Regulatory Arbitrage and Bad Loans

40 Pages Posted: 9 Jun 2014

See all articles by Masaya Sakuragawa

Masaya Sakuragawa

Tokyo Center for Economic Research (TCER); Keio University - Faculty of Economics

Kaoru Hosono

Gakushuin University - Economics

Date Written: June 8, 2014

Abstract

The banks’ forbearance lending to weak firms was one of primary reasons for the prolonged non-performing loan problem in Japan. We analyze whether regulatory arbitrage using lax enforcement of capital requirements was a motive for Japanese banks to continue loans to weak firms. We find evidence supporting the view that regulatory arbitrage was a motive of bad loans Two measures of regulatory arbitrage, the difference between the risk-based capital and the market-valued capital as a proportion of bank asset, and the subordinated debt as a proportion of bank asset, are useful in uncovering evidence that Japanese banks had the perverse incentive of extending bad loans in an attempt to inflate regulatory capital in the 1990s.

Keywords: regulatory arbitrage, bad loans, capital requirements, accounting discretion

JEL Classification: G21 G28

Suggested Citation

Sakuragawa, Masaya and Hosono, Kaoru, Regulatory Arbitrage and Bad Loans (June 8, 2014). Available at SSRN: https://ssrn.com/abstract=2447492 or http://dx.doi.org/10.2139/ssrn.2447492

Masaya Sakuragawa (Contact Author)

Tokyo Center for Economic Research (TCER) ( email )

Sankyo Building
Room 703, Main Building
Chiyoda-ku, Tokyo, 1-7-10
Japan

Keio University - Faculty of Economics ( email )

2-15-45 Mita, Ninato-ku
Tokyo 1088345
Japan

Kaoru Hosono

Gakushuin University - Economics ( email )

1-5-1 Mejiro, Toshima-ku
Tokyo 171-8588
Japan

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