This in main bank affiliation will besystematically related
This paper investigates whether there has been risk-sharing between banks andborrowing companies through the main bank relationship in Japan. The paper willdiscuss, if the main bank relationship is based upon a mechanism ofrisk-sharing, changes in the relationship ought to be systematically related tochanges in the risk that borrowing companies face. And also, it will discuss theimportance of the main bank relationship as a means of risk-sharing by comparingthe correlation between financial expenses and the operating profits of specificcompanies with the degree of their dependence on main banks.
First, it is necessary to define what a Japanese main bank is. The mainbank is defined as the financial group (kinyu keiretsu injapanese) in the paper. Financial group is defined in principle by theamount of financing that a bank supplies to a particular borrowing company.
Whena given company has taken out the largest amount of loans from a particular bankfor the past three or more years consecutively, the company is viewed asbelonging to that banks financial group. Nearly all the companieslisted 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 ofother banks and financial institution as well. While the main bank is animportant lender, the company must also rely on loans from the main bankscompetitors which in sum far exceed those from the main bank itself.Although the generally accepted notion among researchers in that the mainbank relationship in Japan is extremely stable, this evidence suggests that theJapanese main bank is one of much more fluidity than has been generallybelieved. Now, the paper presents some factors that might account for the actualchanging patterns of main bank affiliations. These factors are (a) theuncertainty of companies operating performance, assuming the main bankrelationship serves an important function of risk-sharing between companies andbanks, it can be derived that an increase in the uncertainty of the businessenvironment for a specific industry should decrease the proportion of companiesthat change their main bank, thus, changes in main bank affiliation will besystematically related to changes in the uncertainty of the performance ofcorporate borrowers; (b) the history of the main bank relationship, as theaccumulated value of the main bank relationship is assumed to be positivelycorrelated with the duration of the relationship, the longer a company hascontinued to maintain a main bank relationship with a specific bank, ceterisparibus, the less likely the company is to break that relationship off; thisproposition concerning the changeableness of the main bank relationship is alsoa testable one; (c) the growth of the borrowing companies, it can be regarded asrelated to main bank changes in 2 ways: first, the growth of a company raise itsreputation and credibility in financial market so that the lenders dont needto spend much information cost to confirm its credit, if the main bankrelationship means economizing on information costs, we can expect thosecompanies have achieved relatively rapid growth to show more tendencies to leavemain bank relationships that those that have been stagnant; second, rapidlygrowing companies will tend to switch their main bank relationships to largebanks as its easy to accommodate their customers expanding demands fordiversified financial services.
and (d) the leading bank factor, since theleading banks have capability of supplying a larger variety of services,including financial services overseas, they tend to increase their shares inmain bank relationships.There is a type of contingency claim between banks and the borrowingcompanies which are in their financial groups. Namely, the lending rate remainsrelatively low when the market rate rises, and the rate stays relatively highwhen the market rate fails.
Through this sort of contract, the borrowers areable 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 loanmarket, banks and firms share risks through loan contract arrangement. They evensay that some part of the loan interest rate rigidity in Japan can be explainedby the implicit contracts between banks and borrowing companies.However, the stabilization of interest expenses does not necessarily implythe stabilization of the borrowing companies operating performance. Thisbecomes clearer if we consider the next set of accounting equations for theJapanese company: (operating profits)+(non-operating revenues)-(non-operatingexpenses)=(ordinary profits); (ordinary profits)+(extraordinary profit and loss+ special retained funds)-(corporation taxes)= profits for the period.In Japan, more than 80%of non-operating expenses is occupied by financialexpenses, and almost all of these financial expenses are composed of interestpayments and discounting fees.
And so, if the corporate objective were really tomaintain the stability of ordinary or net profits, then financial expenses suchas interest payments should move in a manner which to some extent offsetsmovements in operating profits. Only in this manner, rather than through thestabilization of interest payments, would changes in operating profits be lesslikely to destabilize net profits. In fact, it is possible to imagine cases inwhich the stabilization of interest expenses, far from stabilizing net profits,actually increase their volatility.
In this sense, if the main bank relationship actually serves to diversifyrisk, we should observe financial expenses of client companies being adjusted tooffet shifts in their operating profits. In the periods when the operatingprofits of companies are relatively low, we should observe manifestation of animplicit contract that lowers their financial expenses, so that a large-scaledrop in the net profits that the company can claim is averted. The effectiveborrowing rate of interest for the company is not the contracted face value rateof interest, but the effective rate of interest that takes into accountthe interest rate of the compensatory balances.
If financial expenses areadjusted according to the above-hypothesized implicit contract mechanism, theinterest revenues the borrowing company gains from its deposits must also bepart of this mechanism.But, these interest revenues are included in the category of non-operatingrevenues. Among such non-operating revenues are included the capital gainsrealized from the sales of securities owed by the borrowing company. Companieswhose operating profits have drastically fallen often sell the securities theyown as a method of restraining the fall of business profits; this device itselfhave no direct connection with whether risk-sharing exists through the main bankmechanism.
The point of the paper was to investigate whether or not the main bankrelationship in Japan actually performs a risk-sharing function. It investigatedthis issue from two angles. The first was to examine the relationship betweenchanges in main bank affiliations and changes in the uncertainty that borrowingcompanies were confronted with.
The second was to examine whether the main bankrelationship actually contributed to offsetting movements in the operatingperformance of individual companies. Both of these examinations suggest negativeconclusion; in general, no systematic relationships can be observed which wouldindicate the existence of risk-sharing between main banks and their majorcustomers.Category: Business