to discover the problem • Lack of control over useless activities in the
at this stage (Seddik,2017:10). institution (Shani,2020:165).
2. The financial deficit stage: This stage occurs when Third: The Causes of Financial Failure:
the administration notices a financial default and when Most of the studies that were exposed to the
the company is not able to meet its necessary cash causes of financial failure focused on the fact that they
needs. In this stage, the company's assets exceed its are due to several factors, the most important of
liabilities, but the problem is the inability to convert which are: (Al-Khayat,2014:14); (Robbins,1994:314);
the assets into cash to cover the outstanding debts. (Gup,1983:237); intense competition; and the inability
(Ross, el, at.,2002:857) of banks to cuckoo in the face of competitors.
3. The stage of financial insolvency: This stage lies in 1. The economic factors represented by the local
the company's inability to exploit its normal policy to economic conditions of the environment in which
obtain the required cash and use it to meet its due the company operates, as well as the
liabilities and achieve the required growth. It becomes international economic conditions.
unable to pay its expenses, and insolvency arises as a 2. Weak management of banks and their lack of
result of the significant decrease in the cash balance knowledge.
available to the company in order to increase liabilities, 3. The high cost of financing sources.
which means that if the company was able to convert 4. Accumulated losses.
non-cash assets into cash within a specified period, it 5. The phenomenon of globalization and its great
would be able to escape from the expected failure (Al- influence on the failure of many companies due to
Murshidi,2018:258). the dominance of giant companies on the markets
4.The stage of total failure: This stage is considered of many countries, especially developing
crucial in the life of the company, as the company countries, led to the bankruptcy of many
cannot avoid admitting failure if all attempts by the companies.
company’s management to obtain additional financing 6. The rapid technological developments and the
end, and here the total liabilities exceed the value of inability of companies to keep pace with them.
the assets, which means complete failure and Fourth: Models Used to Measure Financial
bankruptcy (Goedan,1971:348). Failure Indicators:
5. The stage of declaring or confirming bankruptcy: it 1- Model: 1980 Kida
is the last stage in which legal measures are taken to It is one of the important quantitative models
protect the rights of lenders, and thus the institution is for predicting financial failure, which Kida reached in
declared bankrupt. 1980, as the model relied on the method of multiple
declining and deteriorating profitability for consecutive discriminatory analysis to choose five financial ratios
periods. that were able to apply with an accuracy of 91%, and
• Lack of competition with imported or locally this model was represented by the following equation
manufactured products (Seddik,2017:10), (Al-Hamdani,2018:95).
• Imbalance and confusion in the capital structure and Z= 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4 + 0.271X5
the high rate of borrowing, particularly short-term
Since:
Variable variable symbol relative weight
Net profit after interest and tax/total assets X1 1.04
Shareholders' equity/total liabilities X2 0.42
Current assets/current liabilities X3 0.461
Sales/total assets X4 0.453
cash/total assets X5 0.271
Source: (Mohammed & Alsunaidi,2021:15)

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What distinguishes this model from other Z = positive; the probability of financial failure of the
models is that it relies on a different criterion to judge bank is low (the bank is successful).
the success or failure of the bank, as the bank is 2. Model: Sherrod
viewed as a failed bank if the value of Z resulting from It is considered one of the most important modern
the equation is negative, and the lower this value, the models for predicting financial failure, and the model
greater the probability of failure. Conversely, if a relies on six independent financial indicators in
positive Z value appears, the bank's probability of addition to the relative weights of the excellence
failure is weak, meaning it is among the successful function coefficients that were given to these variables
banks, and the higher this value, the lower the according to the following formula: (Arkan,2015:240).
probability of failure for it. Z = 17X1 + 9X2 + 3.5X3 + 20X4 +
And if: 1.2X5 + 0.10X6
Z = negative; the probability of financial failure of the
bank is high (the bank is failing).
Since:
variable ratio type variable symbol relative weight
Working capital/total assets liquidity X1 17
Current assets/total assets liquidity X2 9
Total equity / total assets to lift X3 3.5
Total assets/total liabilities to lift X5 1.2
Total property rights/total fixed assets to lift X6 0.10
Source: (Mohammed & Alsunaidi,2021:16)
It is noted from the above model that it focused loans if the risk ratio is weak or decline if the opposite
on three main ratios: liquidity ratios with a weight of is found, so Sherrod classified the level of project
26, profitability ratios with a weight of 20, and quality into five categories according to the degree of
financial leverage ratios with a weight of 4.8. This risk or the level of failure of the bank, through which it
means that the bulk of this model is represented in is possible to know the extent The degree of risk to
liquidity ratios and financial leverage ratios. Before which loan grantors may be exposed is shown in Table
banks in credit analysis, and thus Sherrod also sees 2.
that they fulfill the desired requirements in granting
Class The Degree of Risk and The Level of Failure Z value
The first category Unfailing (Excellent) Z ≥ 25
Category two Low probability of failure (low risk) 25 > Z ≥ 20
The third category Hard to predict failure (medium risk) 20 > Z ≥ 5
Fourth category Prone to fail (high risk) 5 > Z ≥ 5-
Fifth category Highly Fail Prone (Very High Risk) 5->Z
Source:)Arkan,2015:74(

PRACTICAL RESULTS The following is the output of the application for each
Analysis And Assessment of The Financial model:
Failure of Commercial Banks: First: Analysis of The Value of The Prediction Function
For the purpose of measuring financial failure Z According to The Kida Model for The Research
using the )Kida( and )Sherrod( models, the commercial Sample
banks in the Iraq Stock Exchange were chosen as the It is clear from Table 3 that the results of the
study sample population, and then a research financial ratios calculated according to the Kida model
comparison was made between the two models in on the data of commercial banks, the study sample
terms of the reliability and accuracy of measurement that made up the model, are as follows:
for each model on the one hand and the degree of
congruence between the two models on the other.

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Table (3) shows the results of the Kida model's financial ratios for the research sample in 2020.
No. Bank code X1 X2 X3 X4 X5
1 BCOI 0.057 0.995 1.964 0.023 0.650
2 BBOB 0.014 0.244 0.945 0.012 0.729
3 BIBI 0.008 0.866 1.816 0.029 0.626
4 BUND 0.002 0.768 0.484 0.015 0.036
5 BNOI 0.002 0.524 1.437 0.030 0.493
6 BSUC 0.003 3.743 4.249 0.012 0.752
7 BASH 0.031 1.365 2.226 0.005 0.883
8 BMNS 0.005 0.286 0.124 0.012 0.871
Source: Prepared by the researcher
Table 4: Analysis of the value of the prediction function Z according to the Kida model for the research sample for the
year 2020
The Bank's
Bank
Bank Name Kida Model Equation Z Value Position on
Code
Forecasting
(1.04*0.057(+)0.42*0.995(+
Iraqi Commercial
BCOI )0.461*1.964) +(0.463*0.023) + 2.107 Successful
Bank
(0.271*0.650)
1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BBOB Baghdad Bank 0.889 Threatening
+ 0.271X5
Iraqi Investment 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BIBI 1.472 Successful
Bank + 0.271X5
United Bank for 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BUND 0.523 Threatening
Investment + 0.271X5
The National Bank 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BNOI 1.056 Successful
of Iraq + 0.271X5
Sumer Commercial 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BSUC 3.773 Successful
Bank + 0.271X5
Ashur International 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BASH 2.164 Successful
Bank + 0.271X5
Mansour 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BMNS 0.473 Threatening
Investment Bank + 0.271X5
Source: Prepared by the researcher

The Kida model was applied to the data of 2.164, and 2.107, respectively). Successful banks, but
Iraqi commercial banks for the year 2020, the study their success rate is lower than the rest of the banks in
sample, to predict financial failure, which is shown in the research sample, as the values of Z for them were
Table 4. From the positive (Z) value for all banks, it (0.473, 0.523, 0.889), respectively.
becomes clear to us that all banks in the study sample Second: Analysis of the value of the prediction
have a low probability of financial failure, that is, they function Z according to the Sherrod model for
are successful, unless they differ in the probability the research sample:
ratio, so we find that the most successful banks are Table 5 shows the results of the financial
the Sumer Commercial Bank, followed by the Ashur ratios calculated according to the Sherrod model on
International Bank, and then the Iraqi Commercial the data of commercial banks in the study sample that
Bank, as the values of (Z) for them reached (3.773, made up the model, as follows:

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Table (5) The results of the financial ratios of the Sherrod model for the research sample during the year 2020

Bank Code X1 X2 X3 X4 X5 X6

BCOI 0.405 0.984 0.498 0.065 1.995 93.264

BBOB 0.176 0.945 0.196 0.018 1.244 4.989
BIBI 0.001 0.973 0.464 0.009 1.866 17.204
BUND 0.429 0.209 0.434 0.001 1.767 2.049
BNOI 0.279 0.942 0.343 0.027 1.524 17.042
BSUC 0.750 0.895 0.789 0.003 4.743 9.034
BASH 0.527 0.942 0.577 0.040 2.365 13.766
BMNS 0.001 0.967 0.222 0.006 1.285 9.988
Source: Prepared by the researcher
Table (6) Analysis of the value of the prediction function Z according to the Sherrod model for the
research sample for the year 2020
The bank's
Bank
Bank name Sherrod model equation Z value position on
code
forecasting
(1.04*0.057(+)0.42*0.995(+ The bank is not
Iraqi Commercial
BCOI )0.461*1.964) +(0.463*0.023) + 30.522 subject to
Bank
(0.271*0.650) bankruptcy
1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BBOB Baghdad Bank 14.543 Threatening
+ 0.271X5
Iraqi Investment 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BIBI 14.542 Successful
Bank + 0.271X5
United Bank for 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BUND 13.046 Threatening
Investment + 0.271X5
The National Bank 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BNOI 18.529 Successful
of Iraq + 0.271X5
The bank is not
Sumer Commercial 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BSUC 30.251 subject to
Bank + 0.271X5
bankruptcy
Ashur International 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BASH 24.498 Successful
Bank + 0.271X5
Mansour 1.04X1 + 0.42X2 + 0.461X3 + 0.463X4
BMNS 12.158 Threatening
Investment Bank + 0.271X5
Source: Prepared by the researcher

The Sherrod model was applied to the data of banks, the study sample, are safe from financial
Iraqi commercial banks for the year 2020, the study failure, but some of us are vulnerable, and They differ
sample, to predict financial failure, which is shown in in the probability ratio, so we find that the best
Table (6). From the value of (Z), the Commercial Bank successful banks are the Sumer Commercial Bank,
of Iraq obtained the highest value of (30.522), which followed by the Ashur International Bank, then the
represents the degree of ability to continue as well as Iraqi Commercial Bank, as the value of (Z) for them
its distance from failure. Financial, followed by Sumer reached (3.773, 2.164, and 2.107), respectively; either
Commercial Bank with a ratio of (30.251), and Al- Al-Mansour Bank for Investment or the United Bank
Mansour Investment Bank occupies a positive value for for Investment, then the Bank of Baghdad, are
(z), which amounted to (12.158), because the value of successful banks, but their success rate is lower than
Z calculated for the research sample according to this the rest of the banks in the research sample, as the
model is positive for all Iraqi commercial banks listed value of (Z) for them was (0.473, 0.523, and 0.889,
on the Iraq Stock Exchange, so All Iraqi commercial respectively.

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REFERENCE :
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