Unnatural Selection: Perverse Incentives and the Misallocation of Credit in Japan

39 Pages Posted: 25 Apr 2003 Last revised: 7 Nov 2022

See all articles by Joe Peek

Joe Peek

Federal Reserve Bank of Boston

Eric S. Rosengren

Federal Reserve Bank of Boston - Supervision and Regulation

Date Written: April 2003

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.

Suggested Citation

Peek, Joe and Rosengren, Eric S., Unnatural Selection: Perverse Incentives and the Misallocation of Credit in Japan (April 2003). NBER Working Paper No. w9643, Available at SSRN: https://ssrn.com/abstract=398547

Joe Peek

Federal Reserve Bank of Boston ( email )

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Eric S. Rosengren (Contact Author)

Federal Reserve Bank of Boston - Supervision and Regulation ( email )

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