Evaluating and forecasting banking crises through neural network models: An application for Turkish banking sector

https://doi.org/10.1016/j.eswa.2006.07.005Get rights and content

Abstract

The performance of neural networks in evaluating and forecasting banking crises have been examined in this paper. An artificial neural network model which works with the banking data belonging to the same date and another artificial neural network model which works with cross sectional banking data have been formed and tested. The optimal topologies of these models have been determined by Taguchi approach which is a design of experiments method. Both models can forecast the values of the output neurons consisting of Non-performing Loans/Total loans, Capital/Assets, Profits/Assets and Equity/Assets ratios by using 25 input neurons consisting of macroeconomic variables, the variables related to the external balanced financial system’s structure, and time with very small errors. Consequently, it has been seen that artificial neural networks which are capable of producing successful solutions for semi-structural and non-structural problems, can be used effectively in evaluating and forecasting banking crises.

Introduction

In recent years, banking crises have occurred more frequently in the countries which have developing and transition economies. And some of them had very high costs as they spread into other regions. And serious international institutions’ interventions have been required. Thus, the need for the studies that analyze banking and other financial crises, present various forecasting models and suggest precautions for them has increased. This paper aims to analyze the banking crises process and to establish a forecasting model through artificial neural networks.

Neural networks are technologies that acquire the ability to learn for the computers. They teach the relationships between the inputs and outputs of the events to the computers by using patterns. By the help of taught data various generalizations are made, similar events are interpreted, required decisions are made and related problems are solved.

Artificial neural networks (ANNs) are generally the software systems that imitate the neural networks of the human brain (Trippi & Turban (1996, pp. 4–5)). It is also possible to accept the ANNs as a parallel distributed data process system. And ANNs can be applied successfully in learning, relating, classification, generalization, characterization and optimization functions. Because ANNs have the ability to work with incomplete data, posses error tolerance, and show graceful degradation, they can easily form models for complex problems. Especially in the development of solutions for semi-structural or non-structural problems, artificial neural network (ANN) models can have very successful results. Moreover, they can be cheaper, faster and more adaptable than traditional methods. Most of the problems that the financial managers face are semi-structural. So the qualifications of the ANN models can be very helpful in the formulations and the solutions of them. It is possible to evaluate and forecast banking crises with the help of ANN models.

After introducing the applications of ANNs in finance in the first part of this paper, the formation of the two ANN models for evaluating and forecasting banking crises is explained in the second part. Also, the use of the Taguchi Approach in the optimization of the network topologies is proposed in this part. The results of the two ANN models is found in part three. And finally, the conclusions and future related studies are presented.

Section snippets

Application of neural networks in financial and commercial domains

Since the 1940s, ANNs have been used in various applications in engineering. As artificial intelligence technologies have improved, they also began to be used in the solution of medical, military and astronomical problems. Today, their potential success in formulating solutions for financial problems is area of interest.

Real-world problems have qualitative and quantitative dimensions. Real-world users of decision tools can benefit from more qualitative capabilities and increased user

Formation of the neural network models

In the formation of an ANN system, a sustainable neural network model based on the nature of the problem should be selected and a neural network should be constructed according to the characteristics of the application domain. Familiarity with existing applications of other financial studies can help determine the appropriate network topology (architecture) and selection of the best-suited computational model for learning and inference.

These application process of an ANN model design includes

Results of Model I

It has been found that the first ANN model could learn the relationships between the input and the output neurons successfully. So it would seem possible for this ANN model to estimate the output neuron values by using the input neuron values for the same date.

Model I had a learning rate of 0.1; a momentum rate of 0.4; and a threshold value of 80%. There were three hidden layers between the input and output layers. The first and the second hidden layer had 20 neurons each, the third 50 neurons.

Conclusion and future works

Models I and II could forecast the values of the output neurons consisting of Non-performing Loans/Total Loans, Capital/Assets, Profits/Assets and Equity/Assets ratios by using the 25 input neurons consisting of macroeconomic variables, the variables related to the external balance and financial system’s structure, and time with very small errors. Both ANN models appeared to have learned the relationships between their input and output data successfully. And then, the input and the output data

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