Academic journal article Journal of Money, Credit & Banking

In Search of "Capital Crunch": Supply Factors Behind the Credit Slowdown in Japan

Academic journal article Journal of Money, Credit & Banking

In Search of "Capital Crunch": Supply Factors Behind the Credit Slowdown in Japan

Article excerpt

THE SEEMING inability of standard macroeconomic policies to revive the Japanese economy continues to generate debates about the underlying cause of Japan's stagnation. While the fact that short-term nominal interest rates are already near zero has led some observers to infer that Japan is caught in a liquidity trap (Krugman 1998), others have concluded that Japan's economic slump is more structural than cyclical in character, arising from such structural weaknesses as distress of the banking system, aging of the population, rigidity in the labor market, and overregulation of the service sector.

Among the structural factors, the view that problems in the banking system are chiefly responsible for Japan's economic malaise in the 1990s has received perhaps the most widespread support in policy circles (Bayoumi 1998). The proponents of this view argue that a deterioration of loan quality (1) and substantial losses in banks' securities holdings (the result of the dramatic decline in Japanese share prices) gradually eroded the capital positions of the banks throughout the 1990s (Hoshi and Kashyap, 2000, Kanaya and Woo, 2001). At the same time, facing closer scrutiny by the market and regulators alike, and unable to raise new capital, banks responded to the erosion of their capital base by reducing their loans. The argument goes on to suggest that the contraction in bank lending, by pushing marginal borrowers into bankruptcy, lifted the stock of nonperforming loans and further pressured banks' capital positions. This is the so-called credit crunch or, to borrow the expression coined by Syron (1991), (2) the "capital crunch" theory of Japan's crisis. Given the dominant role of banks in financial intermediation (Borio 1996) (3) and the importance of credit channels in Japan (Bayoumi 1999), (4) its conclusion is that the "clogged" credit channels have neutralized the effects of loose monetary policy.

The credit crunch view of the Japanese economic crisis has gained momentum within the Japanese government, which, overcoming initial public opposition to the use of government funds for bailing out distressed banks, introduced a 60 trillion yen bank restructuring package in October 1998. (5) Moreover, in another move calculated to lessen the pressure on banks' capital positions, the government that year took steps to relax the regulatory framework by introducing accounting changes that artificially raised the capital ratios of all banks. (6) At the same time, banks have also been encouraged to withdraw from their international operations so as to face a less stringent capital adequacy requirement. (7) The government also increased funding for the credit guarantee schemes (designed to allow small- and medium-sized firms to gain access to the credit market). Finally, to compensate for the lapse in bank credit, the Bank of Japan (BOJ) in November 1998 relaxed conditions on its commercial paper (CP) purchase by moving the maturity limit from three months to one year. Subsequently, the BOJ started to aggressively take on commercial paper on a repurchase basis, in the process becoming a major provider of lending, albeit an indirect one, to the nonfinancial sector of the economy.

This study tests the hypothesis that the shortage of bank capital constrained the ability of Japanese banks to lend in the 1990s. Using data from a sample of banks representing 90% of Japan's banking assets in 1997, the paper makes three findings. First, in the beginning of the 1990s, weakly capitalized banks appeared to increase their lending more rapidly than more strongly capitalized ones. Although this finding does not necessarily imply the absence of capital crunch, it does contrast sharply with most findings about American banks during the same period when the Basle Capital Accord was being phased in. Second, the paper finds support for the capital crunch hypothesis in 1997 by documenting a positive and statistically significant correlation between new lending growth and bank capital. …

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