The Effectiveness of Bank Recapitalization in Japan

This study examines the effectiveness of bank recapitalization policies in Japan. Based on a careful reading of the "business revitalization plan" submitted by banks requesting government funds, we identify four primary goals of the capital injection plan in Japan: 1) to increase the bank capital ratios 2) to increase lending, in particular to small and medium enterprises, and avoid a "credit crunch" 3) to increase write-offs of non-performing loans and 4) to encourage restructuring. Using a panel of individual bank data, we empirically estimate the effectiveness of the Japanese government policy of public fund injection in achieving the first three of these stated goals. Our empirical analysis of international and domestic banks reveals that the capital injections going to the larger international banks were more effective than those used toward regional banks in Japan. The first capital injection in 1997 was effective primarily in helping international banks to clear the 8% capital adequacy ratio (BIS ratio) required under the Basel Accord. The second round capital injections seem to have been even more effective, boosting capital adequacy ratios for the regional as well as international banks, and encouraging other policy objectives such as increased lending to small and medium enterprises.