Bank risk and returns: did prompt corrective action make a difference?

Purpose - The purpose of this paper is to assess the effects of prompt corrective action on bank risk and returns in an empirical framework. Design/methodology/approach - The paper uses a difference-in-difference specification to analyse whether and how PCA affects bank risk and returns. As part of robustness, the analysis also uses a fixed effects specification with Driscoll–Kraay standard errors to account for serial correlation and cross-sectional dependence. Findings - The findings reveal that banks under PCA framework contribute less to systemic risk and exhibit higher market valuation. These findings differ across recapitalised versus non-recapitalised banks and for banks with differing asset quality, capital and profitability. The overall price impact is a decline in lending rates and deposit costs. Originality/value - To the best of the author’s understanding, this is one of the early studies in the Indian context to carefully examine the linkage between PCA and bank behaviour.