Subprime loan problems have hit financial institutions globally since 2007. Many financial institutions have reported huge losses and had financial troubles. Among them, in the United States, Lehman Brothers filed for bankruptcy in September 2008, Bear Sterns was sold to JP Morgan Chase under Federal Reserve Bank pressure in March 2008, and there was a run on Indy Mac in July 2008.
The possibility of a credit crunch has been discussed since the summer of 2007 (e.g., The Japan Times, Oct. 13, 2007). Indeed, bank credit and loans and leases in bank credit in the U.S. had been increasing almost monotonically for years, and started decreasing in April 2008 (Figure 1). How can we cope with this creeping crisis? The purpose of this paper is to find prescriptions by learning from the Japanese experience of sharp decline in loans in the 1990s.
The Japanese loan market was in a severe slump from 1990 to 2003; this was a significant historical event. The solid line in Figure 2 represents the amount of loans advanced by domestically licensed banks in Japan since 1944, showing that the 1990s was the first decade in postwar Japan: that the amount of loans began decreasing significantly.
A closer inspection reveals that loans became stagnant around 1993, but continued to increase until around 1998, then began to decrease until 2004. The graph shows a recovery after 2005. The dotted line in Figure 2 represents the bank credit of commercial banks in the U.S. since 1973, which shows a monotonic upward trend. However, as shown in Figure 1, this trend became stagnant after April 2008, suggesting that the United States has been facing a sharp decline of outstanding loans as of July 2008. Thus, it is important for us to ask what we can learn from the nightmarish events of financial distress in Japan in the 1990s.
When Japan faced this remarkable stagnancy of loans in the 1990s, it was said that firms, especially small and medium sized firms, were in trouble because their applications for loans had been refused by banks. The general opinion, including that of the Diet, the government and the media, was that the banks were to blame, and that the problem stemmed from the banks’ reluctance to advance loans.
Some economists attributed the Japanese depression of the 1990s to the fall in stock prices, which decreased banks’ assets, which, in turn, impaired their capital, so that they were compelled to compress loans in order to clear the BIS regulation. A fall in land prices may have been another cause: it decreased the values of collateral and banks suffered losses due to the bankruptcy of their borrowers. Thus, Japan fell into a vicious circle: an increase in the bankruptcy of borrowers, together with a fall of land prices, increased nonperforming loans, which in turn caused the banks to reduce their loans to firms, i.e., it led to a credit crunch. Conversely, the credit crunch increased the bankruptcy of borrowers and worsened the Japanese economy. In order to end this vicious circle, the Japanese government injected a huge amount of public funds into banks in 1998 and 1999.
However, the problem is not so simple. The decrease in the amount of loans may come from the demand side, not from the supply side. Because the Japanese economy was in a serious slump and the loan interest rate was falling throughout the 1990s, this view is highly convincing. If this is the case, it is necessary to increase the demand for loans by raising the firms’ effective demand to revitalize the slumped Japanese economy. A measure to support banks, such as injection of public funds, can only have a limited effect on raising the loan amount.
This paper aims to elucidate which side, supply or demand, caused a decrease in loans in Japan in the 1990s. As will be explained in the next section, almost all of the previous studies on the credit crunch have focused on the effects of own capital ratios and nonperforming loans on the supply of loans, disregarding the demand side of loans. Even if the effect is found, it may still be true that raising the demand for loans is the key to recovery. This paper is unique in estimating the shifts of both the supply and demand functions to explicate which side primarily caused the decrease in loans, and in investigating the factors that caused the shifts of those functions. Using a prefectural panel data set, this paper also tries to clarify whether the credit crunch hit the Japanese economy uniformly or whether it affected only specific regions.
The rest of the paper is organized as follows. In the next section, we survey the literature. In section 3, we explain the analytical framework, specification of our model, estimation method and data. In section 4, we present the results and discuss them. Section 5 concludes.
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