Impacts of the BIS regulation on the Japanese economy

The Japanese economy in the 1990s is a typical example of “pro-cyclical effect” of the BIS regulation. The regulatory authority tried to mitigate its negative impacts by enlarging the definition of Tier II category of the bank capital. Finally, the authority bailed out all major banks by providing the public money to maintain the BIS capital ratio. This unprecedented difficulty of the banking system to supply credit gave negative impacts to the future prospects of the economy, which resulted in the reduced demand for bank loans. It contributed to a reduction of the money supply, leading to the prolonged deflation and recession. It took a long time to recover the public confidence in the banking system. Due to the enlarged definition of the BIS capital, the BIS capital ratio of Japanese banks were consistently cleared the 8% level. On the contrary, the market-valued capital ratio, which is theoretically more straightforward than the BIS capital ratio, sensitively reflects the bank's soundness responding to the bad loan ratio and the ROA. The market-valued capital ratio is the more accurate measure of the bank soundness even for the regulatory purposes.