The Effect of Bank Recapitalization Policy on Credit Allocation, Investment, and Productivity: Evidence from a Banking Crisis in Japan

This paper examines the ramifcation of government capital injections into financially distressed banks during the 1997 Japanese banking crisis. By leveraging a unique dataset merging firm-levelfinancial statements and bank balance sheets, the study aims to examine whether the capital injections primarily benfited high-productivity firms or were misallocated to struggling "zombie" firms. The empirical results suggest that banks, post-injection, increased lending to both high-productivity non-zombie firms and low-productivity zombie firms. While the former is in line with conventional theories that prioritize high-productivityfirms for investment and productivity enhancement, the latter suggests credit misallocation towards struggling firms mainly for debt servicing. Intriguingly, the study finds no evidence that these injections promoted investments among firms, irrespective of their productivity orfinancial health status. In particular, we provide suggestive evidence that zombie firms even reduced investments, especially in infrastructure, while high-productivity non-zombie firms did not exhibit a signficant investment boost despite receiving more loans. However, these high-productivity firms displayed positive growth in labor productivity and total factor productivity, potentially driven by sales growth and increased advertisement expenses rather than employment and wage adjustments.