The Effect of Bank Credit on Asset Prices:
Evidence from the Japanese Real Estate
Boom during the 1980s
This paper studies whether bank credit fuels asset prices. Financial dereg- ulation during the 1980s allowed keiretsus to obtain finance publicly and reduce their dependence on banks. Banks that lost these blue-chip customers increased their property lending, and serve as an instrument for the supply of real estate loans. Using this instrument, I find that a 0.01 increase in a prefecture’s real estate loans as a share of total loans causes 14–20% higher land inflation compared with other prefectures over the 1981–91 period. The timing of losses of keiretsu customers also coincides with subsequent land inflation in a prefecture.
JEL codes: E44, G21, G28 Keywords: bank credit, asset prices, financial regulation.
THE PURPOSE OF THIS paper is to determine whether bank credit affects asset prices. The Japanese real estate boom during the 1980s provides a unique episode to help answer this question. In particular, this paper studies the extent to which an exogenous shock to the supply of bank credit fuels land prices. I show that I have an instrument for the supply of real estate loans, which is the decrease in banks’ loans to keiretsu firms beginning in the early 1980s. I then take advantage of the cross-sectional and time-series variation in Japan’s 47 prefectures. Using this
I am indebted to David Weinstein and Hugh Patrick for giving me the opportunity to be a visiting scholar at the Center on Japanese Economy and Business (CJEB) at Columbia Business School during the summer of 2004 and for many helpful conversations. I would like to acknowledge David Weinstein for providing me with access to the Development Bank of Japan Corporate Finance Data Set and the CJEB for providing me with access to the Nikkei NEEDS database. I thank Takeo Hoshi for sharing his data and for his initial encouragement to pursue this topic. I also benefited from comments from Ricardo Caballero, Roberto Rigobón, James Vickery, Sujit Kapadia, Deborah Lucas (the Editor), an anonymous referee, participants at the MIT International Workshop, the 22nd Symposium on Banking and Monetary Economics in Strasbourg, and the 18th Australasian Finance and Banking Conference in Sydney.
NADA MORA is an Assistant Professor in Economics Department, The American University of Beirut (E-mail: [email protected]).
Received August 8, 2005; and accepted in revised form February 22, 2007.
Journal of Money, Credit and Banking, Vol. 40, No. 1 (February 2008) C© 2008 The Ohio State University
58 : MONEY, CREDIT AND BANKING
instrument, I find that a 0.01 increase in a prefecture’s real estate loans as a share of total loans causes 14–20% higher land inflation over the 1981–91 period. The timing of losses of keiretsu customers also coincides with subsequent land inflation in a prefecture.
There is consensus in the literature on Japan that a shock in the 1980s led banks to increase lending in the real estate sector. The regulatory change that decreased the demand for loans by keiretsus is a candidate for that shock. The first part of this paper shows that lending to keiretsus declined as a result of the financial deregulation, which enabled keiretsu firms to obtain financing from the public market. This supports the Hoshi and Kashyap (2000, 2001) (hereafter HK) hypothesis, which is that large and well-known firms (mostly keiretsus) substantially reduced their dependence on bank financing by issuing bonds during the 1980s. Therefore it was a choice by firms to move away from banks. In contrast, the “good opportunities” hypothesis would imply that banks chose to move away from keiretsu firms. Real estate may have been perceived to have good opportunities, rationalizing a shift of bank lending to the real estate sector during the 1980s.1 The results of extensive tests do not suggest that this was the case in Japan.
The regulatory change during the 1980s was not the first to change the financial landscape in Japan. The history of the Japanese financial system runs contrary to the popular opinion that it is unique in its emphasis on banks. This has been a relatively recent phenomenon. The history of the system evolved as an outcome of regulatory changes, which in turn were endogenous to macroeconomic shocks. Among the more important shocks to the Japanese economy were World War II and the oil shocks in the 1970s (see Hoshi and Kashyap 2001). It is interesting that firms (including small and medium size enterprises) funded themselves mostly through the capital market from the Meiji restoration until the 1930s. For example, the share of bond and equity finance in the external sources of funds for non-financial firms reached 0.7 in 1935 (Ueda 1994). The government’s motivation to restrict competition was a result of the 1930s and war. It was at this time that the government took control of the allocation of credit and used banks to implement its preference toward funding the military. During the Japanese miracle period from the 1950s to the early 1970s, the government’s priority shifted from the military to industry. As a result, the system did not revert to the pre-war emphasis on capital markets. The savings restrictions on households guaranteed the flow of funds to the banks, which in turn channeled them to keiretsus.
It was only with the development of the Japanese corporate bond market that keiretsus decreased their demand for bank loans. I establish that this shock can be used to assess whether bank credit affects asset prices. The main part of the paper then explains the Japanese bubble in land prices and its differential impact across Japan’s prefectures using the keiretsu loan shock as an instrument. When banks lost
1. A third view emphasizes monetary factors which can be related to the “good opportunities” view. For example, Ueda (2000) argues that monetary policy was responsible for the wide swings in asset prices that caused increased bank lending toward real estate.
NADA MORA : 59
their keiretsu customers, they increased their lending to the real estate sector and that in turn fueled land prices.
Previous papers assessing why banks in Japan increased their real estate lending during the 1980s take land prices as given, overlooking the idea that the increase of bank credit in real estate may itself have contributed to aggregate land price inflation. In standard asset pricing models with no credit market imperfections, the willingness of banks to offer loans would have no impact on asset prices. Therefore, the presence of credit constraints is fundamental to the empirical analysis in this paper. Kiyotaki and Moore (1997) provide a useful frame of reference. They assign a dual role to assets: they are not just factors of production, but also serve as collateral for loans. As a result, credit limits are affected by asset prices. Therefore, a firm’s borrowing capacity and its demand for credit will be affected by changes in asset prices. A positive productivity shock causes land prices to increase and raises the net worth of firms. This allows firms to borrow more, leading to a demand for land that increases with its price.2
However, this paper is concerned with the effects of allowing for shocks to the supply of loans. In a separate note which extends the analysis in Kiyotaki and Moore (1997),3 I show that asset prices (and asset holdings) can also be affected by shocks to credit limits. A similar credit cycle is created when banks ease binding credit limits independently of firms’ net worth, allowing them to borrow more, invest more in the asset, and hence drive up the price of the asset.
Gerlach and Peng (2005) note that there can be a role for credit in asset valuations, an idea which goes back to Kindleberger (1978). This is also in the spirit of Ito and Iwaisako (1996). In a setup with asymmetric information, they show that the extent to which banks are willing to extend credit matters for projects that require acquisition of land or stocks. Using a VAR, they find that total bank loans to real estate lead the aggregate real land price in Japan, while only current land price inflation helps explain the growth of bank loans. Gerlach and Peng find instead that the direction of influence goes from demand and property prices to bank credit when looking at aggregate data from Hong Kong.
The main contribution of this paper is in isolating the effect of bank credit on real estate prices using an instrument for the supply of real estate loans. A second contribution is in applying the analysis to dis-aggregated data. The results are relevant to the current policy debate on land price inflation, and the role of banks in fueling real estate lending. The closest paper to this one is Peek and Rosengren (2000), which studies the effect of an exogenous negative loan supply shock (originating in Japan) on the United States. They find that the decline in Japanese bank lending contributed to a substantial decline in new construction projects in the US.
The rest of this paper is organized as follows: Section 1 tests whether the fall in keiretsu loans was driven by firms or banks; having determined that the evidence
2. It is for this reason that a positive productivity shock causes the constrained borrowers to demand more credit and invest more. In contrast, the first-best allocation is not affected and the only outcome is that agents increase their consumption.
3. Available on author’s website, http://alum.mit.edu/www/namora.
60 : MONEY, CREDIT AND BANKING
supports the former, Section 2 assesses whether, and to what extent, bank credit affects land prices; Section 3 concludes.
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