Can Bank Health Affect Investment? Evidence from Japan

Does weakness in the banking sector adversely affect the real economy? If so, how large is the effect? In this article, the author answers these questions for Japan in 1991-92. He tests whether a firm's investment is sensitive to the financial health of its main bank, controlling for stock market valuation and cash flow. Investment is lower by 30 percent at firms that have one of the lowest-rated banks as their main bank. Because the weakest banks deal with few firms, the estimated effect of the problems in the banking sector on the Japanese economy during this period is small.