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U.S. prompt corrective action and bank risk

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  • ap Gwilym, Rhys
  • Kanas, Angelos
  • Molyneux, Philip

Abstract

This paper examines whether Prompt Corrective Action (PCA) was effective in reducing default and credit risk in U.S. banking. We employ parametric, non-parametric, nonlinear and switching cointegration tests and a general-to-specific testing procedure to examine if PCA-defined bank ratios and risk measures share common stochastic trends. We find strong evidence of switching cointegration between PCA-defined ratios and default risk. This occurs in 1993 and coincides with the adoption of PCA legislation. We conclude that PCA is effective in reducing default risk. In contrast, there is no clear evidence of cointegration between the PCA-defined ratios and credit risk. Our findings show that tougher capital standards mitigate default risk and therefore provide indirect support for current on-going capital regulation.

Suggested Citation

  • ap Gwilym, Rhys & Kanas, Angelos & Molyneux, Philip, 2013. "U.S. prompt corrective action and bank risk," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 26(C), pages 239-257.
  • Handle: RePEc:eee:intfin:v:26:y:2013:i:c:p:239-257
    DOI: 10.1016/j.intfin.2013.06.002
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    Cited by:

    1. Beccalli, Elena & Frantz, Pascal, 2016. "Why are some banks recapitalized and others taken over?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 45(C), pages 79-95.
    2. Chernykh, Lucy & Cole, Rebel A., 2015. "How should we measure bank capital adequacy for triggering Prompt Corrective Action? A (simple) proposal," Journal of Financial Stability, Elsevier, vol. 20(C), pages 131-143.
    3. Angelos Kanas, 2014. "The impact of prompt corrective action on the default risk of the U.S. commercial banking sector," Review of Quantitative Finance and Accounting, Springer, vol. 43(2), pages 393-404, August.
    4. Loveland, Robert, 2016. "How prompt was regulatory corrective action during the financial crisis?," Journal of Financial Stability, Elsevier, vol. 25(C), pages 16-36.

    More about this item

    Keywords

    Prompt corrective action; Credit risk; Default risk; Cointegration; Switching cointegration;

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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