AHP as an Early Warning System: An Application in Commercial Banks in Turkey

Abstract

Banking sector performance is important at the stage of economic growth. During the past two decades, many of developed and developing countries in the world experienced bank failures on a large scale. The Analytic Hierarchy Process (AHP) is a multiple criteria decision-making methodology designed to help decision makers in prioritizing decisions that involves both tangible and intangible criteria and has been implemented extensively all over the world. The paper employs the AHP to evaluate the performance of commercial banks in Turkey during the period 1997–1999. The main starting point for this study is to evaluate the performance of the banks in Turkey. Turkish banking industry’s financial ratios are placed in a hierarchical decision structure to calculate financial performance score for the commercial banks in Turkey. We used AHP as a systematic methodology of acquiring knowledge from experts through group decision-making. Forty-eight banks are prioritized based on 26 financial criteria using AHP. We, however, observed that failed banks ranked in lower rows. In other words, based on this analysis the decision-makers can also predict the likelihood of a banking failure. Sensitivity analysis was performed using Expert Choice. Ranking was sensitive to capital, liquidity and shares-in-sector ratios. In other words, small change in the importance of these criteria caused rank reversal of certain banks. In this paper, the banking performance score was constructed by using publicly open financial data. This framework can be used as an Early Warning System (EWS) to detect the banks that would experience serious problems and can help the decision makers to select the banks to invest in. Capability to test solution’s robustness is another superiority of the methodology since real life problems are dynamic in nature.