Understanding the Rise and Decline of the Japanese Main Bank System: The Changing Effects of Bank Rent Extraction

55 Pages Posted: 15 Mar 2010

See all articles by Xueping Wu

Xueping Wu

City University of Hong Kong (CityU) - Department of Economics & Finance

Jun Yao

Hong Kong Polytechnic University

Multiple version iconThere are 3 versions of this paper

Date Written: March 15, 2010

Abstract

This paper shows how main bank rent extraction affects corporate decisions about investment and financing in a changing regulatory environment, and how an equity market boom can ominously increase bank risk during the transition from a relationship-oriented financial system to a transaction-based competitive system. Our model predicts that main bank control tends to produce overinvestment by the client firm. This overinvestment, however, is initially contained by the shortage of loanable funds, even when new equity is available to the firm. Abundant loanable funds facilitate overinvestment to the detriment of firm profitability. The shift of control rights back to the firm due to the financial deregulation undercuts the bank influence only to increase bank risk, because the ex ante rational bank is left financing projects with higher downside risk. The high-flying equity market further lowers costs of new equity and aggravates the “equity for growth and bank debt for downside risk” bias. This makes the bank harder than ever to diversify its risk. The insights of this paper help shed light on why Japan’s main bank system was beneficial in the postwar (capital constrained) period, but became harmful during the (capital abundant and bubble-laden) 1980s, and why the adverse shocks of the post-deregulation 1990s had such severe effects on the banking system.

Keywords: Main Bank, Rent Extraction, Investment Efficiency, Financing, Bank Risk

JEL Classification: G21, G28, G30, G32

Suggested Citation

Wu, Xueping and Yao, Jun, Understanding the Rise and Decline of the Japanese Main Bank System: The Changing Effects of Bank Rent Extraction (March 15, 2010). Available at SSRN: https://ssrn.com/abstract=1569987 or http://dx.doi.org/10.2139/ssrn.1569987

Xueping Wu

City University of Hong Kong (CityU) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
+852 3442 7577 (Phone)
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HOME PAGE: http://personal.cityu.edu.hk/~efxpwu/

Jun Yao (Contact Author)

Hong Kong Polytechnic University ( email )

Hung Hom, Kowloon
Hong Kong

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