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Bank capital shocks and portfolio risk: Evidence from Japan

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  • Iwatsubo, Kentaro

Abstract

Despite the downward trend of land prices and the ex-post low return on real estate loans, Japanese banks increased their lending to the real estate sector during the 1990s. We argue that this phenomenon can be explained by the risk-shifting incentives of banks and discover that banks with low capital-to-asset ratios and low franchise value chose high-risk assets such as real estate loans. Unlike previous studies, we show that the capital-risk relationship is nonlinear and changes from positive to negative as franchise value falls. We also find that a capital adequacy requirement did not prevent risk-taking behavior of undercapitalized banks since they then just issued more subordinated debts to meet this requirement. In contrast, government capital injections led banks to reduce risky loans at the margin. Recapitalization by issuing subordinated debts helped banks recover their capital losses and mitigated the credit crunch, but consequently allowed them to increase their exposure to the real estate sector and worsened the bad loan problems.

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Bibliographic Info

Article provided by Elsevier in its journal Japan and the World Economy.

Volume (Year): 19 (2007)
Issue (Month): 2 (March)
Pages: 166-186

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Handle: RePEc:eee:japwor:v:19:y:2007:i:2:p:166-186

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Web page: http://www.elsevier.com/locate/inca/505557

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Cited by:
  1. Oliver Arentz & Johann Eekhoff & Christine Arentz, 2010. "Zur Finanzmarktkrise: Die Rolle der Immobilienbewertung," IWP Discussion Paper Series, Institute for Economic Policy, Cologne, Germany 01/2010, Institute for Economic Policy, Cologne, Germany.
  2. Kenshi Taketa & Gregory F. Udell, 2007. "Lending Channels and Financial Shocks: The Case of Small and Medium-Sized Enterprise Trade Credit and the Japanese Banking Crisis," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 25(2), pages 1-44, November.

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