The fall in lending to Keiretsus


Japan liberalized its financial system in the 1980s. As part of this deregulation, firms reduced their borrowing from banks. The HK hypothesis is that large and well- known firms substantially reduced their dependence on bank financing by issuing bonds during the 1980s (with the market substituting reputation for monitoring). In contrast, the “good opportunities” hypothesis implies that banks chose to move away from keiretsus to the more promising real estate sector.

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In this section, I briefly summarize existing evidence for the HK hypothesis, i.e., the idea that the development of the Japanese corporate bond market caused an exogenous fall in demand for bank loans, which then fueled an increase in bank real estate lending (as shown in Figure 1). I then present new evidence consistent with the HK hypothesis using both bank-level and firm-level data.

1.1 Previous Literature

Hoshi and Kashyap articulate their view in several papers, drawing several stylized facts from data on publicly traded Japanese firms (Hoshi and Kashyap 2000, 2001). First, there was a substantial decrease in bank borrowing among large firms, and particularly manufacturing firms. The ratio of bank debt to total assets for large

FIG. 1. Keiretsu Loans, Loans to Listed Firms, and Loans to Real Estate Sector (as a Share of Total Loans, All Banks, Average).

NOTES: Source: The keiretsu loans and loans to listed firms were provided by Takeo Hoshi, who compiled them from Keizai Chosakai, Kin’yu Kikan no Toyushi (Investment and Loans by Financial Institutions), various issues. The real estate loans and the total loans come from the Nikkei NEEDS database.


manufacturing firms fell from 0.35 in the 1970s to below 0.15 by 1990. Second, firms replaced bank loans with bond financing. Third, the shift appears to have occurred relatively soon after they became eligible to do so. There was rationing in the corporate bond market prior to 1976. Beginning that year, a firm could issue as many bonds as it chose provided that it met specific accounting criteria (see the Appendix and Table A3 for details). Hoshi and Kashyap also find that banks which relied more heavily on customers with access to capital markets subsequently under-performed compared with other banks.

Hoshi (2001) tests the hypothesis in two steps using individual bank data. He finds that banks that increased the proportion of loans to the real estate sector during the 1980s ended up with a higher non-performing loan ratio in 1998. He then uses a panel of 150 banks to regress the change in a bank’s real estate loan ratio on lagged changes in keiretsu loan ratios, controlling for land prices and year effects. Banks experiencing a greater decline in their keiretsu loan share subsequently increased their real estate loans during the 1980s. Although this offers support for the HK view, it does not rule out the “good opportunities” view. It is better to distinguish between the two hypotheses using firm data, and I will take this up in Section 1.2 below.

Hoshi, Kashyap, and Scharfstein (1993) document that the share of bank debt for the 112 firms that were permitted to continuously issue convertible bonds from 1982 to 1989 was lower and increasingly so as compared with the remaining 424 firms in their sample. Weinstein and Yafeh (1998) emphasize the holdup problem of firms by banks prior to liberalization. They find that although close bank-firm ties increase the availability of capital to manufacturing firms, the associated cost of capital is higher. Much of the difference in capital use between affiliated and unaffiliated firms disappeared by 1981. They interpret this as evidence supporting the importance of the liberalization of the foreign exchange law in 1980.

Even if firms reduced their borrowing from banks in favor of bond markets, it does not fully explain the shift of banks to real estate. Faced with a decrease in demand for bank loans from keiretsus, other alternatives include looking for other loans, investing in government bonds, seeking foreign opportunities, or choosing to reduce deposit rates and shrink in size. These possibilities are considered in Section 1.2, but first I summarize the existing literature.

Hoshi and Kashyap argue that gradual deregulation, combined with the policy of limited liability, can explain why banks did not shrink as they lost their keiretsu customers. One implication of the gradual deregulation was that households had limited savings options and continued to channel their funds to banks. When combined with interest rate controls to ensure positive profit margins and a policy of government deposit guarantees, banks attempted to make up through volume the decrease in margins during this period. The “convoy” system in Japan ensured that no bank was allowed to go bankrupt. Therefore the government assumed banks’ credit risk. As the main bank system receded in importance, it was not effectively replaced with a proper regulatory system to evaluate and monitor risk-taking by banks. Further implications of deregulation are highlighted in the Appendix. Variations of these arguments are

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