This paper argues that the slow and incomplete deregulation of the financial system in the 1980s was the most important factor behind the Japanese banking troubles in the 1990s. The regression analysis of Japanese banks shows that the cross-sectional variation of bad loans ratios is best explained by the variation in the growth of loans to the real estate industry. The variation of growth of real estate lending, in turn, is explained by the varied experience of losing existing customers to capital markets. The rapid appreciation of land prices in the late 1980s also fueled the growth of real estate lending.
Keywords: Financial deregulation; Bad loans; Real estate lending; Keiretsu loans
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.