An explanation of Main Bank relationship in Japan

This paper investigates whether there has been risk-sharing between banks and
borrowing companies through the main bank relationship in Japan. The paper will
discuss, if the main bank relationship is based upon a mechanism of
risk-sharing, changes in the relationship ought to be systematically related to
changes in the risk that borrowing companies face. And also, it will discuss the
importance of the main bank relationship as a means of risk-sharing by comparing
the correlation between financial expenses and the operating profits of specific
companies with the degree of their dependence on main banks.

First, it is necessary to define what a Japanese “main bank” is. The “main
bank” is defined as the “financial group” (“kinyu keiretsu” in
japanese) in the paper. “Financial group” is defined in principle by the
amount of financing that a bank supplies to a particular borrowing company. When
a given company has taken out the largest amount of loans from a particular bank
for the past three or more years consecutively, the company is viewed as
belonging to that bank’s “financial group.” Nearly all the companies
listed in the first section of Tokyo Stock Exchange have a main bank. However,
these companies borrow not just from their main bank, but from a large number of
other banks and financial institution as well. While the main bank is an
important lender, the company must also rely on loans from the main bank’s
competitors which in sum far exceed those from the main bank itself.

Although the generally accepted notion among researchers in that the main
bank relationship in Japan is extremely stable, this evidence suggests that the
Japanese main bank is one of much more fluidity than has been generally
believed. Now, the paper presents some factors that might account for the actual
changing patterns of main bank affiliations. These factors are (a) the
uncertainty of companies’ operating performance, assuming the main bank
relationship serves an important function of risk-sharing between companies and
banks, it can be derived that an increase in the uncertainty of the business
environment for a specific industry should decrease the proportion of companies
that change their main bank, thus, changes in main bank affiliation will be
systematically related to changes in the uncertainty of the performance of
corporate borrowers; (b) the history of the main bank relationship, as the
accumulated value of the main bank relationship is assumed to be positively
correlated with the duration of the relationship, the longer a company has
continued to maintain a main bank relationship with a specific bank, ceteris
paribus, the less likely the company is to break that relationship off; this
proposition concerning the changeableness of the main bank relationship is also
a testable one; (c) the growth of the borrowing companies, it can be regarded as
related to main bank changes in 2 ways: first, the growth of a company raise its
reputation and credibility in financial market so that the lenders don’t need
to spend much information cost to confirm its credit, if the main bank
relationship means economizing on information costs, we can expect those
companies have achieved relatively rapid growth to show more tendencies to leave
main bank relationships that those that have been stagnant; second, rapidly
growing companies will tend to switch their main bank relationships to large
banks as it’s easy to accommodate their customer’s expanding demands for
diversified financial services.and (d) the “leading bank” factor, since the
leading banks have capability of supplying a larger variety of services,
including financial services overseas, they tend to increase their shares in
main bank relationships.

There is a type of contingency claim between banks and the borrowing
companies which are in their financial groups. Namely, the lending rate remains
relatively low when the market rate rises, and the rate stays relatively high
when the market rate fails. Through this sort of contract, the borrowers are
able to some extent to avoid the risk of movements in the market interest rate.
There is another study supports the hypothesis that in the Japanese bank loan
market, banks and firms share risks through loan contract arrangement. They even
say that some part of the loan interest rate rigidity in Japan can be explained
by the implicit contracts between banks and borrowing companies.

However, the stabilization of interest expenses does not necessarily imply
the stabilization of the borrowing companies’ operating performance. This
becomes clearer if we consider the next set of accounting equations for the
Japanese company: (operating profits)+(non-operating revenues)-(non-operating
expenses)=(ordinary profits); (ordinary profits)+(extraordinary profit and loss
+ special retained funds)-(corporation taxes)= profits for the period.

In Japan, more