Working Paper: NBER ID: w9643
Authors: Joe Peek; Eric S. Rosengren
Abstract: This study examines the misallocation of credit in Japan associated with the perverse incentives of banks to provide additional credit to the weakest firms. Firms are far more likely to receive additional credit if they are in poor financial condition, and these firms continue to perform poorly after receiving additional bank financing. Troubled Japanese banks allocate credit to severely impaired borrowers primarily to avoid the realization of losses on their own balance sheets. This problem is compounded by extensive corporate affiliations, which provide a further incentive for banks to allocate scarce credit based on considerations other than prudent credit risk analysis.
Keywords: credit allocation; Japan; banking crisis; economic stagnation
JEL Codes: E51; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Japanese banks' self-interest (G21) | continued lending to weak firms (G33) |
| continued lending to weak firms (G32) | preventing necessary market corrections (G18) |
| corporate affiliations (L14) | misallocation of credit (E51) |
| misallocation of credit (E51) | insulates firms from market forces (L10) |
| troubled firms receiving additional bank financing (G21) | continued poor performance (D29) |
| additional credit (E51) | perpetuation of insolvency (G33) |
| banks with capital ratios near required levels (G28) | more likely to extend loans to weak firms (G32) |
| increased loans (G21) | negative effect on firm stock prices (G32) |