The Emergence of A Parallel World: The Misperception Problem for Bank Balance Sheet Risk and Lending Behavior

Inoue, Hitoshi and Nakashima, Kiyotaka and Takahashi, Koji (2018): The Emergence of A Parallel World: The Misperception Problem for Bank Balance Sheet Risk and Lending Behavior.

Abstract

We examine the reason that there have coexisted the two opposing views on distressed banks' lending behavior in Japan's post-bubble period: the one is the stagnant lending in a capital crunch and the other is the forbearance lending to low-quality borrowers. To this end, we address the measurement problem for bank balance sheet risk. We identify the credit supply and allocation effects of bank capital in the bank loan equation specified at loan level, thereby finding that the ``parallel worlds'', or the two opposing views, emerge because the regulatory capital does not reflect the actual condition of increased risk on bank balance sheet, while the market value of capital does. By uncovering banks' engagement in patching-up of the regulatory capital in the Japan's post-bubble period, we show that lowly market capitalized banks that had difficulty in building up adequate equity capital for their risk exposure decreased the overall supply of credits. The parallels world can emerge whenever banks are allowed to overvalue assets with their discretion, as in Japan' post-bubble period.

• Item Type: MPRA Paper
• Language: English
• Keywords: bank capital structure; capital crunch; forbearance lending; loan-level data; uncertainty; bank risk taking.
• Subjects: G - Financial Economics > G0 - General > G01 - Financial Crises; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation

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