Bank lending and bank-firm relationships in Japan

This dissertation studies two topics: the causes and effects of credit misallocation by Japanese banks in the 1990s and the evaluation of bank-led rescues of financially distressed firms. Chapter 1 explains why Japanese banks shifted their loan portfolio toward the real estate sector during the 1990s despite the downtrend of land prices. I argue that this phenomenon can be explained by the risk-shifting incentives of banks due to the deposit insurance system and/or the implicit bail-out guarantee by the government. I identify a novel non-linear relationship between bank capital and portfolio risk: banks respond to a significant capital loss by increasing their portfolio risk if franchise value is sufficiently low and by decreasing it if franchise value is sufficiently high. My theoretical predictions are supported by the data from Japanese banks. I also find that recapitalization by issuing subordinated debts helped banks recover their capital loss and mitigated an economy-wide credit crunch, but consequently allowed them to increase real estate loans and worsened the bad loan problems. Chapter 2 explores whether bank credit allocation can affect real economic activity in a banking crisis. I theoretically show that the risk-shifting incentives, together with the lending constraint due to the capital requirement, could cause the credit crunch in less risky industries. Using a large matched sample of banks and firms in Japan, I provide evidence that investment by non-bond issuing manufacturing firms was undermined by the inefficient credit allocation by their main banks. I use the real estate loan ratio as a proxy for credit misallocation since increased holdings of real estate loans by banks significantly worsened bad loan problems in the 1990s. Chapter 3 challenges the conventional view that Japanese banks monitor and discipline client firms in financial distress. I argue that managers of the firms with strong bank ties may do away with corporate restructuring by relying on financial support from their main bank. I find that main bank client firms in financial distress retrenched expenses and improved corporate performance significantly less than the firms without close bank ties in the heyday of the main bank system.