Forbearance Lending: A Case for Japanese Firms

After the collapse of the asset price bubble, Japanese banks are said to have been reluctant to write off bad loans, even in cases where there is little prospect of borrower firms being able to repay the loans extended. This phenomenon is known as forbearance lending. We illustrate this using a simple model in which a bank is shown to have an incentive to engage in forbearance lending to a borrower firm whose debt-asset ratio exceeds a certain threshold as its liquidation value (or net worth) is eroded. Then, using corporate panel data, we test for non-linearity between loans and debt-asset ratios: i.e. whether loans were apt to increase to a firm whose debt-asset ratio was above a certain level. It is found that, after the bubble burst, this non linearity became evident for non-manufacturing firms, especially those in the construction and real estate industries. Furthermore, an increase in loans to highly indebted firms in these industries is found to lower their profitability. These findings are consistent with the view that forbearance lending certainly took place in Japan, and that it suppressed the profitability of inefficient non-manufacturing firms.