ESRI Discussion Paper Series No.365 The Effect of Bank Recapitalization Policy on Credit Allocation and Corporate Investment: Evidence from a Banking Crisis in Japan

This paper examines the effect of government capital injections into financially distressed banks on credit allocations and firm investment during the Japanese banking crisis. A standard investment theory suggests capital injection increases bank loans to high-productivity firms for promoting investments. In contrast, a theory of credit misallocation by Peek and Rosengren (2005) argues that banks have a perverse incentive to increase their loan supply to severely impaired firms. To assess the relative importance of these two theories, we combine the balance sheet data of Japanese manufacturing firms with that of banks and examine whether the effect of capital injections differs across different types of firms in terms of their total factor productivity (TFP) and zombie statuses. The regression analysis shows that the capital injections increased the supply of credit to two very different types of firms: high-productivity non-zombie firms and low-productivity zombie firms. On the other hand, we find that the supply of credit induced by capital injection only promotes investment by high TFP firms, but not by zombie firms. The result indicates that both mechanisms---one promoting efficient credit allocation via capital injection while the other leads to credit misallocation toward zombie firms---are quantitatively important for explaining the allocation of credits induced by Japanese government capital injections. Our analysis shows that capital injection increased the average investment rates of high-productivity firms with the 90th percentile TFP or above by 1.9 percentage points but finds no evidence that capital injection promoted investment by low-productivity zombie firms.