The Emergence of a Parallel World: The Misperception Problem for Bank Balance Sheet Risk and Lending Behavior

We examine the reason that there have coexisted two opposing views on distressed banks' lending behavior in Japan's post-bubble period: one is stagnant a capital crunch and other forbearance to low-quality borrowers. To this end, we address measurement problem for bank balance sheet risk. identify credit supply allocation effects of loan equation specified at level, thereby finding ``parallel worlds'', or views, emerge because regulatory does not reflect actual condition increased risk sheet, while market value does. By uncovering engagement patching-up period, show lowly capitalized banks had difficulty building up adequate equity their exposure decreased overall credits. The parallels world can whenever are allowed overvalue assets with discretion, as Japan' period.