The Effect of Bank Recapitalization Policy on Corporate Investment: Evidence from a Banking Crisis in Japan

Abstract

This study examines the effect of government capital injections into financially troubled banks on corporate investment during the Japanese banking crisis of the late 1990s. By helping them to meet the capital requirements imposed by Japanese banking regulation, recapitalization enables banks to respond to loan demands. This, in turn, helps firms to increase their investment, especially for high-productivity firms, for which the return from investment is high. To test this mechanism empirically, combining the balance sheet data of Japanese manufacturing firms with that of banks, we examine how the impact of bank regulatory capital ratios and capital injections on bank loans and firm's investments vary across firms, depending on their total factor productivity (TFP) and financial health status. We find that the estimated interaction of a firm's TFP with a bank's capital ratio or capital injection is positive and significant, implying that the effect of capital injections on bank loans and investments is larger for high-productive firms than it is for low-productive firms. Counterfactual policy experiments suggest that capital injections made in March of 1998 and 1999 had a substantial reallocation effect, shifting investments from low- to high-productivity firms.