The implementation of the 2006 new Basel accord is a major reform in the banking area but it already gives rise to occasionally harsh criticism, notably on the new measures of banking risks (Altman and al. (2001, 2002); Kirstein (2002) for example). Among other potential pitfalls, the new Basel accord might decrease lending to emerging countries and cause procyclicity of credit. Criticism of the1988 Basel accord has already been severe.
The 1988 implementation of the capital requirement ratio has not only failed to reduce the frequency of banking crises, but several studies have highlighted its impact in terms of economic slowdown and domestic credit crunch.
This ratio aims at holding banks to higher standards of capital adequacy, in front of the risk level of the assets. The capital is classified into two categories. The Tier 1 capital is equity capital while Tier 2 capital includes other assets close to capital like subordinated debts and convertible bonds. Usually, the implementation of the capital accord at the end of the 80’s or at the beginning of the 90’s makes a lot of banks needs to raise their capital ratio to meet the 8% minimum required. Poorly capitalized banks have two options. The first is to boost the capital, the numerator, with the issue of new equities, subordinated debt, and preferred stock and/or by the growth of loan loss reserves.
The second concerns the denominator: banks can alternatively or simultaneously reduce the risky assets by shrinking loans or by substituting them with riskless assets like government bonds. Peek and Rosengren (1995) and Hall (1993) for the United States confirm empirically the domestic credit crunch hypothesis. Formal actions to meet the ratio caused poorly capitalized US banks to reduce bank-dependent loan supply, particularly to businesses, during the 1988/1992 period. In Japan, Honda (2002), for the 1986/1995 period, documents the empirical evidence that Japanese banks with lower capital ratios reduced domestic lending. Ito and Sasaki (1998) confirm this result particularly for the Japanese city banks, between 1990 and 1993.
While the credit crunch hypothesis is well documented, few studies analyse to what extent the bank portfolio shifts affect other assets in the balance sheets. To meet the risk-based capital ratio, banks can reduce domestic lending but also their risky overseas lending operations. Montgomery (2005) finds evidence (for fiscal years 1982-1999) that Japanese international banks reduced heavily risk-weighted assets from 1988, such as domestic loans to all industries and international loans.
However, nothing is said about the international borrowers. Peek and Rosengren (1997) confirm empirically the hypothesis that the Japanese capital crunch caused a dramatic decline in total assets and particularly in the Japanese international claims to the US from September 1988 until September 1995. They argue that close lending relationships in Japan make banks reluctant to reduce domestic credit. In this context, the binding risk-based capital requirement resulted in a decrease in foreign lending, notably in the United States, via U.S. branches of Japanese parent banks. In the same way, this paper investigates the direct link between capital requirement and Japanese foreign assets.
Another important issue, not yet empirically analysed, is to what extent the international credit crunch of Japanese banks affected emerging debtors. Did the Japanese capital crunch affect the foreign assets of the Japanese banks during the early 90’s? Can this Japanese capital crunch partially explain the credit crunch in Asia in 1997? King (2001) argues that the Japanese banks were the critical actors who triggered the Asian crisis when they reduced their credit, first to Thailand during 1996 in order to meet the capital requirement and avoid more losses due to the growing financial instability in Japan and a large number of bankruptcies in the industrial sector.
The domestic banking and economic problems at the beginning of the 90’s became international when Japanese banks restructured their balance sheets by withdrawing funds in Asia in 1997. This overseas credit crunch reflects an international channel of crisis transmission. As the largest lender in Asia and particularly in Thailand, Japanese banks signalled a change in sentiments to other foreign banks which also reduced their international claims to Asian countries and banks. No empirical tests have yet been concluded on the link between the implementation of the Basel accord in Japan and the Thai crisis. By focusing on the capital ratio and on the international claims, we present a new view on a major subject in the financial crisis literature (Kaminsky and Reinhart, 1999; Corsetti, Pesenti and Roubini, 1998; Radelet and Sachs, 1998): the triggering factors of crises in emerging markets. Our empirical results support the responsibility of the Japanese capital requirement in the triggering of the Thai crisis.
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