Bank recapitalization in the U.S. - lessons from Japan

Montgomery, Heather and Takahashi, Yuki (2011): Bank recapitalization in the U.S. - lessons from Japan. Published in: The Journal of Social Science No. 71 : pp. 5-24.

Abstract

This study empirically investigates the effectiveness of the Capital Purchase Program (CPP), the centerpiece of the United States 700 billion dollar policy response to the global financial crisis of 2008. We frame our analysis of the United States policy response against the backdrop of Japan’s banking crisis and policy response in the late 1990s. As one of the only advanced economies with a large global presence in international finance, Japan’s banking crisis of 1997 and the effectiveness of the policy response offered important lessons to U.S. policymakers in 2008. Based on empirical studies of Japan’s bank recapitalization program, we distill the most crucial lessons to be the importance of speed, adequate scale and customized restructuring in forming recapitalization packages.

The United States and other economies affected by the 2008 global crisis took this first lesson to heart and reacted with unprecedented speed to events in the Autumn of 2008. But despite the large headline figure of 700 billion dollars, the program was not of adequate scale and was actually smaller than Japan’s recapitalization program of 1997-1998 in relative terms. More critically, program implementation in the first year was standardized and there was no investigation into the recipient banks’ business plans or financial condition to allow restructuring to be tailored to each individual recipient bank. These latter two points significantly hampered the effectiveness of the bank recapitalization program.

Our findings demonstrate that the program was successful in achieving at least one policy objective of the program: boosting recipient banks regulatory capital ratios. But we find that the program failed to achieve another important policy objective, to stimulate bank lending. To the contrary, we find evidence that recipient banks reduced lending, presumably because of the pressure to cut highly risk-weighted assets in order to increase their capital adequacy ratios. Although encouraging banks to increase bad loan write-offs was not an explicit policy objective of the CPP according to our reading of statements from the Department of Treasury, we also look at the impact of the program on bad loan write-offs and find no evidence that recapitalization stimulated bad loan write-offs either.

The main empirical results here echo the findings of analysis of Japan’s bank recapitalization program in 1997. In Japan’s case, the second round capital injections in 1998 were of significantly larger scale and more tailored to meet the needs of recipient banks, which increased the effectiveness of the policy intervention. Future research will investigate whether the United States followed a similar pattern and the CPP recapitalizations of 2009 were more effective than those made in the first year of the program.

• Item Type: MPRA Paper
• Language: English
• Keywords: Capital injection; Systemic crisis
• Subjects: G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

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