Distance to default, subordinated debt, and distress indicators in the banking industry*

The recent financial crisis has highlighted the inadequacy of present supervisory arrangements to identify reliable ex‐ante indicators of banking distress. For a sample of US bank holding companies, we analyse the extent to which distance to default based on market data can be explained using accounting‐based indicators of risk. We show that a larger number of bank fundamentals help predict default for institutions that issue subordinated debt. For banks that issue sub‐debt, we find that higher charter values and low bank capitalizations further increase the power of bank fundamentals to predict default risk.