Page 45 - Azerbaijan State University of Economics

S.A.Najafov: Debt rigidity crisis

prices collapse (figure 1) while liabilities remain, leaving households‘ and

businesses‘ balance sheets underwater. In order to regain their financial health and

credit ratings, households and businesses to repair their balance sheets are forced to

pay down debt and refuse new borrowing. Moreover, Koo notes that even after

companies‘ and households‘ balance sheets are fully repaired they refuse to borrow

money and he connects it to debt ―trauma‖.

But we think that as borrowing assumes the fulfillment of debt in future,

Japanese lending crash is caused not by deterioration of balance sheet, but by fears of

companies that their future incomes and assets value will be insufficient to repay debt:

as companies‘ income and asset value decline during recession, debts in periods of

recession don‘t decrease; and it is downward debt rigidity that explains why private

sector in Japan pays down debts and refuses new borrowing. Banks also during

recession are less willing to lend as banks because of risks to be unable to pay debts to

depositors tighten the requirements for debtors and so decrease the lending.

Thus low lending activity in Japan is caused by downward debt rigidity that on

the one hand, makes companies less willing to borrow, and on other hand, makes

banks less willing to lend.

Thus the only way to overcome the reluctance of both firms to borrow and

banks to lend is profit participating financing. It will prevent fears of companies to

face loan default and so will make them more willing to take loan. Banks also will

be more willing to lend as participation of debtors in profit/loss of banks will

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