Why Does the Problem Persist?
"Rational Rigidity" and the Plight of Japanese Banks

One of the most perplexing factors in the Japanese financial crisis is the apparently non-optimal and non-rational behaviour of Japanese banks. In this article, we provide a "rational" explanation for bank behaviour based on the long-term relationships between banks and entrepreneurs and show that they result in "rational rigidity" in lending. We find three implications of rational rigidity - a low lending rate, a low bankruptcy rate, and an institutional pledge of no profit maximization - in Japanese banks. We argue that this type of banking is viable as long as the economy expands and asset prices go up, which was the case before the asset market crash in 1990. The stagnation and free-fall of asset prices in the 1990s exerted tremendous pressure on Japanese banks but did not paralyse them completely in the 1990s, although there are indications that they failed to restructure distressed large corporations in some industries, notably construction and real estate. Thus, the problem is not that paralysed banks are blocking recovery, but that their current rational rigidity in banking practices is no longer viable as private enterprises in the market economy are suffering from asset price

deflation and economic stagnation. Major institutional changes seem, therefore, inevitable.