Review Paper on Composite Leading Index Creation for Forecasting the Bangladeshi Financial Sector


Macro-prudential Cycle, Shumway Method, Dynamic Hazard Model, Financial Sector, Economic Crises

How to Cite

Afreen, M. (2020). Review Paper on Composite Leading Index Creation for Forecasting the Bangladeshi Financial Sector. International Journal of Finance & Banking Studies (2147-4486), 9(4), 23-32.


In perspective of the economic vulnerability faced by banks in financial sector, this study mirrors the methodology used by Shumway (2001) – the dynamic hazard model that is able to forecast systemic risk in financial market arena. Here, the terminology followed is based on the CAMELS framework variables: capital adequacy, asset, management, earnings, liquidity and sensitivity to market risk. The objective of this study is to construct a macroprudential indicator (MPI) for the case of Bangladeshi financial market. The result will then be tested for robustness with macro-stress test. Lagged independent variables will be used in the simple hazard model to allow early prediction of MPI in the year in which the crisis happens. The empirical findings can be used as a guideline for the Bangladesh Government and policy makers in accessing, examining and forecasting the health of the Bangladeshi financial system and formulate suitable financial system policies for control. MPI generates information about systemic risk allowing the detection of potential economic crises functioning as an early warning indicator. Government and policy makers will be able to make early preparation in cushioning any potential crises by means of the MPI. Thus the impact of the crises could be minimized and eventually reduce its impact on the Bangladesh economy. The specific objectives are to assemble a novel MPI that is able to recommend early signals of financial market vulnerability, to identify the MPI turning points and establish a comprehensive reference chronology for Bangladeshi financial market and to evaluate the predictive performance of newly constructed MPI on characterizing Bangladeshi financial sector.


Alam, M. Z. & Masukuzzaman, M. (2011). Risk Management Practices: A Critical Diagnosis of Some Selected Commercial Banks of Bangladesh: Journal of Business and Technology, Dhaka.

Altman, E. I. (1993). Corporate Financial Distress and Bankruptcy: A Complete Guide to

Predicting and Avoiding Distress and Protting from Bankruptcy (John Wiley and Sons, Inc., New York). ISBN-13: 978-0471087076. ISBN-10: 0471087076

Agresti, A. M., Baudino, P. & Poloni, P. (2008). The ECB and IMF indicators for the macro-prudential analysis of the banking sector: A comparison of the two approaches. Germany: European Central Bank. 1144486.

Bangladesh Bank (2009). Prudential Regulations for Banks: Selected Issues. Bangladesh Bank working paper series. Retrieved from: http:

Bank for International Settlement (2012). Operationalising the selection and application of macroprudential instruments. Committee on the Global Financial System. Papers No: 48. URL:

Bhattacharyay, B. N. (2003). Towards a Macro-Prudential Leading Indicators Framework for Monitoring Financial Vulnerability. CESifo Working Paper No: 1015.

Begley, J., J. Ming, and S. Watts. (1996). Bankruptcy classication errors in the 1980s: An empirical analysis of Altman's and Ohlson's models, Review of Accounting Studies. 1, 267-284. DOI: 10.1007/BF00570833.

Blundell-Wignall,A. and Roulet, C., (2014). Macro-prudential policy, bank systemic risk and capital controls. OECD Journal: Financial Market Trends, Volume: 2013/2. Pages: 1-22. DOI: 10.1787/fmt-2013-5jzb2rhkhks4

Boyd, J.H., G. De Nicolo and A.M. Jalal (2006). Bank risk taking and competition revisited: New theory and new evidence. IMF Working Paper 297. IMF: Washington DC. DOI: 10.5089/9781451865578.001

Clement, P. (2010). The term “macroprudential”: origins and evolution. BIS Quarterly Review. 59-67.

Choudhury, M. A. H (2013). Stock Market Crash in 2010: An Empirical Study on Retail Investor’s Perception in Bangladesh. ASA University Review.

Crockett, A. (2000). Marrying the Micro and Macro-prudential Dimensions of Financial Stability. 11th International conference of banking supervisors, basel, Switzerland. DOI: 10.2139/ssrn.1165494

Cole, R. A., & Wu, Q. (2009a). Prediction bank failures using a simple dynamic hazard model. Federal Deposit Insurance Corporation Working Paper.

Cole, R. A., & Wu, Q. (2009b). Is hazard or probit more accurate in predicting financial distress? Evidence from U.S. bank failures. Munich Personal RePEc Archive Paper. DOI: 10.2139/ssrn.1460526

Cox, D.R., & Oakes, D. (1984). Analysis of Survival Data. New York: Chapman & Hall.

Cumming, Christine and Beverly J. Hirtle (2001). The Challenges of Risk Management in Diversified Financial Companies. Economic Policy Review , Federal Reserve Bank of New York, 7, 1-17.

Diamond, D., and R.G. Rajan (2001). Liquidity risk, liquidity creation and financial fragility. Journal of Political Economy 109, 287-327. or

Eun,C. S., Resnick,B. G., & Sabherwal S. (2012). International Finance Global Edition (6th ed.). New York: McGraw-Hill Irwin.

Eidenberger., J., Neudorfer., B. Sigmund., M. & Stein., I. (2013). Quantifying Financial Stability in Austria – New Tools for Macroprudential Supervision. Oesterreichische National Bank. Financial Stability Report 26, December, pg 62-81.

Hawkesby, C. (1998). Maintaining financial system stability: the role of macro-prudential indicators. Reserve Bank of New Zealand, 63(2), 38-52.

Hoque, N. M. & Kabir, R. M (2006). Financial Globalization and Vulnerabilities: Lessons from Bangladesh. Daffodil International University Journal of Business and Economics, Dhaka.

Hollo, D., Kremer., M., & Duca., M., L. (2012). CISS – A Composite Indicator of Systemic Stress in the financial system. ECB Working Paper Series 1426.

International Monetary Fund (2000). Macroprudential Indicators of Financial System Soundness. International Monetary Fund Occasional paper No.192.

Islam, M.A., Islam, R.M., Siddiqui, M.H. and Karim, L. (2014). Convertibility of Capital Account: A Comparative Analysis. Business and Economic Research, Macrothink Institute, 4(1), 108-132. DOI: 10.5296/ber.v4i1.4711

Juks, R., & Melander, O. (2012). Countercyclical Capital Buffers as a Macroprudential Instrument. Stockholm: SverigesRiksbank.

Khor, M. (1998). The economic crisis in East Asia: causes, effects, lesson. Third World Network. Retrived from

Ministry of Finance Bangladesh. (2011). Bangladesh Economic Review. Economic Advisers Wing, Finance Division, Ministry of Finance, Bangladesh. Available at: <>

Moorhouse, A. (2004). An introduction to financial soundness indicators. Monetary & Financial Statistics. Retrieved from:

Mortinen, Poloni, Sandars & Yesala (2005). Analysing banking sector conditions: how to use macro-prudential indicators. European Central Bank Occasional Paper Series No. 26. SSRN:

Murshid, S. A. K (2009). The Global Financial Crisis: Impact on Bangladesh. Bangladesh Institute of Development Studies, Dhaka. Website:

Ministry of Finance Bangladesh. (2016). Bangladesh Economic Review. Economic Advisers Wing, Finance Division, Ministry of Finance, Bangladesh.

Organization for Economic Co-operation and Development (2008). Handbook on Constructing Composite indicators; Methodology and user guide. Paris: Organization for Economic Co-operation and Development Publishing. DOI: 10.1787/533411815016

Pyle, D. H. (1997). "Bank Risk Management: Theory," Institute of Business and Economic Research, University of California, Finance Working Paper No. RPF272, July 1997.

Rahman. M., Bhattacharya. D., Iqbal. A., Islam. T., and Kumar. T. (2009). Global Financial Crisis Series (Paper 01): Bangladesh. Overseas Development Institute.

Reserve Bank of New Zealand (2013). Macro-prudential policy memorandum of understanding information release. Retrieved from: Informationreleases/financialsector/macro-prudentialmou.

Salas, J. and V. Saurina (2003). Deregulation, market power and risk-taking in Spanish banks. European Economic Review. 47, 1061-75. DOI: 10.1016/S0014-2921(02)00230-1

Selialia, F., Mbeleki, T., & Matlapeng, K. (2009). Macroprudential analysis of financial system: the case of South Africa. Irving Fischer Committee Bulletin, 33, 110-133.

Shumway, T. (2001). Forecasting bankruptcy more accurately: a simple hazard model. The Journal of Business, 74(1), 101-124. DOI: 10.1086/209665

United Nations World Food Programme (2009). Bangladesh: Effects of Financial Crisis on Vulnerable Households. Retrieved from:

WFP (World Food Program), (2010). Bangladesh Follow up case study, Impact of Global Financial Analysis. Retrived from:

White, W. (2012). “Ultra Easy Monetary Policy and the Law of Unintended Consequences”, Federal Reserve Bank of Dallas, Globalisation and Monetary Policy Institute, Working Paper, No.126(September). DOI: 10.24149/gwp126

World Bank (2008). ‘Likely Implications of the Ongoing Global Financial Crisis for Bangladesh’. Media Briefing, Dhaka, Bangladesh. 26 November.

Wolken,T. (2013). Measuring systemic risk: the role of macro-prudential indicators. Reserve Bank of New Zealand Bulletin. 76, 13-30. Retrieved from.

Zmijewski, M. E. (1984). Methodological issues related to the estimation of financial distress prediction models, Journal of Accounting Research 22, 59-82.

Creative Commons License

This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.