As for recent Japanese bank behavior, there exist two inefficacies. One is credit crunch, that is, banks hesitate to lend money to new good projects. The other is excessive additional loan to bad-performing firms. These two perverse bank behaviors look like contradictive each other. In this paper, we explain these contradictive behaviors stem from the violation of the absolute priority rule (APR) among the stakeholders in Japan.
Under the legal violation of priority rule, the borrowers with inefficient projects can finance from a new junior creditor, transferring the credit value of the senior creditor to the new junior one. In such a situation, it is the best behavior for the senior creditor, i.e. bank, which tries to protect the value of his senior credit, to finance the inefficient project by himself before the junior creditor might lend money.
This behavior implies inefficient excessive additional loan. Furthermore, since banks expect not to avoid such ex-post inefficiency and the accompanied loss due to the violation of APR, they are unwilling to lend to the originally efficient project in ex-ante. This results in credit crunch.