Do Banks Reduce Lending Preemptively in Response to Capital Losses?

Author Name NISHIYAMA Shinichi  (Bank of Canada) /OKADA Tae  (Graduate School of Economics, Osaka University) /WATANABE Wako  (Graduate School of Economics and Management, Tohoku University)
Creation Date/NO. March 2006 06-E-016
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We empirically examined whether declining bank loans in Japan in the late 1990s are the result of banks' downward adjustments of lending supply (a "credit crunch") in response to capital losses (a "capital crunch"). Estimating the new lending supply function as a non-linear function of the capital to asset ratio, we found that the (new lending supply) function is not only increasing in bank capital but also concave in bank capital, which supports the view that a "credit crunch" occurs since forward-looking banks have an incentive to avoid failing to meet regulatory requirements in the future.