Evidence on a cause of Japan's prolonged banking crisis

Abstract

This article shows that during the 1990s bank relationships tightened liquidity constraints when firms had good prospects, and relaxed the constraints when firms had poor prospects. These results suggest that both under- and over-investment problems were more prevalent for firms that had close ties to banks, providing an additional reason for the delay in solving the bad loan problem in Japan. Furthermore, the results cast doubt on the conventional view that main banks are efficient at restructuring financially distressed firms, at least during the 1990s when bank health was severely damaged by the bad loans problem.