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Transmission of Liquidity Shock to Bank Credit: Evidence from the Deposit Insurance Reform in Japan

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Author Info
Masami Imai () (Department of Economics, Wesleyan University)
Seitaro Takarabe
Abstract

Finding the causal effects of liquidity shocks on credit supply is complicated by the endogenous relation between loan demand and liquidity position of banks. This paper attempts to overcome this problem by exploiting, as a natural experiment, the exogenous deposit outflow prompted by the removal of a blanket deposit guarantee on time deposits in Japan. We find that just as the government placed a cap on insurance for time deposits in 2002, weak banks suffered from a large outflow of partially insured time deposits. More importantly, we find that those weak banks were not able to raise a sufficient amount of fully insured ordinary deposits to make up for the loss of time deposits, which, consequently, forced them to cut back on loan supply. These results are consistent with the theory that the imperfect substitutability of insured deposits and uninsured deposits affects the tightness of banks’ financing constraints and ultimately the supply of bank loans.

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Paper provided by Wesleyan University, Department of Economics in its series Wesleyan Economics Working Papers with number 2009-001.

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Length: 48 pages
Date of creation: May 2009
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Handle: RePEc:wes:weswpa:2009-001

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Related research
Keywords: Deposit Insurance; Bank Lending Channel; Japan; Natural Experiment;

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Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages

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