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

51 Pages Posted: 15 Mar 2007

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: Janurary 2007

Abstract

This paper shows how main bank rent extraction affects corporate decisions about investment and financing and then the banking system itself under changing contracting conditions. Interestingly, during the transition from a relationship-oriented financial system to a transaction-based competitive system, an equity market boom can ominously increase bank risk. More precisely, 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 bank capital, even when new equity is available to the firm. Abundant bank capital facilitates overinvestment to the detriment of firm profitability. The shift of control rights back to the firm thanks to the financial deregulation undercuts the bank influence only to erode its loan quality, because the ex ante rational bank is left financing projects with higher downside risk. The high-flying equity market further lowers the asymmetric information 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 in a dynamic perspective 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 (Janurary 2007). Available at SSRN: https://ssrn.com/abstract=970054 or http://dx.doi.org/10.2139/ssrn.970054

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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