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Preemptive Strategies for the Assessment and Management of Financial System Risk Levels: An Application to Japan with Implications for Emerging Economies

Author

Listed:
  • Theodore M. Barnhill

    (Department of Finance/Financial Markets Research Institute, The George Washington University, Washington, DC 20052, USA)

  • Panagiotis Papapanagiotou

    (Financial Markets Research Institute, The George Washington University, Washington, DC 20052, USA)

  • Marcos Rietti Souto

    (Financial Markets Research Institute, The George Washington University, Washington, DC 20052, USA;
    EEIMVR/UFF & CAFES, Brazil)

Abstract

We estimate the current potential default cost of the large amount of bad loans in the Japanese banking system to fail to range from 30 trillion yen to 45 trillion yen or higher. For many banks this would deplete at least 50% of their capital. However, it would also fix the loss and avoid potentially larger losses if weak credits continue to be supported. Using a simulation methodology, we also find that the assumed level of credit risk, equity investment, bank operating expenses, bank net interest margin, and the assumed future financial environments interact to determine future bank risk levels. If the negative financial and real estate market conditions of the recent past persist over the next three years, it is very likely that the major Japanese banks will suffer further large losses and exhaust their already low levels of capital. Alternatively, a return to a more positive economic and financial environment would moderate the risks and the cost of resolving the current problems. Nevertheless, under both scenarios, the risk of further bank failures appears to be substantial and additional large capital infusions will likely be needed to avoid losses by depositors. The implications of this analysis for emerging economies, center on the management and regulation of financial institutions in countries where financial market regulatory structures are in a state of change and asset price bubbles also occur.

Suggested Citation

  • Theodore M. Barnhill & Panagiotis Papapanagiotou & Marcos Rietti Souto, 2004. "Preemptive Strategies for the Assessment and Management of Financial System Risk Levels: An Application to Japan with Implications for Emerging Economies," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 7(01), pages 1-42.
  • Handle: RePEc:wsi:rpbfmp:v:07:y:2004:i:01:n:s0219091504000056
    DOI: 10.1142/S0219091504000056
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    References listed on IDEAS

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    1. Takeo Hoshi & Anil Kashyap, 2000. "The Japanese Banking Crisis: Where Did It Come From and How Will It End?," NBER Chapters, in: NBER Macroeconomics Annual 1999, Volume 14, pages 129-212, National Bureau of Economic Research, Inc.
    2. Joe Peek & Eric Rosengren, 1997. "Collateral damage: effects of the Japanese real estate collapse on credit availability and real activity in the United States," Working Papers 97-5, Federal Reserve Bank of Boston.
    3. Mr. David Woo & Mr. Akihiro Kanaya, 2000. "The Japanese Banking Crisis of the 1990's: Sources and Lessons," IMF Working Papers 2000/007, International Monetary Fund.
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    Cited by:

    1. Barnhill, Theodore M. & Souto, Marcos Rietti, 2008. "Systemic bank risk in Brazil: an assessment of correlated market, credit, sovereign and inter-bank risk in an environment with stochastic volatilities and correlations," Discussion Paper Series 2: Banking and Financial Studies 2008,13, Deutsche Bundesbank.

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    More about this item

    Keywords

    Market and credit risks; bank modeling; Japan crisis;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance

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