Deflation, bank credit growth, and non-performing loans: Evidence from Japan

In this paper, I examine the link between bank credit growth and non-performing loans in an economy with deflationary pressures. Using panel OLS regressions and two-step GMM regressions, I find evidence for the time-varying relationship between bank credit growth and non-performing loans in a sample of 82 publicly listed commercial banks in Japan during the period 1993-2013. I show that bank credit growth positively correlates with non-performing loans prior to the onset of the global financial crisis of 2007 but negatively correlates with non-performing loans afterwards. I find evidence to support the notion that large banks drive the observed effects of credit growth on non-performing loans. In addition, credit growth and non-performing loans have no effect on profitability. Overall, the findings suggest that while the increase in the supply of bank loans increases the level of non-performing loans, it does not lead to higher profitability.