Does a Large Loss of Bank Capital Cause Evergreening? Evidence from Japan

Abstract Using the real estate lending share of the bank's loan portfolios at the peak of the Japanese asset price bubble as an instrument for bank capital, we identify the impact of capital adequacy on the allocation of bank lending between low quality and high quality borrowers. We find that, in FY 1997, a large loss of capital resulting from the regulator's tougher stance towards banks induced the banks to reallocate their lending portfolios toward low quality borrowers