1997 Reports

BIS capital regulations and Japanese banks' bad loan problems

Marsh, Terry A.; Paul, Jean-Michel

We present evidence that the loan problems of Japanese banks are related to the introduction of the 1992 BIS capital regulations. The cross-sectional correlation between the major twenty-one banks' prior-to-1992 BIS capital deficiencies and their risky lending is around 50%. The risky lending generated higher short-term retained earnings and thus increases in capital. More capital-deficient banks also used the external capital market less, indicating greater asymmetry-of-information problems for the weaker banks. Regional II banks that were not affected by the BIS regulations did not increase their risky lending, while their brethren with overseas operations did. Finally, we find no evidence in excess returns on Japanese banks' stocks that the BIS regulations ex ante benefited them.