Bank Relationships and the Misallocation of Credit

  • Peek, Joe (PI)

Grants and Contracts Details


The severe economic crisis in Japan, associated with the collapse of the Japanese stock and real estate markets and the dramatic deterioration in the health of the Japanese banking sector, represents one of the major economic events of the late twentieth century. It is even more striking because the second largest economy in the world remained stagnant for more than a decade, and even today shows no evidence of returning to the robust health that characterized most of its postwar history. Why this economic weakness has persisted for so long is an important public policy issue and has been the source of substantial speculation and debate, with problems in the financial sector likely being a key contributor. In particular, the misallocation of credit by troubled Japanese banks associated with pressures emanating from their historical ties to troubled firms may be a key contributor to the continuing stagnation of the Japanese economy. Two forms of corporate affiliations are the focus of this study: bank-centered financial (horizontal) keiretsus and the main bank system. A concern is that these corporate affiliations have subverted corporate governance, insulating firms from the discipline that otherwise would come from outside directors, shareholders, and creditors, resulting in suboptimal business and financial decisions. While previous studies have examined how these corporate affiliations affect investment decisions, stock returns, and corporate governance decisions, they have not directly examined how such affiliations impact the availability of credit. This study will utilize a unique firm-level database that enables an examination of loans to firms to determine the extent to which such finance is affected by corporate affiliations, as well as the implications for macroeconomic activity and the effectiveness of monetary policy of any such misallocation of credit. The study has three main objectives. The first, and primary, objective is to investigate the impact of main bank and keiretsu affiliations on credit allocation during periods of firm and/or bank distress. Preliminary evidence suggests that credit has been misallocated due to pressures from keiretsu and main bank ties, and that this misallocation has been allowed, and even encouraged, by government policies. The second objective is to investigate the macroeconomic implications of this credit misallocation, in particular focusing on its contribution to the continuing stagnation of economic activity in Japan. The third objective is to investigate the contribution of the troubled banking sector to the breakdown of the monetary policy transmission mechanism, and thus to the inability of monetary policy to restart the Japanese economy. This study has important implications for appropriate policies to deal with banking crises, as well as the costs of inappropriate policies. If scarce credit is allocated to uncompetitive and troubled firms, Japan will not experience the natural cleansing which results from the major restructuring that typically occurs in an economic downturn, with the consequence that longer-run economic growth may be reduced. In that instance, it may not be that economic growth is stifled from too little overall credit, but rather from scarce credit being allocated to firms with the least productive investment opportunities. When this misallocation of credit is combined with declining total domestic bank loans due to pressures on banks having difficulties achieving their capital requirements, the transmission of monetary policy can be short-circuited. Furthermore, given that the Japanese economy remains the second largest in the world, resolving the crisis is important for the economic prospects for other countries, especially those in East Asia.
Effective start/end date8/1/027/31/05


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