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The Credit Risk of Japanese Banks during the Bubble Period: A Pilot Study of Macro Stress Simulation

by Tokiko Shimizu of the Bank of Japan, and
Shigenori Shiratsuka of the Bank of Japan

October 2000

Abstract:  This paper estimates the aggregate credit risk inherent in the loan portfolio of Japanese banks during the bubble period. The estimation results suggest that, if a sufficiently prudent (or forecastable from the theoretical relationships observed in the past) scenario could have been projected for the probability of bankruptcy, the concentration of credit and the future fluctuation of collateral prices at the end of fiscal 1989, the magnitude of non-performing loans currently held by Japanese banks could have been predicted. Of course, it is a matter of debate whether or not individual banks could have projected such a scenario at that time. However, there is a close relationship among the three risk factors used in the simulation, namely, (1) concentration of credit in the real estate and related industries, (2) correction of the deviation of land prices from their theoretical values, and (3) deterioration of the credit situation of the real estate and related industries, such that the first risk factor leads to the second risk factor, which in turn results in the third risk factor after a fall in land prices reduces the value of collateral. This suggests the tremendous usefulness of developing and improving a methodology to measure risk from the past relationships. From this standpoint, there is a need to further develop the type of research conducted in the paper, namely, that in which the methodology of risk analysis in the finance literature is combined with the results of macroeconomic research concerning the future anticipated fluctuations of real economic activities.

JEL Classification: G10, G11, G21.

Keywords: Credit Risk, Extended Value at Risk, Macro Stress Simulation, Asset, Price Bubble, Macro Prudential Policy.

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