The Use of Market Information in Bank Supervision: Interest Rates on Large Time Deposits

In theory, information from the prices of bank claims could be used as a complement to off-site surveillance in bank supervision. Unfortunately, the vast majority of banks do not issue claims that are actively traded in secondary markets. These banks do rely heavily on one type of claim that is sensitive, at least to some degree, to bank risk: jumbo CDs. Indeed, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) was designed to impose more of the cost of failures on this class of claimants. We construct an accounting proxy for the default premiums on jumbo CDs that we use to rank banks by the probability that they will experience serious financial problems during future periods. We compare the accuracy of this ranking of banks to a ranking of banks derived from a conventional early warning model. We find that the predictive power of the default premiums on bank CDs is much less than the predictive power of the traditional early warning model.