Bank failures are theorized to have adverse consequences for other firms in general, and for customers (both loan and deposit) of the failed institutions in particular. Other firms may be adversely affected, whether customers of the failed bank or not, because the failure may signal existing but yet unrecognized problems at other banks or ignite problems at other banks through spillover or contagion, and foretell adverse economic conditions for the economy in the region or nationwide. Firms that are customers of the failed institution may be relatively more adversely affected than firms that are customers of other banks because, among other things, they may lose an ongoing source of funding and need to incur the expense of search and providing financial and other information about themselves to new lenders. But all firms and bank customers may not be equally affected by bank problems and failures. The effects may be related to characteristics of the individual firm, such as its financial condition, reliance on bank credit, or industry. A number of recent studies have provided empirical evidence that bank problems and failures adversely affect the market value of a bank’s corporate borrowers, both in the United States and a number of other countries (Slovin, Sushka, and Polonchek, 1993; Yamori and Murakami, 1999; Djankov, Jindra, and Klapper, 2001; Bae, Kang, and Lim, 2002; Ongena, Smith, and Michalsen, forthcoming). This paper contributes to the literature both by providing evidence on the effects of bank failures on the banks’ loan customers in another country—Japan—and by examining whether the adverse effects on the failed bank’s customers differ from those of other, noncustomers.
This study finds that, as in previous studies, the market value of customers of the failed banks are adversely affected at the date of the failure announcements. In addition, the effects are related to the financial characteristics of the client firms. For nonfinancial firms that have a less valuable banking relationship, the less severe the adverse impact. However, we find that these effects are not significantly different from the effects experienced by all firms in the economy. That is, the bank failures represent “bad news” for all firms in the economy, not only the customers of the failed banks. To the extent that these results for Japan are representative, they case doubt both on the importance of bank failures on bank customer relationships and on the meaningfulness of the results of studies from other countries that find significant adverse effects for loan clients, but do not test for effects for other firms.
In recent years, an extensive literature has developed that examines the costs and benefits of bank-customer relationships, typically defined as multiple interactions between banks or bank loan officers and their borrower customers, whereby the bank gathers valuable, often confidential information about the client.1 In the presence of asymmetric information between firms and investors, long-term banking relationships can provide Pareto-improving solutions to the financing of firms. Close ties between banks and customer firms can generate information that would otherwise be not available to investors in public markets; make it possible for banks and firms to write contracts with features that, among other things, are not feasible or enforceable in public markets or in one-time transactions; provide the flexibility and the ability to renegotiate contracts which would allow banks and firms to adjust to unanticipated shocks; allow banks to better monitor the assets and activities of clients, mitigating agency problems; certify the value of the firm to outside investors; and enable intertemporal smoothing of contract terms that enhance the value of contracts.
