The Impacts of "Shock Therapy" under a Banking Crisis: Experiences from Three Large Bank Failures in Japan (Subsequently published in "Japanese Economic Review" Vol. 57, No. 2 (Jan. 2006), pp.232-246. )

Abstract

A bank failure can have various adverse consequences for the clients. The adverse impacts might, however, differ depending on who takes over the operation of the failed banks. In this paper, we show that how to manage the new banks is important in mitigating the short-run and long-run consequences of bank failures. In the analysis, we focus on clients of three large failed Japanese banks - Hokkaido Takushoku Bank, the Long-term Credit Bank of Japan (LTCB), and the Nippon Credit Bank. We examine when the number of bankruptcies increased and how the market valuation changed for the client firms after the banks' operations were taken over by new banks. As for the clients of LTCB, there were dramatic increases of bankruptcies in the short-run but the surviving clients showed significant recovery of their stock prices. In contrast, as for the clients of the other two banks, there was neither dramatic increase of bankruptcies nor significant recovery of their stock prices. The result implies that "shock therapy" or "soft budget constraints" had dramatically different consequences in solving bad loan problems in Japan.