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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.

Suggested Citation

  • Iwatsubo, Kentaro, 2005. "Bank Capital Shocks and Portfolio Risk: Evidence from Japan," CEI Working Paper Series 2004-24, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
  • Handle: RePEc:hit:hitcei:2004-24
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    File URL: http://hermes-ir.lib.hit-u.ac.jp/rs/bitstream/10086/13921/1/wp2004-24a.pdf
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    References listed on IDEAS

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    Cited by:

    1. repec:mbr:jmonec:v:8:y:2013:i:1:p:141-167 is not listed on IDEAS
    2. Oliver Arentz & Johann Eekhoff & Christine Arentz, 2010. "Zur Finanzmarktkrise: Die Rolle der Immobilienbewertung," IWP Discussion Paper Series 01/2010, Institute for Economic Policy, Cologne, Germany.
    3. 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, vol. 25(2), pages 1-44, November.
    4. repec:eee:riibaf:v:42:y:2017:i:c:p:404-421 is not listed on IDEAS
    5. Montgomery, Heather & Takahashi, Yuki, 2014. "The economic consequences of the TARP: The effectiveness of bank recapitalization policies in the U.S," Japan and the World Economy, Elsevier, vol. 32(C), pages 49-64.
    6. repec:asi:aeafrj:2018:p:231-247 is not listed on IDEAS
    7. repec:wsi:ijfexx:v:04:y:2017:i:02n03:n:s2424786317500256 is not listed on IDEAS

    More about this item

    Keywords

    Bank risk; Risk-shifting incentives; Fran-chise value; Capital adequacy requirement;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models

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