Prudential Regulation and the “Credit Crunch”: Evidence from Japan


  • I owe gratitude to Ben Bernanke for his continuous advice, support, and extensive comments and discussions. I also thank Han Hong, Charles Yuji Horioka, Takeo Hoshi, Yukinobu Kitamura, Jean-Phillip Laforte, Guido Lorenzoni, Takafumi Kaneko, Anil K. Kashyap, Daiji Kawaguchi, Yoichi Nemoto, Kazuo Ogawa, Gary Saxonhouse, Michael Woodford and an anonymous referee. Thanks also to seminar and conference participants at the Princeton Macro/International Student Workshop, Osaka University, Bank of Japan, Keio University, Kobe University, Hitotsubashi University, Tsukuba University, National Graduate Research Institute for Policy Studies, and the NBER Japan Project Meeting for many useful comments and suggestions. Financial support from the Economics Department of Princeton University and the Zengin Foundation is gratefully acknowledged. Any possible errors in the pages that follow are my own.


The underlying causes of sharp declines in bank lending during recessions in large developed economies, as exemplified by the U.S. in the early 1990s and Japan in the late 1990s, are still being debated due to the lack of any convincing identification strategy of the supply side capital–lending relationship from lending demand. Using within bank share of real estate lending in the late 1980s as an instrumental variable for bank capital, we find that Japanese banks cut back on their lending in response to a large loss of bank capital in fiscal year 1997.