Impaired Bank Health and Default Risk

Empirical studies in corporate finance have long been interested in the role of bank in reducing the costs of financial distress. In my recent paper, I investigated how various measures of bank health as well as defaults of major trading partners affected probability of bankruptcy of medium size firms in Japan. Using probit models, we examined the causes of bankruptcy for unlisted Japanese companies in the late 1990s and the early 2000s. The environment and events in Japan provide a “natural experiment” that allows the empirical test. We found that several measures on bank-specific financial health had significant impacts on borrower’s probability of bankruptcy, even when observable characteristics relating to these borrower’s financial variables were controlled. In particular, a close bank-firm relationship, which usually reduces the probability of bankruptcy, exacerbated the impacts under the financial crisis that damaged the bank health measures substantially.