Banking regulations: an examination of the failure of African Bank using Merton’s structural model

Abstract

The business of banking involves the taking of deposits and the making of loans. Banking balance sheets are typically highly leveraged, with equity capital generally dwarfed by debt capital. Banks are regulated entities; the nature of regulation does not, generally, consider the market prices of the securities issued by a particular bank. In this contribution, we evaluate the capacity of the Merton structural model to provide insight into a bank’s financial health in the context of the failure of African Bank in 2014