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

47 Pages Posted: 9 Dec 2018 Last revised: 8 May 2021

See all articles by Kiyotaka Nakashima

Kiyotaka Nakashima

Independent Economist

Koji Takahashi

Bank for International Settlements (BIS)

Multiple version iconThere are 2 versions of this paper

Date Written: April 25, 2021

Abstract

We examine the reason why two opposing views on distressed banks' lending behavior in Japan's postbubble period have coexisted: one is stagnant lending in a capital crunch and the other is 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 the 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 sheets, while the market value of capital does. By uncovering banks' efforts to increase regulatory capital in Japan's postbubble period, we show that banks with low market capitalization, and which had difficulty in building up adequate equity capital for their risk exposure, decreased the overall supply of credit. Parallel worlds can emerge whenever banks are allowed to overvalue assets at their discretion, as in Japan' postbubble period.

Keywords: bank capital structure; capital crunch; forbearance lending; loan-level data; bank asset risk; bank risk taking

JEL Classification: G01, G21, G28

Suggested Citation

Nakashima, Kiyotaka and Takahashi, Koji, The Emergence of a Parallel World: The Misperception Problem for Bank Balance Sheet Risk and Lending Behavior (April 25, 2021). Available at SSRN: https://ssrn.com/abstract=3284379 or http://dx.doi.org/10.2139/ssrn.3284379

Koji Takahashi

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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