Bank recapitalization in the U.S. - lessons from Japan

This study empirically investigates the effectiveness of the Capital Purchase Program (CPP), the centerpiece of the United States 700 billion dollar policy response to the global financial crisis of 2008. We frame our analysis of the United States policy response against the backdrop of Japan’s banking crisis and policy response in the late 1990s. As one of the only advanced economies with a large global presence in international finance, Japan’s banking crisis of 1997 and the effectiveness of the policy response offered important lessons to U.S. policymakers in 2008. Based on empirical studies of Japan’s bank recapitalization program, we distill the most crucial lessons to be the importance of speed, adequate scale and customized restructuring in forming recapitalization packages. The United States and other economies affected by the 2008 global crisis took this first lesson to heart and reacted with unprecedented speed to events in the Autumn of 2008. But despite the large headline figure of 700 billion dollars, the program was not of adequate scale and was actually smaller than Japan’s recapitalization program of 1997-1998 in relative terms. More critically, program implementation in the first year was standardized and there was no investigation into the recipient banks’ business plans or financial condition to allow restructuring to be tailored to each individual recipient bank. These latter two points significantly hampered the effectiveness of the bank recapitalization program. Our findings demonstrate that the program was successful in achieving at least one policy objective of the program: boosting recipient banks regulatory capital ratios. But we find that the program failed to achieve another important policy objective, to stimulate bank lending. To the contrary, we find evidence that recipient banks reduced lending, presumably because of the pressure to cut highly risk-weighted assets in order to increase their capital adequacy ratios. Although encouraging banks to increase bad loan write-offs was not ...