The Ministry of Finance and the disclosure of bad debts in Japan: A model

Abstract

The reluctance of The Ministry of Finance (MOF) to disclose non-performing loans in the banking industry caused a delay in its rescue operations and, as a result, exacerbated the financial crisis in Japan in the 1990s. This paper attempts to answer the question of why the MOF balked at disclosing the bad loan problem. We focus on the reputation concern of the MOF, and develop a model which explores factors that prevented the MOF from truth-telling. The model predicts that the reputation effect might be high in booms and low in recessions. Indeed, the MOF was beginning to announce the amount of bad loans after the economy had entered a recession. The model also enables us to assess the recent development of the Japanese financial system from the perspective of reputation effects.