Revised article published in American Economic Review 87, no. 4 (September 1997): 495-505.
One of the more dramatic financial events of the late 1980s and early 1990s was the surge in Japanese stock prices that was immediately followed by a very sharp decline of more than 50 percent. While the unprecedented fluctuations in Japanese stock prices were domestic financial shocks, the unique institutional characteristics of the Japanese economy produce a framework that is particularly suited to transmit shocks to other countries through the behavior of the Japanese banking system.
The large size of Japanese bank lending operations in the United States enables us to use U.S. banking data to investigate the extent to which this domestic Japanese financial shock was transmitted to the United States, as well as to identify a supply shock to U.S. bank lending that is independent to U.S. loan demand. We find that binding risk-based capital requirements associated with the decline in the Japanese stock market resulted in a decline in commercial lending by Japanese banks that was both economically and statistically significant. This finding has added importance given the severe real estate problems currently faced by Japanese banks. How Japanese regulators choose to resolve these problems will have significant implications for credit availability in the United States as well as in other countries with a significant Japanese bank presence.