Recapitalisation And The Risk–Return Tradeoff In Banks: Evidence From An Emerging Market

Abstract

This study explores the impact of changes in capital structure resulting from recapitalization on the risk-return relationship and stability of banks in an emerging market setting. The analysis deviates from previous literature that examines capital adequacy ratios by breaking down the process of recapitalization into different financing mechanisms, including equity financing, debt financing, derivatives, and asset appreciation. The study uses panel data on Nigerian Deposit Money Banks during the period 2012-2024, using fixed-effects models with Driscoll-Kraay standard errors to account for cross-sectional dependence and macroeconomic shocks. It is observed that there is a clear trade-off between profitability and resilience. The research finds that recapitalization through equity and debt leads to an improvement in the balance sheets' ability to absorb shocks by improving liquidity and lowering non-performing loans. At the same time, recapitalization leads to a temporary decrease in the banks' profits and deposits due to adjustment costs. The use of derivative-based instruments is also shown to depress the profit margins. The results demonstrate that the effectiveness of recapitalisation is conditional on the structure of capital adjustment, thus, highlighting the importance of financing channels in shaping bank behaviour. The study adds empirical evidence to the current body of knowledge on banks and financial stability in that it sheds some light on the risk-reward balance with regard to capital regulation in developing countries.