Prudential Regulations and Banking Behavior in Japan

Many types of financial supervision policies have been implemented since the emergence of the financial crisis in the late 1990s, including measures to provide full deposit protection, to inject public funds into banks, to implement prompt corrective action, and to promote so-called relationship banking. This article gives an overview of these policy approaches and surveys empirical studies on financial supervision policies in Japan. The empirical studies that have attempted to assess these policies have clearly shown the following: (1) protecting full deposits may encourage banks' moral hazard, (2) prompt corrective action constrains moral hazard, and (3) the injection of sufficient amounts of public capital to compensate for capital shortfalls at individual banks may mitigate the banks' reluctance to lend, while the injection of small amounts of public capital, when not accompanied by an examination of bank assets, will fail to have the desired effects on lending. Meanwhile, relationship banking, which has been promoted by the Financial Services Agency, has been examined by empirical studies using surveys of companies, but the results of these studies have not facilitated the formation of a consensus on the matter.