Bank Capital Shocks and Portfolio Risk: Evidence from Japan

Kentaro Iwatsubo, 健太郎 岩壷 and ケンタロウ イワツボ

No 2004-24, CEI Working Paper Series from Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University

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.

Keywords: Bank risk; Risk-shifting incentives; Fran-chise value; Capital adequacy requirement (search for similar items in EconPapers)
JEL-codes: C33 G21 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2005-03
References: View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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https://hermes-ir.lib.hit-u.ac.jp/hermes/ir/re/13921/wp2004-24a.pdf

Related works:
Journal Article: Bank capital shocks and portfolio risk: Evidence from Japan (2007)
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