Monetary and Economic Studies Vol.19, No.2 / May 2001

Should Japanese Banks Be Recapitalized?

Douglas W. Diamond

When a bank is a relationship lender, its financial health affects the access to credit of its borrowers. If bank regulators or uninsured private depositors might force a bank to close, it will take any action necessary to remain open. This can lead to inefficient and excessive foreclosure of the bank’s relationship-based loans to viable borrowers, or alternatively to the inability to collect existing loans due to its fear of recognizing an accounting loss if a loan is called. The level of bank capital then has real effects on its borrowers’ access to credit. A subsidized recapitalization of banks with relationship-based loans can be a good policy. The size of the recapitalization is critical, because providing too small an amount of subsidized capital can be worse than providing no capital. Providing subsidized capital to banks without relationship-based loans is never a good policy.

Keywords: Bank capital; Recapitalization; Relationship lending; Banking; Bank failure

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.

Copyright © 2001 Bank of Japan All Rights Reserved.

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