Bad Loans and Liquidation: The Case of Japan

We study why Japanese banks have been reluctant to write off bad loans, and why authorities have postponed action. We argue that the combination of capital requirements and asymmetric information between banks and outsiders may have given banks incentives to roll over their bad loans. Furthermore, we show that if the market for collateral is illiquid, the single bank may be less willing to write off its bad loans when the number of banks suffering from bad loans is high. We argue that the government may have postponed action because of a short time horizon.