Capital requirement and financial crisis: The case of Japan and the 1997 Asian crisis

This study investigates the direct link between the implementation of the 1988 Basel capital requirement in Japan and the shrinkage of banks’ foreign assets, particularly in Thailand in the 1990s. The empirical analysis proceeds in two stages. The first stage investigates the hypothesis that the capital crunch in Japan induced Japanese banks to alter their portfolios and reduce their foreign assets. The second step tests the hypothesis that the change in behaviour of the Japanese banks induced the increase of the probability of financial crisis in Asia. Our results support the responsibility of the Japanese capital requirement, among other factors, in triggering the 1997 Asian financial crisis as an external common shock and give a new angle on the financial crisis literature.